Marketable securities are investments in debt or equity instruments that are listed on a public market such as a stock exchange. Since there are many buyers and sellers for such securities, they are liquid and can be sold easily.
While the term ‘marketable securities’ can sometimes also refer to all such securities for which an active secondary market exists regardless of their maturity, majority of the accounting literature uses the term for liquid market-quoted securities that have a maturity of up to 12 months. Under this predominant definition, marketable securities are also called short-term investments.
Marketable securities are second most liquid current asset after cash and cash equivalents. They are presented on a balance sheet in the current assets section just above cash and cash equivalents (or below) depending on whether the assets are presented in ascending (or descending) order of liquidity.
Marketable securities differ from cash equivalents in the sense that cash equivalents typically have a maturity of 3 months or less while marketable securities may have a maturity of up to 12 months. Further, cash equivalents have stricter liquidity requirements.
Marketable securities are predominantly of two types: debt or equity. Debt securities have a fixed cash flows stream for a specified period of time while equity securities represent ownership interest in a company. Examples of marketable securities include:
- Shares of common stock of a company listed on a stock exchange
- Government bonds with maturity less than 12 months which are quoted on open market
- Treasury bills tradable on secondary market
- Corporate bonds with less than 12 months to maturity, etc.
- Preferred shares, if a liquid market is available for them
It is important that an open market exists for securities for them to be classified as marketable securities. For example, shares of common stock of privately owned company, etc. are not marketable securities because they do not have an active market.
Connect, Inc. had $40 million idle cash. In the first quarter of financial year X, the company’s Treasury Manager entered into the following transactions:
|16 Jan||Purchased 200,000 shares of Fizz, Inc. for $63.23|
|30 Jan||Invested in zero-coupon treasury bond of face value $20 million due to mature on 30 Mar for $19.6 million.|
|01 Feb||Sold 50,000 shares of Fizz, Inc. for $65.5.|
|15 Feb||Fizz, declared dividend of $1.5 per share|
|01 Mar||Sold 5,000 share of Fizz, Inc. for $62.5.|
|30 Mar||The $20 million government bond matures.|
The price per share of Fizz, Inc. stock stood at $67 on 30 Mar.
Journalize the transactions and work out the value at which the investments should appear on the balance sheet of the company as at 30 Mar. Also work out the effect on income statement for the quarter.
16 Jan: investment in new securities is recorded at the amount paid for them at the time of acquisition. The purchase of 20,000 Fizz, Inc. shares should be recorded as follows:
|Investment in Fizz, Inc. (200,000*63.23)||12,646,000|
30 Jan: similarly, the investment in zero-coupon government bond for $19.6 million is journalized as follows:
|Investment in Government Bonds||19,600,000|
1 Feb: when marketable securities are sold at a price higher than their acquisition price, a gain is recorded. The gain on sale of 50,000 Fizz, Inc. shares is worked out as follows:
|Investment in Fizz, Inc. (50,000*63.23)||3,161,500|
|Gain on Investment in Fizz, Inc. (balancing)||113,500|
15 Feb: any dividends or interest earned on marketable securities is recognized as income. The $1.5 dividend per share on the remaining shares of Fizz, Inc. (200,000 – 50,000) is recognized as follows:
|Dividend receivable (150,000*$1.5)||225,000|
1 Mar: when marketable securities are sold at a price lower than the acquisition price, a loss is recognized. The loss arising from sale of 50,000 shares of Fizz, Inc. at $62.5 is as follows:
|Loss on investment in Fizz, Inc.||36,500|
|Investment in Fizz, Inc. (50,000*63.23)||3,161,500|
30 Mar: when government bond matures, $20 million cash is received. The difference between the final proceeds from the bond at maturity and the price paid results in gain or loss:
|Cash (equal to the maturity value)||20,000,000|
|Investment in Government Bond||19,600,000|
|Gain on Investment in Government Bonds||400,000|
30 Mar: at the year end, marketable securities are adjusted to their fair value (i.e. market value) based on the closing price. Connect, Inc’s portfolio as at 30 Mar consists of 100,000 Fizz, Inc. shares trading on 30 Mar at $67.5 per share. The following adjustment records the unrealized gain.
|Investment in Fizz, Inc. 100,000*$(67-$63.23)||377,000|
|Unrealized gain on Investment in Fizz, Inc.||377,000|
At the year end, Connect, Inc. balance sheet will show an amount of $6,700,000 (100,000*$67) as marketable securities in the current assets section. The company’s income statement shall report dividend income of $225,000, interest income (from government bonds) of $400,000 and capital gains of $454,000 (=$113,500 gain on first sale of Fizz, Inc. shares - $36,500 loss on second sale of Fizz, Inc. share + $377,000 unrealized gain at the quarter end).
by Obaidullah Jan, ACA, CFA and last modified on