Three classifications define the intent of the investor with respect to how long the investor intends to hold a particular investment, whether it be a trading security, available-for-sale security, or held-to-maturity security. These three classifications are accounted for under the cost method. The maturity date of each investment determines the balance sheet classification as short-term or long-term.
A trading security is usually a stock or bond purchased with the intent of active trading or near-immediate sale, for short-term investment purposes only. Because of the short-term intent associated with trading securities, fluctuations in value are regularly measured and adjusted to fair value at financial reporting dates. Any resulting gain or loss of value from the investment is recorded as an unrealized gain or loss and reported as net income. Once the asset is actually sold, a realized gain or loss will be recognized, and the unrealized gain or loss does not remain on the books.
Consider the balance sheet presentation of Doug Company's trading investments as of the balance sheet date of December 31, 2018.
Doug Company's Trading Investments on the Balance Sheet
| Investment | Current Carrying Amount | Fair Value on 12/31/18 | Unrealized Gain (Loss) |
|---|---|---|---|
| Mack Company | $10,000 | $11,500 | $1,500 |
| Blue Company | $5,000 | $4,500 | ($500) |
| Sun Company | $26,200 | $27,300 | $1,100 |
| Total Trading Securities | $41,200 | $43,300 | $2,100 |
The entire group of trading securities is reported at their aggregate fair market value as of the balance sheet date. The balance of total trading securities in the current asset section of the balance sheet on December 31 is increased by $2,100 to $43,300. A valuation offset of $2,100 will be recognized as an unrealized gain.
An investment that is an available-for-sale security is a short-term or long-term asset that is usually marketable, though there is no clear intention to sell it. Valuation is adjusted to fair market value. Securities held as available-for-sale (debt or equity securities) must be recorded based on their fair values under GAAP guidelines. Unrecorded gains and losses are reported as part of other comprehensive income.
An investment classified as a held-to-maturity (HTM) security is a bond or note with features that may make them less liquid than others and are intended to be held to defined maturity dates. Held-to-maturity investments are reported at amortized cost, that is, the carrying amount after any premium or discount is calculated at issue. If any principal reductions have occurred, those reduce the amortized cost as well.
For example, if Doug Company purchases $100,000,000 of 10-year bonds at $98,000,000 (with a coupon rate below market interest) on December 31, 2018, an entry would be made.
Held-to-Maturity Bond Purchase Journal Entry
| Date | Account | Debit | Credit |
|---|---|---|---|
| 12/31/18 | Investment in Bonds | $100,000,000 | |
| Cash | $98,000,000 | ||
| Discount on Bonds | $2,000,000 |