What is Trading Security?
Trading securities refer to either debt or equity securities that were purchased and are intended to re-sell for short-term profit. When a business or investor buys such securities for the purpose of resales, such securities are classified as trading securities.
As per ASC 948, any mortgage-backed securities held for sale required to reclassify as a trading security. In this category, the securities shall need to be carried out at fair value. Thus, the company that holds such securities shall assess the fair value and record unrealized gain or loss to increase or decrease the value of the securities in the Balance Sheet.
Presentation of Trading Securities
The trading securities are short-term in nature; therefore, we treat them as short-term assets and present them as current assets in the Balance Sheet. The unrealized gains or losses on trading securities as well as the realized gains or losses on sales of trading securities are included in the income statement as part of the continued operation.
Accounting for Trading Securities
As mentioned above, the trading securities are initial recorded at cost and subsequent at fair value. The difference between the cost and fair value shall need to be adjusted as unrealized gains or losses on trading securities. The dividend or interest income on those securities is treated as income from continued operation.
Below are the journal entries for unrealized gains or losses on trading securities:
When the fair value is less than cost (Losses)
| Account Name | Debit | Credit |
|---|---|---|
| Unrealized losses on trading securities | XXX | |
| Trading securities | XXX | |
| (To record unrealized losses on trading securities) |
When the fair value is higher than the cost (Gains)
| Account Name | Debit | Credit |
|---|---|---|
| Trading securities | XXX | |
| Unrealized gains on trading securities | XXX | |
| (To record unrealized gains on trading securities) |
Below are the journal entries for the realized gains or losses on trading securities:
When there is a gain on sales of trading securities
| Account Name | Debit | Credit |
|---|---|---|
| Trading securities | XXX | |
| Realized gains on trading securities | XXX | |
| (To record realized gains on sales of trading securities) |
When there is a loss on sales of trading securities
| Account Name | Debit | Credit |
|---|---|---|
| Realized losses on trading securities | XXX | |
| Trading securities | XXX | |
| (To record realized losses on sales of trading securities) |
In order to illustrate how the journal entry for unrealized gains or losses on trading securities, let’s go through the examples below.
Example 1: Unrealized Gains or Losses on Trading Securities
Let’s assume that ABC Co has four securities A, B, C, and D. In the table below show the cost of each security as well as the fair value as of 31 December 20X1:
| Security | Cost | Fair value | Difference |
|---|---|---|---|
| A | $2,000 | $1,500 | ($500) |
| B | $1,500 | $1,700 | $200 |
| C | $1,000 | $1,200 | $200 |
| D | $1,200 | $1,000 | ($200) |
| Total | $5,700 | $5,400 | ($300) |
From the table above, the total cost of the four securities is $5,700 while the fair value is only $5,400. The difference of $300 (negative) is the unrealized loss on trading securities. This shall need to be adjusted to present the securities at fair value in the statement of financial position.
Below is the journal entry to record the unrealized loss on the securities:
| Account Name | Debit | Credit |
|---|---|---|
| Unrealized loss on trading securities | $300 | |
| Trading securities – A | $500 | |
| Trading securities – B | $200 | |
| Trading securities – C | $200 | |
| Trading securities – D | $200 | |
| (To record the unrealized loss on trading securities) |
Alternatively, we can also adjust the fair value of the security portfolio through direct write-up or direct write-down as part of the asset valuation allowance account as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Unrealized loss on trading securities | $300 | |
| Valuation allowance | $300 | |
| (To record the unrealized loss on trading securities) |
The valuation allowance account is the contra account of the trading security account.
Example 2: Realized Gains or Losses on Trading Securities
Now let’s assume further that at the end of 31 December 20X2, the company sold two of its security portfolio as follow:
- Security B with the fair value of $1,700 as of 31 December 20X1 was sold at $1,800.
- Security C with the fair value of $1,200 as of 31 December 20X1 was sold at $1,000.
In addition, the below table summarizes the fair value of securities A and D as well as the additional securities E and F purchase during the year:
| Security | New cost | FV @ X1 | FV @ X2 | Difference |
|---|---|---|---|---|
| A | $1,500 | $1,700 | $200 | |
| D | $1,000 | $1,300 | $300 | |
| E | $1,200 | $1,200 | 0 | |
| F | $1,300 | $1,400 | $100 | |
| Total | $2,500 | $2,500 | $5,600 | $600 |
From the above table, we can record the journal entry for unrealized gains on trading securities as follows (assuming that the additional securities were already recorded at cost):
| Account Name | Debit | Credit |
|---|---|---|
| Trading securities – A | $200 | |
| Trading securities – D | $300 | |
| Trading securities – F | $100 | |
| Unrealized gains on trading securities | $600 | |
| (To record the unrealized gains on trading securities) |
Alternatively, we can record the journal entry of unrealized gains on trading securities under the valuation allowance method as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Valuation allowance | $600 | |
| Unrealized gains on trading securities | $600 | |
| (To record the unrealized gains on trading securities) |
For securities B and C, there is a separated journal entry to record the realized gains and losses on sales of trading securities as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Cash | $2,800 | |
| Realized losses on trading securities – C | $200 | |
| Trading securities – B | $1,700 | |
| Trading securities – C | $1,200 | |
| Realized gains on trading securities – B | $100 | |
| (To record the unrealized gains on trading securities) |
Conclusion
The accounting for trading securities includes the dividend or interest income from trading securities as well as the fair value adjustment and sales of trading securities. The gains or losses on the fair value adjustment are treated as unrealized gains or losses on trading securities while the gains or losses from sales of such securities are treated as realized gains or losses on trading securities.
