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6 - Accounting for Highly Liquid Investments Known as Trading Securities - YouTube
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I'm Larry Walther and this is principles
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of accounting dot-com chapter six this
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final module for chapter six looks at
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accounting for highly liquid
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investments also known as trading
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securities in a subsequent chapter
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chapter nine and you will be introduced
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to other types of investments such as
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held the maturity securities or
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available-for-sale securities but for
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now our focus on what we call trading
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securities trading securities are
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investments acquired with the intent of
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generating profits by reselling those
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investments in the very near future it's
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a temporary type investment in other
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words the investments are initially
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recorded at their cost however they are
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subsequently in continuously adjusted to
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their fair value at each financial
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reporting date the fair value is the
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price that would be received from the
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sale of an asset in an orderly
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transaction between market participants
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that's a very specific definition this
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is also sometimes called mark-to-market
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accounting let us look at an
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illustration
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Webster company purchased five thousand
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shares of Miriam stock at $10 per share
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with the intent of selling those shares
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in the near future for a profit so on
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the date of acquisition we debit trading
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securities fifty thousand dollars in
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credit cash fifty thousand dollars now
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on March 31 the end of the month assume
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that Miriam stock had declined to $9 per
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share
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remember we paid $10 a share so we have
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a $1 loss or per share or $5,000 total
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loss to record will debit an account
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loss on investments typically called an
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unrealized loss and we're crediting the
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trading securities account $5,000 to
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reflect the reduction in that asset now
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continuing by the end of April the stock
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has gone up to $12 a share so we're
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happy about that our total investment is
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now worth $60,000 so we need to do debit
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trading securities $15,000 to bring it
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from 45,000 at the end of last month up
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to 60,000 at the end of this month
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debit trading securities and here we
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have the offsetting income statement
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credit this time reflecting the
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unrealized gain on the investments these
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gains and losses are unrealized events
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are recorded or recognized in the
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financial statements even though the
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final cash consequences have not yet
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been determined and unrealized but
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recognized gain or loss now thinking
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about this illustration the three
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journal entries have now taken the
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trading security
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so their current $60,000 value there are
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50,000 initial value we subtract five
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thousand for the March decrease to get
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to our March carrying value of forty
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five thousand we add the fifteen
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thousand dollar April increase bringing
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us to our sixty thousand dollar value at
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the end of April the five thousand
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shares at twelve thousand dollars you
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share are now carried it there's sixty
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thousand dollar value to think further
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about fair value accounting the
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rationale for this approach is that the
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market value for the trading securities
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is readily determinable by reference to
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the market and the periodic fluctuations
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have a definite impact on the company
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that should be recognized as those
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occurred given the intent to dispose of
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the investment in the near future the
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belief is that the change in value
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likely have a corresponding effect on
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the ultimate cash flow of the firm and
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there is therefore appropriately
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recognized accounting rules recognize
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those changes as they happen now some
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companies might rather than debiting or
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crediting the trading security account
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directly for change in value maintain a
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separate valuation account for the
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change in value it's an alternative in
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lieu of directly adjusting the trading
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securities account it's a separate
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account it's not unlike the accumulated
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depreciation account if it's a reduction
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it would be a contract you know or it
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could be an adjunct or an add to the
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account if the values increased you get
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the same results however it provides
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additional information about the
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valuation changes in the securities and
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it can be very useful for more complex
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scenarios or tax scenarios where maybe
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you have a tax book difference you will
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not recognize these changes in taxable
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income ordinarily until the securities
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are actually disposed of so it's
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important to maintain accountability
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over the difference between your
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accounting records and your tax basis
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for those securities that's considered
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dividends and interest on the
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investments if those investments pay
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interest or dividends those changes in
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value are typically recognized or
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reporter's income so here I assumed we
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also received a $5,000 dividend we
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debited cash and credit a dividend
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income to reflect that income stream
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finally there's this complex issue of
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derivatives there's an endless array of
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investment options commodity futures
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interest rate swaps and other related
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agreements these are ordinarily referred
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to as derivatives their value is based
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to
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derived from something else for example
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a cotton futures contract takes its
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value from the underlying cotton the
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underlying accounting approach is the
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same that's followed for trading
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securities that is derivatives are
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initially measured at fair value and
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changes in those fair values are
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recognized as they occur now this is a
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complex subject well being on what I'm
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covering here but these are the very
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basic principles that apply to
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derivatives accounting and you'll often
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hear or read about a particular
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derivatives transaction that may sound
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very interesting or intriguing it's
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based on fair value accounting as well
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just as our trading securities
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