Types of For Sale Securities and Their Accounting Treatment (AFS/HTM/HFT)

Updated 12/19/2023

Have you wondered what all those assets on an insurance company’s balance sheet were? Or why do companies carry such a large mix of marketable securities?

Did you know that Microsoft owns over $120 billion in short-term investments, over 70% of its current assets, and over 39% of its total assets? That is a large amount of money tied up in an instrument many investors are unfamiliar with.

Insurance companies, banks, and other financial companies make a fair amount of their income from marketable securities in net investment income. The monies they invest in different bonds, stocks, and real estate yield decent returns for the companies, especially in the short term.

Other companies such as Microsoft, Apple, and Amazon use these tools to make money on the cash they have waiting for additional deployment opportunities.

In today’s post, we will learn:

Okay, let’s dive in and learn more about available-for-sale securities.

What is An Available For Sale Security?

An available-for-sale security, per Investopedia:

An available-for-sale security (AFS) is a debt or equity security purchased with the intent of selling before it reaches maturity or holding it for a long period should it not have a maturity date.” 

Our friends in the accounting world require that companies classify any investments or marketable securities companies make in either debt or equity securities as:

  • Held-to-maturity
  • Held-for-trading
  • Available-for-sale

An available-for-sale security lists on the financial filings at fair value, meaning that we value the investment at the value of its assets and liabilities, or its estimated value, as opposed to market value, which lists the value based on the market’s value, which can be higher or lower than fair value.

A close up of the word stocks over dollar bills

In the case of available-for-sale securities, these list on the balance sheet at fair value. Any changes in value between accounting periods are in the accumulated other comprehensive income section, which resides in the equity section of the balance sheet.

Accounting records any unrealized gains or losses in the AOCI or accumulated other comprehensive income section of the equity section at the bottom of the balance sheet. Ultimately, the impact of the available-for-sale securities is felt on the comprehensive income.

The available-for-sale securities benefit companies in a few ways:

Provide liquidity

Offer additional returns over longer holding periods.

Help diversify portfolio risk.

Unlike held-for-trading securities, AFS securities offer benefits beyond a short-term gain. For example, Microsoft could invest in companies in unrelated industries to reduce risk or choose companies with lower volatility to hedge against other investment risks.

Okay, let’s move on and learn more about the specific types of available-for-sale securities.

Types of Available for Sale Securities

Available for sale, securities come in two main flavors:

  • Financing instruments
  • Investment securities

Financing Instruments

These instruments refer to bonds, which companies use to finance their business operations. Bonds are listed on the issuing company’s balance sheet as a liability because the issuing company is expected to provide a certain return for that investment.

Toy blocks spelling bonds

Bonds have a legal obligation to issue coupon payments and repay the bond investment’s face value at maturity.

For example, if you purchase a bond at a face value of $1,000 and with a coupon payment of 3% over five years. The issuing company must return the original $1,000 investment at the end of the five years, plus pay a 3% coupon every six months over the five years.

Investment Securities

Investment securities are securities bought by the company to make a capital gain or diversify away from some of the other risks associated with its investment portfolio.

Companies that operate in a specific industry have a certain knowledge of that industry over outside investors and may choose to invest in that industry. Of course, this makes sense as it is a great example of a circle of competence, and investing in your strengths is the best idea.

Key takeaways

Discovering which investments the company holds in investment securities is as simple as looking at the 13F filing of the company. Not all companies must file these filings; they must manage assets over $100 million for that requirement to become a reality.

For example, Microsoft does not reach that threshold, whereas Prudential does. We can see if we take a quick look at Prudential’s 13F filing that they hold companies as diverse as:

  • Abbvie (ABBV)
  • Chipotle
  • Paypal

Okay, let’s move on and discover how the available-for-sale security works.

How an Available For-Sale Security Works

Remember that available-for-sale securities are an accounting term for classifying different financial assets.

They are debt or equity securities not in the camp of held-for-maturity or held-for-trading securities; more on these differences in the next section.

One trait concerning available-for-sale securities is that they are nonstrategic, with a price ready for sale at any time. This means the AFS is a device to earn profit for the company without a stated period, unlike other securities.

Unlike gains from the other securities, unrealized gains and losses do not appear on its income statement. Rather, they appear on the company’s balance sheet in the other comprehensive income classification until the securities sell.

Net income shows up in the income statement, and any income from the sale of securities or interest income is a specific line item on the income statement. The interest income stems from interest, dividends, or investments.

This means that the unrealized gains or losses don’t appear on Microsoft or Prudential’s income statement.

Net income accumulates into retained earnings on the balance sheet over several accounting periods. On the other hand, OCI, which includes unrealized gains or losses from AFS securities, rolls into the AOCI (accumulated other comprehensive income) on the balance sheet at the end of the period.

You can find the accumulated other comprehensive income below the retained earnings in the balance sheet’s equity section.

To help illustrate this flow, let’s look at Markel’s financial statements (MKL), the insurance company.

We have the other comprehensive account, which most investors ignore, right below the income statement. We can see any unrealized gains or losses from the available-for-sale securities on the company’s balance sheets.

Here, we can see that Markel earned $2,389 million in other comprehensive income, largely from the change in unrealized gains from the AFS securities.

financial statement

Next, we will look at the balance sheet, where we can see the total amount available for the sale of securities, totaling $12,587 million, a ton! In the equity section, we can see the amount of the accumulated other comprehensive income in the shareholder’s equity section, totaling $237.6 million.

financial statement

Finally, we are looking at the other financial document that most ignore: the consolidated statement of changes in equity. Here, we can see the addition of the net income to Markel’s retained earnings and the other comprehensive income added to the other comprehensive income.

financial statement

The bottom line is that all the financial documents flow from one to another, even though these securities are not sold every quarter. The unrealized gains or losses impact the company’s value by increasing shareholder equity.

When analyzing the balance sheet of any company that carries any balance of marketable securities, it looks at not only the net investment income, which is direct income from dividends, interest, and others flowing directly to the income statement, but also.

But there is also a gain from the unrealized gains or losses on the balance sheet, which grows the shareholders’ value. Even though that growth doesn’t always correlate right to the share price, it is a value.

Let’s discuss the differences between the three types of marketable securities.

The Differences Between The Three Types of Marketable Securities

As we mentioned earlier, there are three kinds of marketable securities:

held for maturity and held for trading and available for sale, types of marketable securities

Held-for-Maturity

These marketable securities are debt or equities the company intends to hold until maturity. A great example is a CD (certificate of deposit) with a maturity date, such as a three-year CD. Other examples are treasury or corporate bonds with specific maturity dates, such as a 10-year.

Held-for-Trading

These marketable securities have one purpose: to be bought and sold quickly. Their purpose is to make a profit from the quick turnaround.

The securities used for held-for-trading can be either debt or equity to return a profit in the short term.

Available-for-Sale

AFS is the catch-all category for marketable securities, with all the marketable securities falling into this category. These securities, both debt and equity, are those that the company plans to hold but have the ability to sell.

Accounting for Available For Sale Securities

From an accounting perspective, the treatment of marketable securities is different. And the differences affect whether the gains or losses appear on the income statement or balance sheet.

a person stacking trees on increasing piles of coins with a calculator

The accounting for available-for-sale securities is similar to trading securities. Because of the short-term nature of the investments, recording both types at fair value.

However, in trading securities, the unrealized gains or losses from the fair value of these securities are recorded in operating income and listed on the income statement. A great example is the portfolios held by Berkshire Hathaway and Markel.

As mentioned earlier, changes in the fair value of available-for-sale securities are unrealized gains or losses in the other comprehensive income statement.

Some companies list this section below their income statement, while others create a separate statement below it.

Both feed the AOCI section of the equity section in the balance sheet.

From an accounting viewpoint, Markel’s purchase is available for selling securities with $100k of cash. Markel records a credit to the cash account, with a $100k debit to the available sale securities account.

If the value of the available-for-sale securities slides to $60k by the next quarter, Markel must “write down” the securities to mark the securities’ fair market value change.

The decrease in value is a credit on the available-for-sale security account and a debit to the other comprehensive account in the balance sheet’s equity section.

These flows show a decrease in the AOCI section from the decrease in the OCI statement.

Of course, if the fair value of the available-for-sale securities increases, the opposite happens. They are notating an increase in the OCI, which translates to an increase in the AOCI section of the shareholders’ equity.

a financial statement

The realization of the benefit to the company purchasing available-for-sale securities is not always when the security is bought or sold.

a financial statement listing investments at fair value as assets

The above is one of the advantages of owning a large bucket of available-for-sale securities. These investments allow many companies to invest in other securities without engaging in many activities managing the securities.

Therefore, the reference is to unrealized gains or losses.

Investor Takeaways

Reading any company’s financial statements is necessary, and understanding the information is sometimes confusing.

And for me, when I started learning about financial companies, trying to decipher the balance sheets, in particular, was difficult.

Most insurance companies’ assets were particularly tied up in investments; it made sense for me to figure those out.

Marketable securities drive much of the income and value of these companies. Insurance companies make much of their income from premiums, but depending on the type of company, life, or property/casualty, another third or more of its earnings will be derived from the investment portfolio.

Most investors think that we only earn value from buying or selling investments. Still, we can earn value from the unrealized gains or losses from marketable securities in the corporate world.

Warren Buffett earns much of Berkshire’s value from the equity portfolio, which flows to the balance sheet’s shareholders’ equity section because he is not turning over much of his portfolio.

Because of recent accounting changes, many of these investments help drive shareholder value. Companies such as Markel and Berkshire derive much of their value from equity portfolios. Still, they also drive value from the available-for-sale securities on the balance sheet.

Learning some accounting related to these terms associated with marketable securities will help you read the balance sheets of insurance companies, banks, and other financials.

But it also relates to companies like Google, Microsoft, and Amazon. The bottom line is that not all of these companies have immediate projects that will drive great returns.

And in this case, they use available-for-sale securities to earn value while waiting for other opportunities.

We will wrap up our discussion on available marketable securities for sale.

Thank you for taking the time to read this post, and I hope you find something of value on your investing journey.

If I can further assist, please don’t hesitate to reach out.

Until next time, take care and be safe out there,

Dave

Dave Ahern

Dave, a self-taught investor, empowers investors to start investing by demystifying the stock market.

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