What are Trading Securities?
Definition: Trading securities are a type of securities that companies hold with the hopes of selling them in the near-term at higher prices. They can either be equity or debt and the intent of holding this type of securities is to make money, especially for liquidity purposes.
Every business strives to achieve some level of liquidity that is supposed to help it maintain its operations. Companies are particularly keen on making sure that they are prepared in case they end up being cash strapped. Trading securities are some of the tools that firms use especially for liquidity purposes.
Trading securities have a fast turnover and they are traded in the open market where traders aim to make profits out of them. They are one of the ways in which companies make quick cash especially when they perform well in the market.
Trading Securities Examples
There are two main types of trading securities: stocks and bonds.
Stocks
Stocks are units of ownership in a company and they are traded in the open market in the case of publicly listed companies. Companies their stocks to the general public as a means of securing more capital for their business operations. It also allows shareholders to participate in the company’s performance and also to benefit from the company’s growth.
Bonds
Bonds are debt instruments which a company uses to secure capital especially if it needs cash urgently. Bonds are considered low-risk investments because they are guaranteed and have a fixed return. They also come with a predetermined expiry date, upon which the company pays back the investor their money with interest.
Characteristics of trading securities
- They are usually traded by companies since the securities are issued within the same industry in which the firm operates.
- They are held for short durations, usually 1 to 3 months. This means they have some reasonable level of liquidity which is good for a firm in case it runs into situations where it is in urgent need of cash.
- Companies trade them when they expect trading securities to gain value. The idea behind this type of investment is to use the markets to continue adding value to the company even through investments.
How are Trading Securities Recorded in Accounting?
Trading securities are actively involved in a company’s financial dealings and so they have to be recorded in the books of accounts. In this case, they are recorded in the balance sheet. Also, they are usually reported at the prevailing market value. This approach is aimed at demonstrating the impact of the economic impact of those trading securities. For example, the company will likely sell the assets within three months and so recording their prevailing value highlights the gains that the company would make if it were to sell the trading assets at the time that their value is recorded.
The fact that the trading instruments have to be recorded at the prevailing market value means that the company that owns the shares has to record the changes in the market prices every day. The changes are recorded in a temporary account before they are put in the income statement. Also note that the value of the trading securities can go either way, especially for stocks because the price of the stocks can drop overnight or in a matter of hours, thus losing previous gains.
Once the bonds or stocks are sold, the temporary account is reconciled to establish whether there has been an overall profit or loss. The results for the specific period are then recorded in the company’s income statement.
How are trading securities reported on the income statement?
Company accountants usually record the outcome of the sale, whether a loss or gain in the income statement. Note that this happens after the trading instruments are sold and they cannot be recorded before then because there would be a likelihood of price changes since the market conditions are constantly changing. They are recorded under operating income as “loss or profit on Sale of Trading Securities.”