Accounting for short-term investments
Learn about accounting for short-term investments: trading securities and available-for-sale securities.
1. Short-term investments definition
Short-term investments are readily marketable securities (stocks and bonds) that are intended to be sold within the time period of current assets. Logically, short-term investments are classified as current assets.
Security investments have to meet the following two (2) criteria to be classified as short-term investments:
- The investment is readily marketable
- Management intends to convert the investment into cash within one (1) year or operating cycle, whichever is longer
Security investments that do not meet both criteria should be classified as long-term. For example, stocks of privately held corporations are likely to have very limited markets, and as the result, such equity investments would not meet the first criterion and should be classified as long-term. Management might not have intent to sell the investment in the near term, and as the result, such an investment should be classified as long-term.
What does readily marketable mean? Readily marketable securities can be converted into cash (i.e., sold) on demand. For instance, stocks and bonds sold on public stock exchanges usually meet this criterion. Readily marketable securities can be classified as trading or available-for-sale (i.e., see next section).
The second criterion is more difficult to evaluate. Management might have an incentive, not intent, to include its investments in the short-term section of the balance sheet to improve the company’s liquidity and working capital ratios.
2. Classification of investments in securities
For valuation and reporting purposes, companies group investments in securities (stocks and bonds) as follows:
- Trading: debt and equity securities that the company intends to sell in the near term
- Held-to-maturity: debt securities that the company has an intent and ability to hold to maturity
- Available-for-sale: debt and equity securities not classified as trading or held-to-maturity
Trading securities are reported in the current section of the balance sheet.
Available for sale-securities can be reported in either the current or noncurrent section of the balance sheet, depending on the management’s intent to sell the securities in the near term.
Both trading and available-for-sale securities are reported at the fair market value.
Held-to-maturity securities are usually classified as noncurrent assets, unless the maturity of such securities is within one year after the balance sheet date. Held-to-maturity securities are recorded and measured on the balance sheet at their amortized cost. Note that only debt securities can be classified as held-to-maturity because equity securities do not have a maturity date. (We exclude discussion of held-to-maturity securities accounting from this guide because such securities normally don’t fall within short-term investments).
Debt securities represent purchases of debt obligations of another entity. Examples of debt securities include the following: corporate bonds, convertible debt, U.S. government securities, commercial paper, etc. Debt investments can be classified as trading, available-for-sale, or held-to-maturity.
Equity securities represent purchases of outstanding stock (common, preferred, or other) of another company. Companies invest in equity securities to earn investment income and to be able to control another company’s management and board of directors. Equity investments can be current (short-term) or noncurrent (long-term).
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