This audio will introduce you to held to maturity securities, trading securities and available for sale securities. It will also enable you understand under which method are these securities accounted, how are these securities reported on the balance sheet, how are these securities classified in statement of cash flows. Also included is how are realized gains and losses, as well as unrealized gains and losses, reported on the income statement.
Investments, in which significant influence, over the operating or financial decisions of the investee, does not exist, are classified into held to maturity securities, trading securities, and available for sale securities.
Held to maturity securities includes, only the debt securities. They require, a positive intent and ability, to hold the securities to maturity. Held to maturity securities, are carried at amortized cost. Effective interest rate method, is used to account such securities. Thus, any unrealized holding gains and loss, are not reported. Note that the realized gains and losses, are included in earnings. Items included in earnings include, interest income, premium and, discount amortization. Held to maturity securities are classified on the balance sheet as, current or non-current, on individual basis. They are classified as investing activities, in the statement of cash flows. Premature sale of held to maturity securities may be considered as maturities if, any of the two conditions are met. The first condition, is that the sale, occurs so close to the maturity date, that the interest rate risk, is virtually eliminated. The second condition, is that the sale occurs after at least 85% of the principal, has been collected.
Trading securities include debt and equity securities, which are purchased and held principally for the purpose of generating gains, on current resale. Cost adjusted for fair value method, is used to account such securities. In cost adjusted for fair value method, carrying amount of securities is adjusted at financial statement dates, for subsequent changes in fair value. Thus, we can say that the trading securities are carried at fair value. Hence, both unrealized and realized gains and losses, are included in income. But note that the changes in current period, shall be reported as realized in the period of sale, only to the extent that such realized gains or losses, have been previously reported as unrealized. Dividends on equity securities held as trading securities, are recognized as income when dividends are declared. If dividends received, exceeds the cumulative earnings since acquisition, the excess dividend is accounted for as a liquidating dividend. Trading securities are reported on balance sheet as either current or non-current, as appropriate. On statement of cash flows trading securities can be classified as either under the operating activities or the investing activities, based on the nature and the purpose for which the securities are acquired. In case of debt securities classified as trading securities, which are reported at fair value, a special accounting treatment is required. The securities are carried at market value while the interest and amortization, are calculated using the effective interest method. Thus any unrealized gains or loss is actually, the difference between the fair value and amortized cost. Note that in such securities, both the interest revenue and the unrealized holding gains or losses, are included in current earnings.
Available for sale securities include debt and equity securities, which are not classified as either the trading securities or as held to maturity securities. These type of securities are not actively traded, nor are they necessarily held to maturity. All realized gains and losses which are previously recognized as unrealized holding gains and losses, are included in earnings. Also include in earnings is dividend and interest income. Cost adjusted for fair value method is used to account available for sale securities. Thus, carrying amount is adjusted at financial statement dates for subsequent changes in fair value. Unrealized gains and losses on available for sale securities, are calculated in the same manner as those on trading securities. However, such unrealized gains and losses are not recognized in income. Unrealized gains and losses on available for sale securities are reported as other comprehensive income. All the accumulated unrealized gains and losses on available for sale securities, are presented as accumulated other comprehensive income in stockholders’ equity. Available for sale securities are classified on balance sheet as current or non-current, on individual basis, based on management’s intent concerning the holding period. In statement of cash flow they are classified under investing activities.
Thus we can summarize that the trading securities and available for sale securities, are reported at fair value in the balance sheet and held to maturity securities are reported at amortized cost. Available for sale securities and held to maturity securities, may be classified as current or non-current on the balance sheet. Trading securities are grouped with current assets on the balance sheet. Unrealized gains and losses, are included in earnings in the period they occur in case of trading securities. They are excluded from earnings, in case of available for sale securities and held to maturity securities. In case of available for sale securities, unrealized gains and losses are included in other comprehensive income. Realized gains and losses are recognized as income in case of available for sale securities and held to maturity securities. Realized gains and losses which are not already recognized as unrealized, are recognized as income in case of held to maturity securities.