What Is a Held-For-Trading Security?
A held-for-trading security is a debt or equity investment acquired by investors with the intent to sell within a short period, typically within one year. Investors hope for the value of the security to appreciate during that time, allowing them to sell it for a profit.
Due to accounting standards, companies must classify investments in debt or equity securities at the time of purchase. Other classifications aside from held-for-trading include held-to-maturity and available-for-sale.
Key Takeaways
- Held-for-trading securities are bought for short-term profit.
- Gains or losses from these securities must be reported on the balance sheet during the holding period.
- Recognized as current assets on the balance sheet.
- Reported at fair value, with unrealized gains or losses reflected in earnings.
- Securities must be classified as held-for-trading, held-to-maturity, or available-for-sale when purchased.
Understanding a Held-For-Trading Security
Held-for-trading securities are purchased to generate short-term profits through price fluctuations when sold in the near future. They are classified as short-term assets and their value is reported at fair value, with unrealized gains and losses included as earnings.
The initial cost basis of these investments is their fair value at purchase. Over time, market values can change, and unrealized gains and/or losses must be recorded as earnings by comparing the fair market value to the original cost basis.
Since they’re expected to be sold within a year, held-for-trading securities are classified as current assets. Their cash flows are considered operating cash flows, unlike held-to-maturity and available-for-sale securities, which generate investing cash flows.
Held-For-Trading Security and Fair Value Adjustment
Any shifts in the fair value of a held-for-trading security necessitate an accounting adjustment, updating the security’s previously reported value on financial statements.
This is done by adjusting the value in the “securities fair value adjustment (trading)” account – a sub-account of the trading securities asset account. A debit or credit indicates an increase or decrease, respectively, in fair value.
These changes result in unrealized gains or losses to earnings. An increase in value requires a debit in the securities fair value adjustment account and a corresponding credit to record the unrealized gain, adding to net income. Conversely, a decrease results in a credit and a corresponding debit to record the unrealized loss, reducing net income.
Example of a Held-For-Trading Security
Imagine that Company ABC buys a security intending to sell it within a year. Initially recorded at purchase cost, this security had a fair value of $1,000 the last time it was reported.
Assume that nine months later, this security now has a market fair value of $1,200. Accounting standards oblige the company to record the updated fair value in its quarterly reports. This necessitates a $200 debit to the securities fair value adjustment account.
With the initial value of $1,000, the trading security’s account ends the period at a fair value of $1,200. The $200 is recorded as an unrealized gain impacting earnings.
In the subsequent period, the fair value adjustments will start from the new value of $1,200.
Related Terms: fair value, unrealized gains, trading security, investment, current assets.
