Question

How does the accounting for investments vary depending on the type of investment (i.e. trading securities, available-for-sale securities, and held-to-maturity securities)? What are the differences between debt and equity securities?

Answer 1

Accounting for investments vary depending on the type of investment.

That already mention it self in the question.

ex. Trading securities

it is a current asset, Trading securities are recorded in the balance sheet at their fair value as of the balance sheet date. This type of marketable security is always positioned in the balance sheet as a current asset.

available-for-sale securities

If a business has investments in debt and equity securities that are classified as available-for-sale securities, and also if the equity securities have readily determinable fair values, then subsequently record their fair values in the balance sheet. Exclude any unrealized holding gainsand losses from earnings, and instead report them in other comprehensive income until they have been realized (i.e., by selling the securities to a third party).

If an available-for-sale security is being hedged in a fair value hedge, then recognize the related holding gain or loss in earnings during the period of the hedge.

Available for sale securities may be classified as current assets on the balance sheet if they are to be liquidated within one year, or as long-term assets if they are to be held for a longer period of time.

Example of Available for Sale Securities

For example, Plasma Storage Devices buys $10,000 of equity securities, which it classifies as available-for-sale. After one year, the quoted market price of the securities drops the total investment value to $8,000. In the following year, the quoted market price of the securities increases the total investment value to $11,000, and Plasma then sells the equity securities.

Plasma records the decline in value in the first year with the following entry:

	Debit	Credit
Loss on available-for-sale securities (recorded in other comprehensive income)	2,000
Investments – Available-for-sale		2,000

Plasma records the increase in value in the second year, as well as the sale of the investment, with the following entries:

	Debit	Credit
Investments- Available-for-sale	3,000
Gain on available-for-sale securities		1,000
Loss on available-for-sale securities    (recorded in other comprehensive income)		2,000

	Debit	Credit
Cash	11,000
Investments – Available-for-sale		11,000

held-to-maturity securities

Held to maturity investment. If the investor intends to hold an investment to its maturity date (which effectively limits this accounting method to debt instruments) and has the ability to do so, the investment is classified as held to maturity. This investment is initially recorded at cost, with amortization adjustments thereafter to reflect any premium or discount at which it was purchased. The investment may also be written down to reflect any permanent impairments. There is no ongoing adjustment to market value for this type of investment. This approach cannot be applied to equity instruments since they have no maturity date.

So, each investment has a specific characteristic and vary depending on the type.

What are the differences between debt and equity securities?

In contrast to debt securities, equity securities are a share of interest in the equity of an entity, such as a partnership or corporation. The most common form of equity securities is that of company stock. Here, the owner of the equity securities actually holds some financial interest in the company itself.

The differences between debt securities and equity securities include:

• Payments: Debt securities holders are owed payments for reimbursement over time according to the securities contract with the borrower. Equity security holders do not receive any reimbursement payments over the course of time. Instead, owners of equity securities often acquire profits by buying and selling the equity securities.
• Profits and Gains: Equity securities holders may often enjoy rights to profits and gains as the company increases in value. Debt securities are only connected with the repayment of interests and principal according to the contract amount.
• Control: Holding a debt securities does not allow the holder to exercise any control over the operations of the borrower. In comparison, equity securities holders, especially stockholders, may be able to exercise some control with regards to certain company decisions.

Thus, debt securities tend to resemble loan contracts between a borrower and a lender, though they can sometimes have different formalities to them. Equity-based securities represent more of an ownership interest in a company or organization.