Trading Securities - Online Tutor, Practice Problems & Exam Prep

Trading securities are short-term investments expected to be sold soon, classified as current assets on the balance sheet. They are initially recorded at cost and subsequently measured at fair value, with unrealized gains or losses reflected on the income statement. For example, if a company purchases shares and later receives dividends, the cash increases, and dividend revenue is recorded. Upon selling the investment, realized gains or losses are determined by comparing the selling price to the last recorded fair value, impacting both cash and equity.

Purchasing Trading Securities

Alright, now let's go through all the details and journal entries for trading securities. So remember, a trading security is a short-term investment that we expect to sell within the near term through active trading, right? We're going to actively be trading these securities. So, trading securities are going to earn income from dividends when we receive dividends, right? Dividends received and the changes in fair value. Okay? So remember, fair value is the market price of the investment. So if the market price of the investment goes up or down, well, we're going to take gains or losses based on those changes in fair value. Okay? So remember, when we talk about the classification, well, this is on the balance sheet. The balance sheet classification, these are going to be current because we're planning on selling them in the short term. We're planning on getting rid of them soon, so they're going to be current assets and the initial measurement, we're always going to measure our investments at cost initially and then we're going to adjust them accordingly based on the type of investment. So the subsequent measurement for a trading security, keep doing so far, is at fair value. Okay? We are going to show on our balance sheet later on, after we've purchased it, we're going to adjust the value to fair value and the unrealized gains or losses. So unrealized means we have not sold, right? We have not sold the investment yet. These are going to show up on the income statement, so those changes in fair value those gains or losses are going to show up on the income statement, even before we sell the trading security.

So let's go ahead and do our cost journal entry when we first purchase the trading security. So let's follow an example here. On November 1st year 1, ABC Company purchased 500 shares of XYZ Company common stock at a price of $60 per share. ABC Company expects to sell the securities in the near future. So they told us it's in the near future; they didn't specifically say it's a trading security, but we can assume it's a trading security because of this terminology. Okay? So we purchased 500 shares of stock at $60 per share. Well, we want to find the total amount of our investment. How much money did we spend? Well, the cost is going to equal the 500 shares that we bought times the $60 per share that we paid, and that's going to come out to $30,000, right? We spent $30,000 on this stock, so that's the number that we need in our journal entry. We have to create an asset for the investment of $30,000, and we paid for it in cash. So the journal entry, we're probably used to by now, is we're going to debit our investment. We're going to debit what we purchased, so it's going to be an investment, and I like to be a little bit more transparent. So I always say something like investment in trading securities, but we'll say investment in TS for trading securities, right? Investment in TS, that's our asset that we just created, and that's going to be a debit for $30,000, and the other side of this is the cash, right? We paid cash, so we need to get the cash off of our books with the credit, and that's going to be for $30,000 as well, right? The amount of money that we spent on the investment. So all we did was trade one asset for another, right? We spent cash to get an asset, so we're going to have our investment account increase by $30,000 and our cash decrease by $30,000. 1,000. So that's just our total assets are going to stay the same; it's just which assets we have. Nothing too crazy there. Let's pause, and then we'll try the next journal entry.

Dividend Revenue for Trading Securities

Alright, so the next journal entry that we may need to make is an entry for the dividend revenue. If we receive any dividends from our investment, that's going to be revenue to our company. So, let's check out an example. On December 10th, year 1, XYZ company declared and paid a dividend of $1 per share. So, in the previous entry, we had purchased 500 shares, right? We had purchased 500 shares, and these 500 shares are going to receive a dividend of $1 per share. So, a $1 per share dividend means we're going to receive from the 500 shares times $1, well, we're gonna earn $500 from this investment. And this is going to be received in cash, right? They paid a dividend of a dollar per share, so each share is going to receive $1. So, that means we're going to receive cash, so our debit is going to be cash for 500, and our credit here is going to be to dividend revenue. Okay? So, this is revenue to the company. We bought this investment to try and earn money and this is us earning that money through this dividend revenue.

And I want to make a quick point about dividend revenue because it's not our typical revenue, right? Our company is not necessarily like an investment bank or some sort of brokerage where we're trying to make money on investments like this. This is kind of a side thing we're doing with some extra cash. So, this is not our operating revenue, okay? So, maybe this company is a t-shirt company that sells t-shirts, well, we would show our revenue from selling t-shirts at the top of our income statement. This revenue would be shown after our operating section. It would be shown in, like our other, maybe like our non-operating expenses and non-operating revenues, gains and losses, so this would be shown after our operating section of our income statement, okay? So, it's not included with all our revenues, where we calculate gross profit and everything like that. So, it's still revenue to the company, it's just not our core business. We're not an investment company, this is just a side thing that we're doing. Cool? So, this isn't too complicated, we got some cash, we earned some dividend revenue, so let's go ahead and put it in here. Cash went up by $500 and we earned revenue. We earned that dividend revenue that's going to go to our income statement and that's going to increase our equity by $500 as well. Cool? So that's about it for our dividend entries. We just have to find out what's the total amount that we received and that's what we're going to receive as cash and put into our journal entry. Cool? Let's go ahead and move on to the next journal.

Unrealized Gains and Losses for Trading Securities (1)

So we've talked about unrealized gains and losses a little bit so far, and we're going to have to adjust our value of the investment based on the fair value, right? And this is going to happen on the reporting dates. So, if, for example, we bought this investment in November, and now it's December 31st, and we're about to release our balance sheet, well, we have to update the value of the investment based on the balance sheet date for these trading securities. Okay? And I want to make a note because this is the main difference between a trading security and an available-for-sale security, which is where we put the unrealized gains and losses. For the trading securities, they're going to show up on the income statement. So, nothing too crazy when it comes to trading securities. It just shows up on the income statement like we're used to, okay? So, when do we show a gain or a loss? Well, we show a gain if the price has increased since we bought it, right? We bought it at a lower price, and now it's worth more; well, we have a gain. And the opposite if we bought it at a high price, and it fell, that would be a loss. So if the market price of the investment has increased since the last valuation, then we have an unrealized gain, okay? Because at this point, why we say it's unrealized is that we haven't sold the investment. We are still holding it. We haven't realized this gain. Realizing it is when we sell the investment, and we actually have this gain happen because we no longer own the investment. It's unrealized when it's just a change in value while we're still holding it. Think about maybe some stock that you've bought in the past, maybe you're a savvy investor, and you've bought some stock and you're just sitting on the stock. You've seen that it's gone up in value, but you haven't sold it yet. Well, you have unrealized gains on that investment. Okay? So if the market price has decreased, well, that's the opposite, right? If the market price has decreased since the last revaluation, and I say last revaluation because this might not be the first time that we're revaluing it to fair value. We're going to be constantly doing this every time we release financial statements, okay? So in this case, we would have an unrealized loss. So we're going to have to keep track of what the value of the investment is and keep track of those changes in the value. Okay?

So let's do an example here. On December 31st, year 1, XYZ Company's stock had a market value of $65 per share. So the market value of the stock had increased, right? We had originally purchased 500 shares at a price of $60, right? And that came out to 30,000, which was our original investment. But now those 500 shares are no longer worth $60. If we chose to sell those investments today, we would get $65 per share, not just $60, right? So there's an unrealized gain in this situation. The price has gone up since we purchased them. So we have to find out what the amount of the unrealized gain is. It's not going to be the total amount of what it's worth now, it's going to be the change from what it was worth before to what it's worth now. So let's see what it's worth now. 500 shares multiplied by $65, right? That's what it's worth now. Let me get out my calculator. No need to do difficult math. 500 times 65, that comes out to 32,500, okay? 32,500 is what it's worth now. So clearly, we have an unrealized gain, right? This investment has increased in value, but it's not like we received cash or anything. There's no receipt of cash. So what we want to do is adjust the value of the investment. Right now the investment is sitting on our books for 30,000, well, we want to change it so that it shows that the value is 32,500. So what we're going to do is notice that the difference between these two, the difference between them is 2,500, right? It was sitting on our books for 30,000, but we want it to say on our books that it's 32,500. So this change in the fair value, that's what we want to put into our journal entry. So what we're going to do is debit the investment. So remember, we had our investment in trading securities. This is the asset that we created when we first purchased the investment. In our first journal entry, we had debited the investment for 30,000 because that's what we paid for it. Well, now we're debiting it again to increase the value up to the fair value. So we're going to debit it by 2,500, okay? And the credit in this situation, well, the credit is going to be the unrealized gain. So remember, we're going to have an unrealized gain and this unrealized gain, I'm going to put it here that it goes to the income statement. Right? Because we're going to have a situation when we deal with available-for-sale securities that they don't go to the income statement; they go to other comprehensive income. But for trading securities, it's just on the income statement, and it would show up generally in that same section where we show dividend revenue after our operating, right? This is a non-operating thing again because this isn't part of our core business. This will show up after our operating income in that other section where we show other things that we're involved in. Cool? So we're going to increase the value of our investment, so our assets go up by 2,500, and we're going to have an unrealized gain, and this is part of equity, right? This is going to our income statement and it's increasing our income. So the unrealized gain is going to increase our income which increases our equity. Alright, so we're going to have an increase in assets, an increase in equity, and that's our journal entry. We need to find what the change in the fair value was and we're going to have to adjust our investment account to that change in fair value. Cool? Alright. Let's pause here and then we'll continue with these T accounts down below.

Unrealized Gains and Losses for Trading Securities (2)

Alright, so let's summarize what we've done so far in these in this T account here for the investment. So we're going to have the investment in trading securities T account. And over here, we'll deal with our unrealized gains and losses just to see where the other side of this is going on. Okay? So the investment in trading securities, remember when we purchased it in our first journal entry, we purchased them for $30,000, right? We purchased them for $30,000 in cash, so it had a balance, we had a debit balance of $30,000, and then in the previous $25,100, right, because of the change in fair value and that entry was a debit to the investment and a credit to the unrealized gain or loss and this was on the income statement here, right, this unrealized gain, and loss was on the income statement. So we showed on our income statement this unrealized gain, and we increased our investment by that amount. So now let's see what happens in our next journal entry. So now it's the end of the next year. Let's say we've held this investment for a while now, it doesn't really matter. It's still a trading security even though we've ended up holding it longer than we expected. This is just for the example. On December 31st, year 2, XYZ company stock had a market value of $50 per share. So notice what's happened here in our T account. At the end of year 1, so 12/31 year 1, we had a value in the account of $32,500, right? That was the fair value as of that date, but now at the end of year 2, the value has dropped to $50 per share, right? At this $32,500 valuation, that was at a value of $65 per share, but now the value has dropped. So we're going to have an unrealized loss, and we need to change the fair value of our investment down to that fair value, okay? So this is where it gets tricky is where it kind of stacks on top of each other. Right now, we're sitting at a value of $32,500. We need to get that value down to the $50 per share. So let's see what our investment would be at $50 per share. So we bought 500 shares initially times the $50 per share. So let's see what that comes out to you. 500 times $50 per share, well, that comes out to $25,000, right? Our investment is now worth $25,000, but it's sitting on our books up here in our T account for $32,500. So we need to change the value to this $25,000 by decreasing it from the $32,500 value, and we have to see what's the difference here. Well, it's going to be a decrease of $7,500, right? And that's the change right there. Let me do it in a different color. Right here is the change in fair value, right? It was sitting on our books. Notice, we're not doing it from the original purchase anymore. We had already adjusted it to this new value of $32,500. Well, now we have to reduce it from that new value, right? From $32,500 is where we have to reduce it now down to $25,000. So what we need in our journal entry is a reduction to the investment account, right? So when we wanted to increase the investment account, we were debiting it, now we want to decrease it with a credit. So our credit in this case is going to be to the investment in trading securities, and that's going to be for the $7,500 change in the fair value. What's going to be the debit in this case? We haven't sold the investment yet, right? We haven't realized any gains or losses. We have an unrealized loss, right? Our investment has lost value, but we haven't sold it yet. So it's an unrealized loss, and when we're dealing with trading securities, where does this unrealized loss show up? On the income statement, right? And that's gonna be the same amount, $7,500. So let me get out of the way and we'll finish this up. So our assets here, our investment asset has decreased by $7,500, and our equity. We took a loss that's gonna lower our income and lower our equity. This unrealized loss is lowering our equity by that same $7,500, okay? So now if I go back to my T accounts up here, let me come back in. Let's go back to our T accounts and let's fill in, what just happened. So now we had a decrease in investment, right? We credited the investment account, and that's what's going to show up here in our T account. We're going to decrease our investment by $7,500, and that's going to get us to our new value as of December 31st year 2. We're going to have the correct value of $25,000 at the fair value of the investment, right? They're only worth $50 per share, so we want to show on our balance sheet that value of $25,000. So in our year 1 income statement, we would have shown this $25,100 gain, and in our year 2 income statement, we would show a $7,500 loss, right? That's in the year 2 income statement, we would have this loss for $7,500. Cool? So the main thing here is to keep track of your fair value, especially if multiple periods are going on. Generally, when you deal with this in your class, it's just going to be one change in fair value, but I just wanted to show you how this progresses, right? I wanted to give you the full picture of how this can happen and, this is what you do. You keep track of the fair value, and change in fair value is what goes into your journal entry. Okay? So the change in fair value from the last revaluation, is what needs to go into your journal entry. Cool? Let's go ahead and wrap up the trading securities with a few more journal entries.

Realized Gains and Losses on Sale of Trading Securities

All right, so now we finally reached the day when we sell the investment. We're going to have a realized gain or loss on the date of sale. Okay? And these realized gains or losses will always show up on the income statement. So, it's only when we're dealing with the unrealized gains or losses that there's going to be different treatment for trading securities and available-for-sale securities. But all securities, when we have a realized gain or loss, that's going to show up on the income statement, okay? So what we have to take into account is what was the last valuation that we did of the stock, right? Because the investment is going to be sitting on our books based on our last valuation, right? We might have bought it at a certain cost and then we would have written it up or down based on the fair value changes. So the last time we adjusted the books, that's what it's going to be sitting on our books for, right, is that last revaluation. And we have to compare the selling price to that last revaluation. So if the selling price is higher than the last revaluation, then we're gonna have a realized gain. And the opposite, if the selling price is lower than the last revaluation, well, we're gonna have a realized loss. That should make sense, right? If we sell it for less than what it’s on the books, it's a loss. If we sell it for more than what's on the books, it's a gain. Cool? So let's go ahead and finish here.

On February 12th, year 3, ABC Company sold its investment in XYZ stock at a market value of $70 per share. So if you remember in our T account on the previous page, we ended in a situation where we had 500 shares sitting on our books for $50 per share at a price of $25,000 total, right? There was a $25,000 total sitting in the investment account for the last fair value revaluation. But now we're finally selling the stock. We're selling the stock at $70 per share. So 500 times the $70 selling price, well, 500 times 70 that's gonna come out to $35,000, right? So 500×70=35000. We sold something that was worth $25,000 to us, right? We sold it for $35,000, it was sitting on our books for $25,000. So the change here was $10,000, right? And this $10,000, this is the realized gain that we have in this situation, right? Because the price had gone up, well we obviously have a gain. We sold it at a realized gain of $10,000. Okay? So remember, it's the change in the fair value, not the total amount we sold it for. Even though we're gonna receive $35,000 in cash, well we have to get the investment off of our books for $25,000 and the remainder is a gain. So the trick here with this journal entry is that there's a few moving parts. This right here, the selling price, this is going to be the cash that we receive, right? We're going to receive $35,000. We sold 500 shares at $70 per share. Well, we're going to receive $35,000, but we have to get the investment off of our books and it was sitting at this $25,000 on our books, so we need to get rid of that and then the remainder is the gain, the $10,000 difference. So let's go ahead and do that. We know that we received cash of $35,000 because we sold the investment for $35,000. Now we have to take the investment off of our books that is sitting on our books for $25,000 investment in trading securities, $25,000 and the difference between the 2, right? The difference between what we sold it for and what it was on our books, that's the gain, right? The gain that's going to our income statement. So we would say gain on sale of investment. So notice since now it's a realized gain, we don't say realized gain, you could say realized gain but this is generally the way you're gonna say it. Gain on sale of investment. Let me move these numbers over. So our debit was $35,000 to cash, credit $25,000 to the investment, and then we have the $10,000 gain that's going to our income statement. And, again, this gain, it's still non operating. Right? It's not gonna go into our operating section of our income statement where we show our actual operations. This is going to go after our operating income in that other section where we show other activities that we do such as investments. Okay? So that's it here. This is what happens if we sell it at a gain. Let's go ahead and fill this in. We received cash of $35,000, so our assets go up by $35,000, but our assets also go down by $25,000, right? So we have a net increase in our assets of $10,000 from this, extra cash and we have this gain on the sale, that goes to our equity. This increases our income, that increases our equity, so our equity goes up by $10,000, our assets go up by a net amount of $10,000 as well. Cool? Alright, so that's an overview of all the journal entries that we'll make with trading securities. Let's go ahead and do a practice problem here.

Reset Company held investments in trading securities with a fair value of $180,000 as of December 31, 2017. Reset had originally purchased the investments at a price of $152,000 on January 1, 2017. What is the appropriate amount for Reset to report for these investments on its December 31, 2017 balance sheet?

• A. $180,000
• B. $152,000
• C. $28,000 gain
• D. Cannot be determined

Chitty Company often has excess cash on hand to invest. Suppose that Chitty purchases 640 shares of Bang Company common stock at a price of $35 per share. Chitty expects to hold the stock for under three months and then sell it. This purchase occurred on December 9, 2018. As of December 31, the market price of Chitty stock had increased to $41 per share. Chitty's journal entry on December 31, 2018 related to the investment in Bang Company stock would include:

• A. A debit to Unrealized Gain on the Income Statement for $3,840
• B. A debit to Investments on the Balance Sheet for $3,840
• C. A credit to Unrealized Gain in Other Comprehensive Income for $3,840
• D. A debit to Cash for $3,840

Here’s what students ask on this topic:

What are trading securities and how are they classified on the balance sheet?

Trading securities are short-term investments that a company expects to sell in the near term through active trading. They are classified as current assets on the balance sheet because the company plans to sell them soon. Initially, trading securities are recorded at cost, and their value is subsequently adjusted to fair value. Any unrealized gains or losses from these adjustments are reported on the income statement, reflecting changes in the market price of the investment.

How are unrealized gains and losses on trading securities reported?

Unrealized gains and losses on trading securities are reported on the income statement. These gains or losses arise from changes in the fair value of the securities while they are still held by the company. For example, if the market value of a trading security increases, an unrealized gain is recorded, and if it decreases, an unrealized loss is recorded. These adjustments are made at each reporting date to reflect the current market value of the securities.

What is the journal entry for purchasing trading securities?

When purchasing trading securities, the journal entry involves debiting the investment account and crediting cash. For example, if a company buys 500 shares of stock at $60 per share, the total investment is $30,000. The journal entry would be:

Debit: Investment in Trading Securities $30,000

Credit: Cash $30,000

This entry reflects the acquisition of the investment and the corresponding decrease in cash.

How do you record dividend revenue from trading securities?

To record dividend revenue from trading securities, you debit cash and credit dividend revenue. For instance, if a company receives a $1 per share dividend on 500 shares, the total dividend revenue is $500. The journal entry would be:

Debit: Cash $500

Credit: Dividend Revenue $500

This entry reflects the receipt of cash from dividends and the recognition of dividend revenue on the income statement.

What is the process for adjusting the fair value of trading securities at the end of the reporting period?

At the end of the reporting period, the fair value of trading securities is adjusted to reflect current market prices. If the market value has increased, an unrealized gain is recorded; if it has decreased, an unrealized loss is recorded. For example, if the fair value of a security increases from $30,000 to $32,500, the journal entry would be:

Debit: Investment in Trading Securities $2,500

Credit: Unrealized Gain on Trading Securities $2,500

This adjustment ensures that the balance sheet reflects the current fair value of the investment.