Investors normally purchase bonds and stocks for one of three reasons: The value of the asset is expected to increase, the asset can provide income in the form of dividends or interest, or the purchaser wants to gain control or influence over the selling company. The assets may be held for later sale, held until maturity or held temporarily for short-term trades. In some instances the company must obtain a quote from a broker to determine the asset's current market value, book a market adjustment and record unrealized loss or equity on the asset.
Investments Held for Sale
If a company is holding debt or equity securities that are available for sale, standard accounting procedures require recognition of any changes in the fair market value of the assets. Increases or decreases in value are recorded at the end of each accounting period, typically at year-end. On most financial statements, the asset is recorded at actual cost when purchased. A contra account, such as a fair value adjustment account or unrealized gain or loss on investments, is used to record changes to the asset's value. If the value declines, the company records an unrealized loss in the account and -- if the value increases -- the company records an unrealized gain or equity. Unrealized gains and losses for these assets typically remain on the balance sheet and are reflected in the owner's equity.
Investments for Short-Term Trading
Securities purchased for short-term trading are recorded at the actual price when purchased. Each accounting period, the asset is adjusted to the current market value. Unlike investments held for sale, securities for short-term trading do not require a contra account. Instead, the company books the change directly to the asset account. The offsetting entry is an income statement account, unrealized gain or loss on investments or unrealized loss-equity.
Investments Held to Maturity
If the company plans to hold bond investments until maturity, no entry is made to adjust the cost basis to current market value. Interest is amortized and an entry is recorded periodically to adjust the cost to reflect interest received.
Standard accounting principles require certain criteria be met before making a market adjustment and recording an unrealized loss or gain. The company should not have any significant influence or control over the asset, which typically means that the purchaser owns less than 20 percent of the selling company. Market adjustments are not made when the purchaser has significant ownership or control of the company. The price must be from a reliable source, such as a bid-ask quote listed on the stock exchange.
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