What is Trade Date Accounting and Why It Matters

Trade date accounting is an important concept in financial reporting that every business should understand. In this comprehensive guide, we’ll explain what trade date accounting is, how it works, and why it matters for your company’s financial statements.

What is the Trade Date?

The trade date refers to the date when a transaction is executed. It’s the date that a company enters into a binding contract to buy or sell an asset.

For example, let’s say Company A agrees to purchase 1,000 shares of Company B’s stock on June 1st. June 1st is the trade date – the date that Company A agreed to the transaction, even though the shares haven’t yet been delivered or paid for.

What is Settlement Date?

While trade date is when the transaction happens, settlement date is when the transaction is completed and settled This is the date that the asset is delivered and payment is made

Using the example above, let’s say the purchase of Company B’s shares settles on June 3rd. On this date, Company B delivers the 1,000 shares to Company A, and Company A pays the agreed upon price to Company B. June 3rd is the settlement date.

The trade date and settlement date are usually a couple days apart, depending on the type of asset. Stocks typically settle within 2 business days in the U.S.

What is Trade Date Accounting?

Trade date accounting is an accounting method that records transactions on the trade date, rather than the settlement date.

Under this method, the transaction is recorded in the company’s books on the date the deal is executed (the trade date), not when it settles.

Going back to our example, Company A would record the purchase of Company B’s shares on June 1st (the trade date) under trade date accounting. The transaction would be recorded even though the settlement hasn’t yet occurred.

How Trade Date Accounting Works

Here is an example to illustrate how trade date accounting works in practice:

• On June 1st, Company A agrees to buy 1,000 shares of Company B for $10 per share, totaling $10,000. This is the trade date.

• On June 3rd, Company B delivers the 1,000 shares to Company A, and Company A pays the $10,000 to Company B. This is the settlement date.

• Under trade date accounting, Company A would record the following entry on June 1st:

  Dr Investment in Company B stock $10,000

  Cr Payable $10,000

• This records the purchase on the trade date even though cash has not yet been exchanged.

• On June 3rd, the payable would be eliminated when payment is made:

  Dr Payable $10,000

  Cr Cash $10,000

So trade date accounting allows the transaction to be recorded immediately on the trade date rather than waiting until settlement.

Why Use Trade Date Accounting?

There are a few key reasons why a company might choose to use trade date accounting:

• Reflects economics of the transaction. By recording the transaction on trade date, the accounting matches the economics. The company has assumed the risks and rewards of owning the asset as of the trade date.

• More timely information. Trade date provides more timely information for financial reporting compared to settlement date. Transactions are recorded closer to the date they actually occur.

• Industry convention. Certain industries like investment companies and broker-dealers are actually required to use trade date accounting by GAAP standards.

Overall, trade date accounting generally provides a better reflection of a company’s financial position and activities during an accounting period. However, settlement date accounting also has benefits, which we’ll discuss next.

Trade Date vs. Settlement Date Accounting

While trade date is more common, some companies use settlement date accounting. Under this method, transactions aren’t recorded until the settlement date when delivery occurs and payment is made.

Here is an example to illustrate settlement date accounting:

• On June 1st, Company A agrees to buy 1,000 shares of Company B for $10 per share, totaling $10,000. This is the trade date.

• On June 3rd, Company B delivers the 1,000 shares to Company A, and Company A pays the $10,000 to Company B. This is the settlement date.

• Under settlement date accounting, no entry would be made on June 1st.

• On June 3rd, the transaction would be recorded:

  Dr Investment in Company B stock $10,000

  Cr Cash $10,000

• The transaction isn’t recorded until the settlement date rather than the trade date.

Settlement date accounting defers recording the transaction until it is fully completed. Some key differences between the two methods:

Trade Date Accounting

• Records transactions on trade date
• More timely financial reporting
• Better reflects economics on trade date
• Required for certain industries

Settlement Date Accounting

• Records transactions on settlement date
• More conservative approach
• May better reflect company’s cash position
• Simpler to record completed transactions

Why Trade Date Accounting Matters

Now that we’ve compared trade date and settlement date accounting, let’s discuss a few reasons why the choice of trade date versus settlement date matters:

• Affects financial statements – Using different transaction dates will affect the timing for when assets, liabilities, gains, and losses are recorded in financial statements. This can impact the balance sheet, income statement, and statement of cash flows.

• Consistency is key – While companies can choose either method under GAAP, they must be consistent in applying one method or the other. Flipping between methods would make financial statements confusing.

• Industry conventions – As mentioned earlier, certain industries must use trade date accounting, so it’s an important concept for investment companies and broker-dealers to understand.

• Audit considerations – Auditors will check that companies are consistent in applying trade date or settlement date accounting and that transactions are recorded in the proper periods.

• Tax implications – The transaction date can also impact the timing for when gains/losses are recognized for tax purposes. Companies should understand the tax implications of their accounting method.

Real World Examples of Trade Date Accounting

Trade date accounting is applied in various situations and industries. Here are a few examples:

• Stock trades – When a stock broker executes trades on behalf of clients, the trades are recorded on trade date for the broker’s bookkeeping and the clients’ account balances.

• Derivatives trading – Derivatives like futures and options are recorded on trade date. The value fluctuations are reflected daily based on trade date prices.

• Foreign currency transactions – A company that buys goods denominated in a foreign currency will immediately record the transaction at the FX rate on trade date.

• Commodity transactions – When commodities like oil, metals, or agricultural products are traded, revenues, costs, and inventory balances are impacted on the trade date.

• Bond transactions – Bonds are recorded in broker-dealer and investor accounts on trade date, though settlement may take longer.

Is Trade Date Accounting Required?

Most companies can elect to use either trade date or settlement date accounting. However, trade date is required for certain industries under U.S. GAAP:

• Investment companies – Under ASC 946-320-25-1, investment companies must use trade date accounting for recording security purchases and sales.

• Broker-dealers – ASC 940-320-25-1 states broker-dealers must record regular-way trades on a trade date basis.

• Banks and credit unions – Under ASC 942-325-25-2, depository institutions must record security purchases and sales on the trade date.

So companies in financial services and investment management must follow the specific guidelines provided under U.S. GAAP. Other industries can choose trade date or settlement date based on what best reflects their business activities.

Key Takeaways About Trade Date Accounting

Some key points to remember about trade date accounting:

• Trade date is the date a transaction is executed, while settlement is when it’s completed.

• Trade date accounting records the transaction on the trade date rather than waiting for settlement.

• Trade date provides more timely financial reporting and matches the economics of the transaction.

• Settlement date accounting defers recording transactions until settlement occurs.

• Most companies can choose trade date or settlement date accounting.

• Certain financial industries are required to use trade date under U.S. GAAP.

Understanding the difference between trade date and settlement date and the associated accounting methods is important for accurate financial reporting. While the choice depends on each company’s specific situation, trade date accounting provides the most timely information in most cases.