Balance Sheet: Classification, Valuation

Debt investments and equity investments recorded using the cost method are classified as trading securities, available‐for‐sale securities, or, in the case of debt investments, held‐to‐maturity securities. The classification is based on the intent of the company as to the length of time it will hold each investment. A debt investment classified as held‐to‐maturity means the business has the intent and ability to hold the bond until it matures. The balance sheet classification of these investments as short‐term (current) or long‐term is based on their maturity dates.

Debt and equity investments classified as trading securities are those which were bought for the purpose of selling them within a short time of their purchase. These investments are considered short‐term assets and are revalued at each balance sheet date to their current fair market value. Any gains or losses due to changes in fair market value during the period are reported as gains or losses on the income statement because, by definition, a trading security will be sold in the near future at its market value. In recording the gains and losses on trading securities, a valuation account is used to hold the adjustment for the gains and losses so when each investment is sold, the actual gain or loss can be determined. The valuation account is used to adjust the value in the trading securities account reported on the balance sheet. For example if the Brothers Quartet, Inc. has the following investments classified as trading securities, an adjustment for $9,000 is necessary to record the trading securities at their fair market value.

The entry to record the valuation adjustment is:

Debt and equity investments that are not classified as trading securities or held‐to‐maturity securities are called available‐for‐sale securities. Whereas trading securities are short‐term, available‐for‐sale securities may be classified as either short‐term or long‐term assets based on management's intention of when to sell the securities. Available‐for‐sale securities are also valued at fair market value. Any resulting gain or loss is recorded to an unrealized gain and loss account that is reported as a separate line item in the stockholders' equity section of the balance sheet. The gains and losses for available‐for‐sale securities are not reported on the income statement until the securities are sold. Unlike trading securities that will be sold in the near future, there is a longer time before available‐for‐sale securities will be sold, and therefore, greater potential exists for changes in the fair market value. For example, assume the Brothers Quartet has available‐for‐sale securities, whose cost and fair market value are:

The entry to record the valuation adjustment is:

In the balance sheet the market value of short‐term available‐for‐sale securities is classified as short‐term investments, also known as marketable securities, and the unrealized gain (loss) account balance of $15,000 is considered a stockholders' equity account and is part of comprehensive income. When the balance is a net loss, it is subtracted from stockholders' equity.

A partial balance sheet for Brothers Quartet, showing the current assets and the stockholders' equity sections, follows: