Definition of Trading Securities in Balance Sheet
Trading securities are either debt or equity securities that a company buys to make a short-term profit by selling them in the near future. As the company’s intent for buying trading securities is not to hold for the long term, the securities must show positive movement in a short span of time and should help companies realize return quickly. In this topic, we are going to learn about Trading Securities in balance sheet.
The company must correctly identify trading securities. As the company wants to sell them quickly, the company doesn’t have a longer horizon to hold and wait for positive movement. Companies trade on securities on which they have expertise on. So the trading security will generally be from the industry similar to the company’s business line.
How to Report Trading Securities in Balance Sheet?
Trading Securities are reported in the Balance Sheet at Fair Value. Fair Value means the value that is running in the market. As trading securities are actively traded in the market, so the price of trading securities change daily in the market.
Trading Securities are purchased for short term gain, so the trading securities are part of Current assets in the Balance Sheet. Under Current Assets, another line item is added, called “Short Term Investment”. All the firm’s investments for the short term are recorded under “Short Term Investment”.Trading securities are included under the “Short Term Investment” heading in the balance sheet.
As the trading securities are recorded at Fair value in the Balance Sheet, so its price will change daily in the market. The gain or loss incurred from the security before actually selling it in the market is called Unrealised Gain/Loss. There is a separate line Item added under the Equity portion of the Balance Sheet to record the Unrealised Gain/Loss of the “Trading Securities in Balance Sheet”. The head under which unrealised gain/loss is recorded in the Equity portion is called “Unrealised Profit/Loss from the sell of Short Term Investment”. The Realised gain/Loss that is dividend income or interest income or profit/loss from sell of the security, is recorded in the Income statement.
Examples of Trading Securities in Balance Sheet
Company XYZ is a steel manufacturing company. The management of the company plans to diversify the income source and decides to invest some money in the equity market. The management thinks that “John Steel”, another steel company in the market, will perform well this year. If the performance of “John Steel” is actually good, then the share price of John Steel will increase. Considering this to be a short term gaining stock. Company XYZ decided to purchase the stock of “John Steel” for trading purpose. “John Steel” also gives a dividend of $4 per share. Company XYZ buys 100shares of John Steel at the rate of $50per share. Show journal entries when the stock price of John Steel will drop to $40, but company XYZ will not sell it.
As Company XYZ will buy John Steel’s stock, cash will go out, and Current Asset will increase. Company XYZ will be buying 100 shares of John Steel. The market price of John Steel is $50. So total investment will be (Share Price * Number of Shares) => 50 * 100 = 5,000
Investment in Trading Securities A/C …. Dr $5,000
To Cash A/C ……Cr $5,000
(Being Securities Purchased with Cash)
As Trading security is purchased with cash, so the cash account will be reduced, and the Investment in trading securities accounts will increase. As a cash account carries a debit balance, so crediting it will reduce the account’s balance. Similarly, investment in trading securities carries a debit balance, so debiting it further increases the account balance.
When the stock pays a dividend, this is considered as a realised return. So Income Statement will be increased with the dividend amount. Company XYZ is holding 100shares of John Steel. As John steel is giving $4 as dividend per share, so total dividend received by company XYZ will be (100 * 4 = 400)
Cash A/c ….. Dr $400
To Dividend Revenue A/C ….. Cr $400
(Being Cash received as a dividend)
The Dividend Revenue will be shown as Income in the Income statement.
The Recorded value of the trading security in the balance sheet is $50, so when the price of John Steel’s share drops to $40, then the fair value of the trading securities will change in the balance sheet, and the unrealised loss will have to be recorded in Equity. As the price dropped from $50 to $40, so there is an unrealised loss of $10 per share. Company XYZ is holding 100 shares, so total unrealised loss is 100 * 10 = $1,000
Unrealised Loss in Trading Asset A/C ….. Dr $1,000
To Investment in Trading asset A/C …. Cr $1,000
(Being unrealised loss from trading asset recorded)
When the trading asset sale is finally made, the adjustment will be reflected directly in the Income statement.
Some of the advantages are given below:
- Trading Securities help to realise short term gain for the company. At times there are good short term opportunities that arise in the market. Trading securities help companies to realise it.
- As trading securities are recorded at Fair value, so it helps to portray the true picture of the investment to the company.
- Trading securities are recorded as Current Assets, so the Current Ratio improves due to the addition of trading securities.
- The liquidity of trading securities is high as they constantly trade in the market. If there is any financial crunch in the company, the company can quickly liquidate the security.
Trading Securities in balance sheet are used as Current asset, so the liquidity problem is not there. Companies should be extremely careful while investing in trading securities, as trading securities are extremely volatile and can end up giving loss. Excess cash for a short term period can be used to purchase trading securities.
This is a guide to Trading Securities in Balance Sheet. Here we also discuss the definition and how to report trading securities in a balance sheet? Along with advantages. You may also have a look at the following articles to learn more –