Question

Why does the accounting for trading securities differ from that of other assets like buildings or inventory?

Answer 1

In accounting, the recognition and treatment of any item is based on the motive behind the transaction. For instance the building a manufacturing company holds, and a building (inventory in this case) owned by real estate company is accounted differently. This is because the real estate company is holding the building for resale, where as the manufacturing company does not have such motive. This is the same case with trading securities. Trading securities is the broad term for investments in the nature of share,bonds,debts etc. which is held by the company for selling them in the near future. These are not held for collecting interest or maturity value, but to make short term profit through sales of these investment. Thus these investments are reported at their fairvalue (ie. is the market value, because it is soon to be sold at market value). Any changes in value of these investments are recognised as unrealized gain or loss under shareholders equity section. Now on sale of these investment, the unrealized gain/loss which is now realized is transferred to income statement. Because it was an operating income for the company. Now, the case of accounting for building is completely different from this, buildings are not held for sale, so it is not necessary to report them at fair value (ie. is the market value) because it is not held for sale at market value soon. Again any gain or loss on sale of building will not contribute operating income, as these gains are extraordinary and not part of normal operating transactions. Inventory is held with the same intention of trading securities, but accounting is different due to the reasons following. Inventory is accounted at lower of lower of cost or net realizable value. The lower criteria is to prevent recording any profit before actual sale of inventory. In normal scenario the cost of inventory will always be lower than its market value (Otherwise no company will manufacture them at first place). But in some conditions (like becoming obsolute) market value might go below the cost of inventory and in this case business should report inventory at net realizable value.