Held to Maturity Debt Securities

Summary

This session focuses on held-to-maturity (HTM) securities, a category of debt investments. HTM is used when a company intends and is able to hold investments like bonds until they mature. Investments are accounted for at amortized cost rather than fair value, with any premium or discount amortized using the effective interest rate method. An example illustrates the process of buying an HTM bond, receiving interest payments, and the amortization schedule. The session also covers journal entries for bond purchases, interest revenue, and potential bond sales before maturity, emphasizing the importance of understanding HTM for accounting students and CPA candidates.

Takeaways

• 📈 Held-to-maturity (HTM) securities are used when a company intends and is able to hold investments, typically bonds, until they mature.
• 💼 HTM securities are accounted for at amortized cost rather than fair value, as the intent is to hold until maturity, making short-term market fluctuations irrelevant.
• 🔍 Only bonds can be classified as HTM because stocks or equity investments do not have a maturity date.
• 📊 Amortization of any premium or discount on HTM securities is done using the effective interest rate method, which is based on the bond's book value.
• 📚 The effective interest rate method is chosen for amortization because it reflects the actual yield of the investment over its life.
• 🏦 Adam Company's example illustrates the process of purchasing a discount bond, receiving interest payments, and the amortization schedule.
• 📋 The initial purchase of a bond is recorded at its cost, and an amortization schedule is prepared to track the bond's carrying value over time.
• 📝 The first journal entry for a bond includes recording the cash received from interest, the interest revenue, and the amortization of the discount.
• 📉 If a bond is sold before maturity, the carrying value is updated to determine any gain or loss on the sale, using the effective interest method.
• 💻 For accounting students and CPA candidates, the speaker recommends visiting their website for supplemental materials, including lectures, exercises, and access to AICPA questions.

Q & A

What are the three categories of debt investments discussed in the script?

The three categories of debt investments discussed are held-to-maturity, trading, and available-for-sale.

What is the definition of held-to-maturity securities?

Held-to-maturity securities are debt investments that a company intends and is able to hold until they mature, typically bonds, as they are the only debt securities that mature.

Why are held-to-maturity securities accounted for at amortized cost rather than fair value?

Held-to-maturity securities are accounted for at amortized cost because the investor intends to hold the bond until it matures, at which point they will receive the face value of the bond, regardless of market fluctuations.

How is the premium or discount on held-to-maturity securities amortized?

The premium or discount on held-to-maturity securities is amortized using the effective interest rate method, which is based on the bond's book value.

What is an example of a held-to-maturity security given in the script?

An example given is a $100,000 eight percent bond purchased for $92,278 on January 1st, 20X0, which is a discount bond because it was bought below its face value.

How often does the bond in the example pay interest, and what is the amount of the first interest payment?

The bond pays interest semi-annually, and the first interest payment is $4,000, which is calculated as $100,000 times 8% times 6/12.

What is the purpose of creating an amortization schedule for a bond?

An amortization schedule is created to track the bond's carrying value over time, showing how the premium or discount is amortized and how it affects the bond's value as it approaches maturity.

What happens to the carrying value of a held-to-maturity bond over time?

The carrying value of a held-to-maturity bond increases over time through the amortization of any premium or discount until it matches the bond's face value at maturity.

What is the process for accounting when a held-to-maturity bond is sold before maturity?

When a held-to-maturity bond is sold before maturity, the carrying value must be updated to reflect the amortization up to the sale date. Any gain or loss is then calculated based on the difference between the sale price and the updated carrying value.

What is the significance of the effective interest rate method in the amortization process?

The effective interest rate method is significant because it provides a systematic way to allocate the bond's discount or premium over its life, ensuring that the bond's carrying value reflects the time value of money.

What advice does the speaker give to accounting students or CPA candidates regarding their studies?

The speaker advises accounting students or CPA candidates to visit their website, foreheadlectures.com, for supplemental materials, lectures, and exercises to enhance their understanding of accounting concepts.