Short term Investment

Short Term Investment

Companies with large amounts of liquid resources often hold most of these resources in the form of marketable securities rather than cash.

Marketable securities consist primarily of investments in bonds and in the capital stock of publicly owned corporations. These marketable securities are trade daily on organized securities exchanges, such as the New York stock Exchange, the Tokyo stock exchanges. A basic characteristics of all marketable securities is that they are readily marketable – meaning that they can be purchased or sold quickly and easily at quoted market prices.

Mark to Market:

Accounting principles are not carved in stone. Rather, they evolve and change as the accounting profession seeks to increase the usefulness of accounting information. A 1993 change in the way companies account for short term investments provides an excellent case in point.

Short term investments once appeared in the balance sheet at the lower of their cost or current market value. This valuation method reflected the cost principle, tempered by conservatism. But in 1993, the FASB changed the rules.

Marketable securities are classified as one of three types: (1) available for sale securities (2) trading securities (3) held-to-maturity securities. These classifications are based in large part on management’s intent regarding the length of time the securities will be held. Most corporations classify their marketable securities as available for sale. In view of this fact, the remainder of our discussion focuses exclusively on this particular classification.

To achieve the objective of presenting marketable securities classified as available for sale at current market value, the balance sheet valuation of these investments is adjusted to market value at the balance sheet date. Hence, this valuation principle often is called mark to market. When the value of marketable securities is adjusted to current market value, an offsetting entry is made to an account entitled Unrealized Holding Gain on Investments. This account appears as a special stockholders’ equity account in the balance sheet.

Unrealized holding gains and losses are not subject to income taxes. Income taxes are levied on gains and losses only when the investments are sold. Nonetheless, unrealized gains and losses are shown in the balance sheet net of the expected future income tax effects. These expected future tax effects are included in the company’s tax liability rather than in the amount shown as unrealized holding gain or loss. Such “deferred tax adjustments” are beyond the scope of our introductory discussion and are addressed in later accounting courses.

Our Assessment of Mark to Market:

The authors of this text commend the FASB on this recent change in accounting principles. Reporting short term investments at market value substantially enhances the usefulness of the balance sheet in evaluating the solvency of a business.

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