Available-for-Sale Securities: Definition, vs. Held-for-Trading

ByObeydul Haque Reading Time: 6 minutes

Available-for-sale securities refer to debt or equity investments that a company purchases with the intent to hold for an indefinite period but not necessarily until maturity or for short-term trading purposes. These securities fall into a middle ground between two other classifications: held-to-maturity (HTM) securities, which are held until they mature, and held-for-trading securities, which are actively traded for profit. AFS securities are typically liquid assets that a company may sell if it needs cash or if market conditions become favorable, but there is no fixed plan to do so at the time of purchase.

The defining characteristic of AFS securities is flexibility. Companies classify investments as AFS when they do not intend to actively trade them for short-term gains (as with HFT) or hold them until maturity (as with HTM). Common examples include corporate bonds, government securities, or equity shares in another company that are not part of a controlling interest. For instance, a corporation might purchase shares of a publicly traded company as a long-term investment without intending to influence its operations or sell the shares in the near term.

Under accounting standards, AFS securities are reported at fair value on the balance sheet. Unrealized gains or losses—changes in the market value of the securities that have not yet been sold—are recorded in a separate component of equity called other comprehensive income (OCI), rather than affecting net income directly. This treatment reflects the fact that AFS securities are not actively traded, and their value fluctuations are considered temporary until the securities are sold.

Accounting Treatment of Available-for-Sale Securities

The accounting for AFS securities follows a specific process under both IFRS and GAAP, though there are slight differences in terminology and application. Here’s how it works:

  1. Initial Recognition: When a company acquires an AFS security, it records the investment at its cost, which includes the purchase price plus any transaction fees (e.g., brokerage commissions).
  2. Subsequent Measurement: At each reporting period, AFS securities are revalued to their fair value, typically based on market prices. The difference between the original cost and the current fair value is an unrealized gain or loss.
  3. Recording Unrealized Gains/Losses: Unlike held-for-trading securities, where unrealized gains or losses impact net income, AFS securities route these changes through OCI. This keeps the income statement insulated from market volatility unless the securities are sold.
  4. Sale of AFS Securities: When an AFS security is sold, the company realizes the gain or loss, which is then transferred from OCI to the income statement. The realized gain or loss is calculated as the difference between the sale price and the carrying value (fair value) at the last reporting date.
  5. Impairment: If the fair value of an AFS security declines significantly and the decline is deemed other-than-temporary (e.g., due to credit deterioration of a bond issuer), an impairment loss is recognized in the income statement, reducing the carrying value of the asset.

For example, suppose a company purchases $100,000 worth of corporate bonds classified as AFS. At the end of the year, the fair value of the bonds rises to $105,000. The $5,000 unrealized gain is recorded in OCI, increasing shareholders’ equity but not affecting net income. If the company sells the bonds the following year for $107,000, it realizes a $7,000 gain ($107,000 – $100,000 original cost), with $5,000 transferred from OCI to the income statement and an additional $2,000 recognized as a gain from the final increase in value.

What Are Held-for-Trading Securities?

Held-for-trading securities, in contrast, are investments acquired with the primary intent of generating short-term profits through active buying and selling. These securities are typically part of a trading portfolio managed by financial institutions, investment firms, or corporations with treasury functions. HFT securities include stocks, bonds, derivatives, or other financial instruments that a company plans to sell in the near future, often within days, weeks, or months, depending on market conditions.

The key feature of HFT securities is their short-term focus. Companies or investors holding these securities aim to capitalize on price fluctuations, leveraging market trends, interest rate changes, or economic events. For example, a bank might purchase shares of a tech company expecting a quick uptick in value after a product launch, or it might buy government bonds anticipating a drop in interest rates.

From an accounting perspective, HFT securities are also measured at fair value on the balance sheet. However, unlike AFS securities, all unrealized gains or losses are recognized directly in the income statement, impacting net income immediately. This reflects the active trading intent and the expectation that these securities will be sold soon, making their market value changes a core part of the company’s operating performance.

Accounting Treatment of Held-for-Trading Securities

The accounting process for HFT securities is straightforward but differs significantly from AFS in its income statement impact:

  1. Initial Recognition: HFT securities are recorded at cost, including transaction fees, similar to AFS securities.
  2. Subsequent Measurement: At each reporting period, the securities are adjusted to fair value based on observable market prices or valuation models.
  3. Recording Unrealized Gains/Losses: All changes in fair value—whether gains or losses—are recorded in the income statement as part of net income. This makes HFT securities more volatile in terms of reported earnings.
  4. Sale of HFT Securities: When sold, the realized gain or loss is calculated as the difference between the sale price and the carrying value at the last reporting date, with no additional equity adjustments required since all prior changes were already recognized in income.

For instance, if a company buys $50,000 in stock classified as HFT and the fair value rises to $55,000 by the end of the quarter, the $5,000 unrealized gain is recorded in the income statement, boosting net income. If the stock is sold later for $57,000, an additional $2,000 gain is recognized, further impacting income.

Key Differences Between AFS and HFT Securities

While both AFS and HFT securities are measured at fair value, their purpose, holding period, and accounting treatment create significant distinctions. Here’s a detailed comparison:

  1. Intent and Purpose:
    • AFS: Acquired for an indefinite period, with no specific plan to sell in the short term or hold to maturity. They serve as a flexible investment option.
    • HFT: Purchased with the explicit goal of short-term trading to profit from price movements.
  2. Holding Period:
    • AFS: Typically held for a medium to long term, though they can be sold if needed.
    • HFT: Held for a short term, often days, weeks, or months.
  3. Accounting for Unrealized Gains/Losses:
    • AFS: Unrealized gains or losses are recorded in OCI, affecting equity but not net income until sold.
    • HFT: Unrealized gains or losses flow directly to the income statement, impacting net income immediately.
  4. Impact on Financial Statements:
    • AFS: Shields the income statement from market volatility, making earnings more stable unless impairment or sale occurs.
    • HFT: Introduces volatility to earnings, as fair value changes are reflected in real-time.
  5. Examples:
    • AFS: A company holding bonds or equity shares as part of a diversified portfolio without a fixed trading strategy.
    • HFT: A hedge fund trading stocks or options to exploit market inefficiencies.
  6. Risk and Volatility:
    • AFS: Lower volatility in reported earnings, suitable for conservative investors or firms prioritizing stability.
    • HFT: Higher volatility, appealing to entities comfortable with risk and active portfolio management.

Practical Implications for Companies and Investors

The classification of securities as AFS or HFT has strategic and reporting implications. For companies, choosing between these categories depends on their financial goals, risk tolerance, and cash flow needs. AFS securities provide a buffer against income statement fluctuations, making them attractive for firms that want to maintain stable earnings while retaining the option to liquidate assets. Conversely, HFT securities suit entities like banks or trading firms that thrive on market speculation and can handle earnings variability.

Investors analyzing financial statements must also understand these classifications. A company with a large AFS portfolio might show steady net income but have significant unrealized gains or losses tucked away in OCI, affecting its overall equity position. On the other hand, a firm heavily invested in HFT securities might report erratic earnings, reflecting market swings rather than operational performance.

Regulatory and Standards Context

The treatment of AFS and HFT securities is shaped by IFRS 9 (Financial Instruments) and ASC 320 (Investments—Debt and Equity Securities) under GAAP. IFRS 9, effective since 2018, introduced a business model approach, where classification depends on how an entity manages its financial assets and the contractual cash flow characteristics. GAAP retains the traditional AFS, HFT, and HTM categories, though recent updates have aligned it closer to IFRS in some respects. Companies must disclose their classification rationale and fair value measurements in financial statement footnotes, ensuring transparency for stakeholders.

Conclusion

Available-for-sale securities and held-for-trading securities represent two distinct approaches to managing investments, each with unique accounting implications and strategic purposes. AFS securities offer flexibility and earnings stability, making them a versatile tool for long-term planning, while HFT securities cater to short-term profit seekers willing to embrace market volatility. Understanding these classifications is essential for companies crafting investment strategies and for investors interpreting financial performance.

I (plan to) write about business, finance, SEO, WordPress, and whatever else interests me. You might find those interesting too. For now, find me on Twitter/ X.