Held to maturity accounting for investments

Accounting

There are several principles applied with respect to holding investments until maturity. If a company acquires a debt security, it must determine if the intent is to hold that security until maturity or if there is a likelihood that the security will be liquidated prior to maturity. Depending on which choice is made, the accounting for the security will be different. If the company does not intend to hold the security to maturity, then the security is accounted for on the balance sheet under the principle of fair value accounting.

If the company intends to hold the security to maturity, and has the capacity to do so, then the security can be treated as "held to maturity" (Spiceland, et al.). The security is recorded at cost the time it is purchased. At each payment period, the entry is recorded using the yield as the amount, not just the interest payment. The yield is comprised of both the interest payment and the discount of the bond. This figure is considered to be the effective market rate. Thus, a journal entry is made using the effective market rate. The cash received will be noted and the remaining difference between the effective market rate and the cash received will be recorded as the discount on bond investment. It is added as an asset, as it is essentially income that will be paid at a later date (maturity).

The value of the investment will fluctuate based on changes in the prevailing interest rate and the underlying company's financial situation. For securities that are not being held to maturity, such changes must be recorded on the balance sheet using the doctrine of fair value. For securities that are being held to maturity, fair value reporting is not required. For such securities, no change in the asset's value is recorded. These are considered to be unrealized gains, but for hold-to-maturity securities these gains/losses are not expected to be realized at any point. The company will note the fair value change in a footnote, but will not record such a change on either the income statement of balance sheet (Spiceland, et al.).

If, however, it becomes necessary to sell investments previously classed as hold-to-maturity, then the following adjustments are made. The cash received from the sale is recorded along with any discount on bond investment is sitting as an asset. The investment in the bonds will be recorded at face value. Any profit above face value will be recorded as gain on investments. This essentially ensures that the asset for discount on bond investment is reversed as a result of the sale. FASB No. 115 lists six conditions under which a change of security status from HTM could occur, including deterioration in the issuer's creditworthiness, a change in tax law, a major business combination or disruption, a change in statutory requirements, an increase in regulator's capital requirements or an increase in the risk weights of debt securities.