The investment portfolio is accounted for in accordance with FASB Statement No. 115 [Accounting for Certain Investments in Debt and Equity Securities]. The three types of securities portfolios as per the pronouncement are trading, available-for-sale, and held-to-maturity. This post shows how to account all type of the above investment portfolio. Enjoy!

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How to Account Trading Securities Portfolio?

Trading securities can be either debt or equity. The intent is to hold them for a short-term period [typically three months or less]. They are usually bought and sold to earn a short-term gain. Trading securities are recorded at market value with the unrealized [holding] loss or gain presented as a separate item in the income statement. Trading securities are reported as current assets on the balance sheet.

Example:

On 12/31/20X9, the trading securities portfolio had a cost and market value of $250,000 and $260,000, respectively. The journal entry to account for this portfolio at market value is:

[Debit]. Allowance = $10,000
[Credit]. Unrealized gain = $10,000

The allowance account has a debit balance and is added to the cost of the portfolio in the current asset section of the balance sheet, as follows:

Trading securities [cost]               = $250,000
Add: Allowance                            =     10,000
Trading securities [market value] = $260,000

The unrealized [holding] gain is presented in the income statement under “other revenue”. Available-for-sale securities may be either debt or equity. These securities are not held for trading purposes, nor is the intent to hold them to maturity. They are reported at market value. The unrealized [holding] loss or gain for the current year is presented under “other comprehensive income” in the income statement, whereas the accumulated [cumulative] unrealized loss or gain for all the years is presented in the stockholders’ equity section of the balance sheet as “accumulated other comprehensive income”.

 

How to Account Available-for-sale Portfolio?

Available-for-sale securities are usually presented as a noncurrent asset.

Example:

On 12/31/20X9 the available-for-sale securities portfolio had a cost and market value of $600,000 and $570,000, respectively. The journal entry to recognize the portfolio at market value is:

[Debit]. Unrealized loss = $30,000
[Credit]. Allowance = $30,000

The allowance account has a credit balance and is deducted from the cost of the portfolio in the noncurrent asset section of the balance sheet as follows:

Available-for-sale securities [cost]                  = $600,000
Less: Allowance                                                =    (30,000)
Available-for-sale securities [market value]    =  $570,000

 

How to Account Held-to-maturity Securities Portfolio

Held-to-maturity securities [typically long-term bond investments] are only debt securities because debt securities [not equity securities] are the only ones with a maturity date. They are reported as noncurrent assets. Held-to-maturity securities are presented at unamortized cost [initial cost adjusted for discount or premium amortization].

Note: Under FASB Statement No. 159 [The Fair Value Option for Financial Assets and Financial Liabilities], a company has the option, if it wishes, to measure held-to-maturity securities at fair market value. If this fair value option is selected, unrealized [holding] gains and losses will be presented separately in the income statement.

If securities are sold, a realized loss or realized gain is recognized. The realized loss or gain is presented in the income statement regardless of whether the portfolio is current or noncurrent. The same realized loss or gain on sale appears on the tax return.

The entry to record the sale of securities is:

[Debit]. Cash [proceeds received]
[Debit]. Loss
[Credit]. Securities [at cost]
[Credit]. Gain

If a balance sheet is unclassified, the investment security portfolio is considered noncurrent. A permanent decline in value of a particular security is immediately recognized with a realized loss being booked shown in the income statement even if it is a noncurrent portfolio. The investment account is credited directly. The new market value becomes the new cost basis, which means it cannot later be written up.

A permanent decline in market price of stock may be indicated when the company has several years of losses, is in a very weak financial condition, and has issued a liquidating dividend. For example, if the company sells some of its major divisions and distributes the proceeds to stockholders, a write-down of the investment may be appropriate.

Example:

In a long-term investment portfolio, one stock in ABC Company has suffered a permanent decline in value from cost of $6,000 to market value of $5,000. The entry is:

[Debit]. Realized loss = $1,000
[Credit]. Long-term investment = $1,000

The new cost now becomes $5,000 [the market value]. If in a later period, the market value increased above $5,000, the stock would not be written up above $5,000. If market value of a portfolio significantly declines between year-end and the audit report date, subsequent event disclosure is needed.

There is inter-period income tax allocation with investments because of temporary differences. A deferred tax arises because unrealized losses and gains on securities are not recognized on the tax return.

 

 
Example:

On 1/1/20X8 Lie Dharma Inc. buys long-term securities of $480,000 plus brokerage commissions of $20,000. On 5/12/20X8 a cash dividend of $15,000 is received. On 12/31/20X8 the market value of the portfolio is $490,000. On 2/6/20X9 securities costing $50,000 are sold for $54,000. On 12/31/20X9 the market value of the portfolio is $447,000. The journal entries follow:

On 1/1/20X8:

[Debit]. Long-term investment = $500,000
[Credit]. Cash = $500,000

On 5/12/20X8:

[Debit]. Cash = $15,000
[Credit]. Dividend revenue = $15,000

On 12/31/20X8:

[Debit]. Unrealized loss = $10,000
[Credit]. Allowance = $10,000

The balance sheet presentation of the long-term investments is:

Long-term investments  = $500,000
Less: Allowance              =    (10,000)
Net balance                    =  $490,000

On 2/6/20X9:

[Debit]. Cash = $54,000
[Credit]. Long-term investments = $50,000
[Credit]. Gain = $4,000

On 12/31/20X9:

[Debit]. Allowance = $7,000
[Credit]. Unrealized loss = $7,000

The balance sheet presentation of the long-term securities is:

Long-term investments = $450,000
Less: Allowance             =       3,000
Net balance                    = $447,000

If instead market value was $435,000, the entry would have been:

[Debit]. Unrealized loss = $5,000
[Credit]. Allowance = $5,000

If instead market value was $452,000, the entry would have been:

[Debit]. Allowance = $10,000
[Credit]. Unrealized loss = $10,000

 

If two or more securities are purchased at one price, the cost is allocated among the securities based on their relative fair market value. In the exchange of one security for another, the new security received in the exchange is valued at its fair market value.

Example:

Preferred stock costing $10,000 is exchanged for 1,000 shares of common stock having a market value of $15,000. The entry is:

[Debit]. Investment in common stock = $15,000
[Debit]. Investment in preferred stock = $10,000
[Credit]. Gain = $5,000

 

There is a memo entry for a stock dividend indicating that there are more shares at no additional cost. In consequence, the cost per share decreases. A stock split increases the shares and reduces the cost basis proportionately. There is a memo entry. Assume 100 shares costing $20 per share were owned. A “2 for 1 split” results in 200 shares at a cost per share of $10. Total par value is still $2,000.