Front of the Class: What are Marketable Securities?

Marketable Securities

I. Definition

Marketable security is “an investment for which there is usually a ready market” (Marketable Security, 2007) or “an Equity or debt instrument (share/stock, bond, note) that is listed on an exchange and can be readily bought or sold” (Marketable Security, n.d. a). It is also defined as, “investments (or are derived from such investments) in companies, government entities and/or market indices (Types of Marketable Securities, 2008)

Thus, a person can increase his line of credit by having marketable securities. This is because the key to marketable security is its liquidity or its property of being converted easily to cash. If the asset can be converted into cash within a year, then it is considered liquid. Similarly a marketable security can be converted into cash easily and quickly since it must have a maturity of less than a year.

II. History of Marketable Securities

Under the Social Security Act of 1935 the income form payroll tax was credited to the Social Security account and the benefits were paid against this account on the treasury ledger. The Act stated that, “It shall be the duty of the Secretary of the Treasury to invest such portion of the amounts credited to the Account as is not, in his judgment, required to meet current withdrawals. Such investment may be made only in interest-bearing obligations of the United States or in obligations guaranteed as to both principal and interest by the United States (Social Security Act of 1935, n.d.)”.

Then in 1939 Amendments, the Federal Old Age and Survivors Insurance Trust Fund was established for the credits on the treasury ledger and its future earnings to be transferred to it. The Amendment stated that, “There is hereby created on the books of the Treasury of the United States a trust fund to be known as the ‘Federal Old-Age and Survivors Insurance Trust Fund’. . . . The Trust Fund shall consist of the securities held by the Secretary of the Treasury for the Old Age Reserve Account on the books of the Treasury on January 1, 1940, which securities and amount the Secretary of the Treasury is authorized and directed to transfer to the Trust Fund, and, in addition, such amounts as may be appropriated to the Trust Fund as herein under provided,” (1939 Amendment, n.d.).

The Social Security Act of 1935 and the 1939 Amendment specified that three types of purchases might be made. These are: securities on original issue at par; by purchase of outstanding obligations at the market price; and via the issuance of “special obligation bonds” (De Witt, 2007). The special security bond became the main asset of the Social Security Trust Fund, particularly in the 60s when the policy was to invest on these special obligations bonds (De Witt, 2007).

Not until the 80s was there a marketable securities addition to the Trust Fund. In 1983, The Greenspan Commission on Social Security Reform revised the investment procedure of the special obligations bond special and, “would be invested on a month-to-month basis, at an interest rate based on the average market rate of all public-debt obligations outstanding, exclusive of ‘flower’ bonds (1983 Greenspan, n.d.).”

Other marketable securities, such as corporate bonds and preferred stocks are issued by corporations, under the same principle.

III. Accounting principles on marketable securities

Marketable Securities which may either be corporate and government bonds and preferred corporate stocks are listed as current assets on the balance sheet. This is because they are liquid and can easily be converted to cash.

Purchase of marketable securities and other related fees to the purchase such as broker fee is recorded by debiting the Marketable Securities and crediting Cash. If it is a bond, then it is accrued interest since the payment date must be computed and paid to the seller. It is recorded as debit Bond Interest Receivable and credit Cash (Marketable Securities, n.d. b).

Interests of Marketable Securities if Bonds is done by computing the interest payment dates and if the date falls after the year-end, then accrue the interest earned. Recording is debit Bond Interest Receivable and credit Bond Interest Revenue. When accrued interest is paid upon the acquisition, then it is removed from the Interest Receivable. When interest payment is received then it is recorded as: debit Cash, credit Bond Interest Revenue or Bond Interest Receivable (Marketable Securities, n.d. b).

Dividends received on Marketable Securities that are stocks are done on the books by debiting Cash and crediting Dividend Revenue. This is done only when the dividend check has been received. The shares from stock dividends or stock splits are not recorded as income and are only noted in memo (Marketable Securities, n.d. b).

Sale of Marketable Securities, either stock or bond, is done by calculating the price received, less other fees, and calculating any accrued interest to date. Then calculate the gain or loss on sale.

IV. Examples of marketable securities

There are several types of marketable securities. The government issued marketable securities are: treasury bills, treasury notes and bonds, TIPS or Treasury Inflation Protected Securities and STRIPS or zero coupon security (Treasury Marketable Fact sheet, 2006).

The Treasury Bills or T-bills are short term marketable securities and they mature in one year or less from the time they are issued. They are purchased at discounted price and when they mature the investor or buyer receives the full face value amount. They can be bought in the banks or through brokers.

The Treasury Notes are similar with the T-bills except that it pays interest every six months until the time it matures. When it matures the investor or buyer shall receive the principal. The Treasury notes have a term of one year to 10 years. They mature in 2, 3, 5 and 10 years.

TIPS or Treasury Inflation Protected Securities are special type of marketable treasury security. The investor or buyer receives a fixed rate interest payment every six month. The interest payments are adjusted according to the inflation-adjusted principal. When it matures, the buyer will also be paid in its inflation-adjusted principal amount or at original par value, depending on which is of greater value.

The STRIPS are Treasury securities which do not pay periodic interests to the buyer or investor. The STIPS are created in order to separate or divide the interest from the principal of the Treasury note or bonds (Treasury Marketable Fact sheet, 2006).

Other examples of marketable securities issued by companies, government and market indices are: Equity Securities, Bonds – Fixed Income Securities, Option Securities, Mutual Funds, Unit Investment Trusts, Commodities and Derivatives (Types of Marketable Securities, 2000).

Equity Securities or stocks represent ownership interest in a company. The owner of the equity security is called the shareholder and he is paid in dividends periodically. The dividends are pro-rata and from the company’s earnings. Dividend payments are declared by the Board of Directors of the company.

Bonds are fixed income securities. Bonds are issued by the companies or government entities when they borrow money from investors. They issue these bonds to the investors and pay certain rate of interest over a period of time. It is called fixed income security since the interest rate is pre-determined or ‘fixed’. These bonds are generally traded on the market, making it more liquid. Unlike equity securities holders, bond holders enjoy limited liability.

Option securities are contracts which give the buyer or investor the right to buy or sell securities on or before the specified date. At the same time, the buyer may or may not exercise these rights or option.

Mutual Funds are determined by the type of marketable securities of the fund. The most common mutual funds are stock funds, bond funds, stock and bond funds, cash investment funds. These funds are issued to raise money from shareholders and invest in other marketable securities.

Bond Funds are also called income funds since it invests in fixed income debt securities. The most common bond funds are corporate bond funds, municipal bond funds, government security bond funds.

Unit Investment Trust or UIT are similar with mutual funds and fixed income securities. UIT is first created from income generating securities and then they are sold to investors who then receive a part of the interest and principal of the investment.

Commodities are goods, hence the name, which are traded on the organized commodity exchange. Examples of these are AMEX Commodity Exchange, Commodity Exchange Inc. – COMEX, New York Coffee, Sugar and Cocoa Exchange and New York Cotton Exchange (Types of Marketable Securities, 2000).

V. Accounting Board Review

The Financial Accounting Standards Board (FASB) established the Statements of Financial Accounting Standards (SFAS) for proper financial statement disclosure. One of the five SFAS is the SFAS 12 which is ‘Accounting for Certain Marketable Securities’. Accordingly, the SFAS 12 states that “marketable equity securities other than those accounted for by the equity method are classified as either current or non-current assets and reported at the lower of cost or market” (Hatami, 1990). Not all members of the FASB agreed with the decision. However the decision was made to make the value changes of the current portfolio to be reported in the income statement.

Then in May 1993, the FASB issued the Statement 115 which required certain equity securities investments to be reported at fair value. This eliminates the lower-of-cost-or-market accounting. The gains and loses on for sale securities are separately reported. The Statement 115 supersedes Statement 12 (EITF Abstracts, 2006)

Works Cited

1939 Amendment. n.d. Social Security Online