Held-For-Trading Security: Role and Fair Value Adjustment

An in-depth look into held-for-trading securities, their characteristics, accounting treatments, and the role of fair value adjustments.

Held-for-trading securities are financial instruments, specifically debt and equity investments, that buyers acquire with the intention to sell within a short timeframe to take advantage of favorable market conditions. These securities are primarily used for profiting from short-term price fluctuations rather than for earning long-term income or capital gains.

Characteristics of Held-For-Trading Securities

Held-for-trading securities possess several distinct features:

• Short-Term Holding Period: These securities are intended to be disposed of within a short period, typically less than one year.
• Frequent Buying and Selling: Transactions involving held-for-trading securities are frequent, in line with trading activities aimed at capitalizing on market prices.
• Marked-to-Market: They are recorded on the balance sheet at their current market value (fair value), with any unrealized gains or losses recognized in the income statement.

Role of Fair Value Adjustment

Fair value adjustment is a critical process in accounting for held-for-trading securities. It involves updating the value of the securities on the balance sheet to reflect their current market price.

Importance of Fair Value Adjustment

• Accuracy: It provides a realistic and current value of the financial assets.
• Transparency: Investors and stakeholders gain a more accurate understanding of the company’s financial condition.
• Performance Measurement: It allows for the accurate measurement of investment performance, as gains or losses are recognized in the period they occur.

Fair Value Adjustment Process

• Initial Recording: Upon purchase, held-for-trading securities are recorded at their acquisition cost.
• Subsequent Measurement: At each reporting date, the securities are re-measured at fair value.
• Unrealized Gains/Losses: Changes in fair value are immediately recognized in the income statement, reflecting the profit or loss.

Example of Fair Value Adjustment

Suppose a company holds a security purchased for $1,000. At the end of the reporting period, the security’s market value is $1,200. The fair value adjustment would involve:

• Recording an unrealized gain of $200 in the income statement.
• Updating the balance sheet to reflect the security’s new value of $1,200.

Accounting Treatment and Reporting

The accounting treatment for held-for-trading securities adheres to specific financial reporting standards.

Under IFRS (International Financial Reporting Standards)

• IFRS 9: Financial Instruments standard outlines the classification and measurement of financial assets, including held-for-trading securities.
• Fair Value Through Profit or Loss (FVTPL): These securities are classified under the FVTPL category, recognizing all fair value changes through profit or loss.

Under U.S. GAAP (Generally Accepted Accounting Principles)

• ASC 320: Investments – Debt and Equity Securities standard governs the accounting for held-for-trading securities.
• Income Recognition: Unrealized gains and losses are reported directly in the income statement, consistent with the fair value adjustment requirements.

Comparisons with Other Securities

It is essential to differentiate held-for-trading securities from other types of financial assets:

Available-For-Sale Securities

• Intended for sale in the longer term compared to held-for-trading.
• Unrealized gains and losses recognized in other comprehensive income, not the income statement.

Held-to-Maturity Securities

• Debt securities intended to be held until maturity.
• Recorded at amortized cost rather than fair value.

FAQs

Why are held-for-trading securities re-measured at fair value?

Re-measuring at fair value ensures that the financial statements present a true and fair view of the company’s financial position based on current market conditions.

How do unrealized gains and losses affect the income statement?

Unrealized gains increase net income, while unrealized losses decrease it, reflecting the potential future economic benefit or detriment from holding these securities.

Can held-for-trading securities be reclassified to another category?

Under IFRS and U.S. GAAP, reclassification is generally not allowed once a security is designated as held-for-trading, unless there is a change in the business model for managing financial assets.

Summary

Held-for-trading securities are a crucial component in financial markets, offering opportunities for short-term gains through active trading strategies. The role of fair value adjustment is central to accurately reflecting their value, ensuring transparency, and providing timely insight into financial performance. Understanding the characteristics, accounting treatments, and comparisons with other securities helps in making informed investment and reporting decisions.

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References

1. “IFRS 9 Financial Instruments,” International Accounting Standards Board (IASB).
2. “ASC 320 Investments – Debt and Equity Securities,” Financial Accounting Standards Board (FASB).