3.4. Change in market price of the marketable securities

At the end of an accounting period, companies determine the market price (i.e., fair value) of trading and available-for-sale securities. If the market price is different from the book value, unrealized gains or losses should be recognized to reflect the fair value of the securities. The accounting treatment of trading and available-for-sale securities is different in this case:

Change in fair value of trading securities

Let’s assume that on December 31, 20X2 the stock of company XYZ is trading for $35 per share while Busy Company purchased the shares for $30 each (i.e., book value). The company holds all 30 shares. To adjust the value of the investment, Busy Company should make the following journal entry (i.e., ($35 - $30) x 30 shares):

If XYZ shares were trading below $30, the company would recognized an unrealized loss on the trading securities. In this case, the company would debit the Unrealized loss on trading securities account and credit the Trading securities account.

Because the investment in XYZ shares is considered trading securities, the company intends to sell these shares in the near term. As the result, the unrealized gain (loss) affects current accounting period and is reported in the income statement. Only the changes in the fair value of trading securities are reported on the income statement in the current period (i.e., affect net income).  The balance sheet value of the trading securities is also adjusted and is carried forward into the future accounting period so realized or unrealized gains (losses) can be recognized in the future. For instance, companies might use a contra-asset Market adjustment account to record unrealized gains (losses) on trading securities. In our example, Busy Company would debit Market adjustment-trading securities instead of Trading securities account. The Trading securities account, in such a case, would be reported at the historical cost.

Change in fair value of available-for-sale securities

Let’s assume that on December 31, 20X2 the stock of company DEF is trading for $18/share. Busy Company sold 5 shares in December and held 15 shares at the end of the accounting period. On December 31, 20X2 the company should record the unrealized loss (i.e., ($18 - $20) x 15 shares) on available-for-sale securities:

If the DEF stock was trading above $20 on December 31, 20X2 Busy Company would debit Available-for-sale securities and credit Unrealized gain on available-for-sale securities. Unrealized holding gains and losses on available-for-sale securities in the current period are reported as other comprehensive income rather than income from continuing operations. The changes in the fair value of available-for-sale securities are reported as a separate component of stockholders’ equity: they are reported as accumulated other comprehensive income in the stockholders’ equity section on the balance sheet (below retained earnings).

Let’s assume that on March 1, 20X3 Busy Company sold all 15 shares of DEF Company for $19 per share. The company would need to take off the books available-for-sale securities (DEF Company) and unrealized price decrease on available-for-sale securities. Recall that the book value of DEF stock as of December 31, 20X2 was $18 share. Hence, Busy Company would carry its investment in DEF Company at $270 (i.e., $18 x 15 shares) on March 1, 20X3.

Also, the company would recognize cash received on the sale of the securities (i.e., $19 x 15 shares). Realized gain (loss) on the sale of available-for-sale securities is the plug-in value. In our example, Busy Company would make the following journal entry on March 1, 20X3:

As we can see from the table above, the realized loss on available-for-sale securities is the plug-in value: the difference between $300 credit (i.e., $270 + $30) and $285 debit (i.e., cash). The company had to take-off the unrealized loss previously recognized in order not to count the loss twice (i.e., both unrealized and realized).

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