Held to Maturity Debt Securities
Summary
TLDRThis 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.
Outlines
📈 Held-to-Maturity Securities Overview
This paragraph introduces the concept of held-to-maturity (HTM) securities, which are bonds that a company intends to hold until they mature. It explains that only bonds can be classified as HTM, not stocks, because stocks do not have a maturity date. The accounting treatment for HTM securities is at amortized cost rather than fair value. This is because the value of bonds tends to fluctuate but will ultimately return to their face value at maturity. The paragraph also discusses the process of amortizing any premium or discount on HTM securities using the effective interest rate method. An example is given where Adam Company purchases a discounted bond, and the process of recording the purchase and setting up an amortization schedule is explained.
📊 Amortization Schedule and Interest Revenue
The second paragraph delves into the specifics of an amortization schedule for a bond investment. It explains how the first and second interest payments are recorded, with a focus on the difference between the cash received and the interest revenue, which is the amount to be amortized. The paragraph outlines the process of updating the bond's carrying value through periodic interest revenue calculations and amortization of the discount. It also touches on the importance of the amortization schedule in determining the gain or loss if the bond is sold before maturity. The speaker encourages students to visit their website for additional resources and to connect on social media.
💼 Journal Entries and Gains on Sale
The final paragraph discusses the journal entries that would be made for the bond investment, particularly focusing on the receipt of cash and interest revenue, as well as the accrual of interest at year-end. It also addresses the scenario where the bond is sold before maturity, explaining how the carrying value is updated to determine any gain or loss on the sale. The paragraph concludes with a call to action for accounting students and CPA candidates to visit the speaker's website for more resources and to invest in their education.
Mindmap
Keywords
💡Held to Maturity
💡Debt Investment
💡Amortized Cost
💡Effective Interest Rate Method
💡Premium and Discount
💡Amortization Schedule
💡Interest Revenue
💡Accrual Accounting
💡Carrying Value
💡Gain or Loss on Sale
💡Subscription Model
Highlights
Introduction to the session discussing health to maturities category in debt investment.
Explanation of three parts of investment: held to maturity, trading, and available for sale.
Focus on held to maturity securities and their criteria for use.
Definition of held to maturity securities and their exclusion of stocks.
Accounting for held to maturity investments at amortized cost, not fair value.
Reasoning behind using amortized cost for held to maturity bonds.
Amortization of premium or discount using the effective interest rate method.
Example of Adam Company purchasing a bond to illustrate the concept.
Description of the bond as a discount bond due to purchase below face value.
Maturity of the bond in five years and semi-annual interest payments.
Accounting for the bond purchase and initial recording at cost.
Explanation of preparing an amortization schedule for bonds.
First interest payment and calculation of interest revenue.
Process of recording interest revenue and adjusting the bond's carrying value.
Repetition of the amortization process until bond maturity.
Reminder to visit the website for supplemental accounting materials.
First journal entry example for receiving cash and interest revenue.
Explanation of accruing interest revenue by year end.
Scenario of Adam Company selling its investments and accounting for it.
Calculation of gain or loss upon selling the bond before maturity.
Final encouragement to use the provided resources for accounting studies.
Transcripts
hello and welcome to the session in
which we will discuss health to
maturities category that is part of the
debt investment so if you invest in that
you could have your investment
categorized under three
parts either health to maturity
trading or available for sale and this
is what we discussed in the prior
session we gave an overview about debt
investments as well as equity investment
in this session we're going to focus on
health to maturity and we'll focus on
trading available for sale then we would
look at the equity section so what is
held to maturity securities well when is
it used well it's used when the company
has the intent and ability to hold the
investment until it mature well remember
the only thing that mature are bonds
that security so you don't have stocks
in this category okay because stocks or
equity investments don't mature now how
do we account for htm how do we account
for these investments at amortized cost
not fair value and we explain why in the
prior session because if you hold the
bond until it mature you will always get
the phase value so if you hold a bond
and the bond goes up in value and it
goes down then it goes down it goes up
then it's up down up up down at the end
it's going to come back to the face
value therefore ignore all these
fluctuation because if you're holding it
you're going to get the face value
that's the purpose and what do we do
we're going to amortize any premium or
discount using the effective interest
rate method generally speaking
why do we amortize using the effective
interest rate method because that's the
method that's based on the balance of
the bond the book value of the bond and
you might the reason is you might buy
the bond at a premium or you might buy
it at a discount just amortize it and i
hope you are familiar with premium and
discount amortization because we learn
about about how we discount bonds in the
bonds section if not please go to
forehead lectures to see how we do so
the best way to illustrate this is to
actually look at an example
adam company purchased one hundred
thousand eight percent bond of forehead
lectures january first twenty x zero
paying ninety two thousand two seventy
eight now without telling you this you
know this is a discount bond because the
bond is a hundred thousand dollar bond
you purchase it below the face value
therefore it's a discount bond
the bond matures in five years
on january 1st 20 x5 the bond yields 10
obviously because it yields 10 percent
it was sold at a discount
okay
because the interest rate the market
rate is 10 so the purchaser
adam company discounted that bond at 10
and the interest is payable
semi-annually july and january now when
you buy a bond what do you have to do
you have to account for the purchase you
have to account for the in for for any
interest received then if you sell the
bond you sell the bond you have to
account for the gain or the loss and
this is what we're going to be doing
first buying the bond well the bond now
it's a debt investment so notice i did
not mention the word bond it's a debt
investment it's an asset
okay versus
bonds payable when we sell a bond when
the company sells a bond that's a
liability two different things i mean i
mean in my in my classes always students
they debit bonds payable no you are
buying an investment you are not
reducing your liabilities when you buy a
bond and you credit cash you purchase it
for 92 000
278 this is on january 1st 20x0
and this is your cost this is how much
you paid for that bond
just any other asset when you buy it
initially you would record it at its
cost then what companies would do just
like when you issue a bond when you i
when you buy a bond you prepare an
amortization schedule and this is what
an amortization schedule looks like i'm
going to go over this amortization
schedule however if you are not familiar
with this by all means go back to my
bonds chapter and learn about bonds
well first the carrying value of the
bond when you bought the bond the
carrying value is the cost which is a
discounted bond then
six months later on july first
the bond will make its first payment you
would receive four thousand dollar in
cash why four thousand well the bond is
a hundred thousand dollar eight percent
bond pays interest semi annually well
one hundred thousand times eight percent
times six twelve the cash received is
four thousand dollar
now we need to know what's the interest
revenue the interest revenue is four
thousand six hundred and fourteen how do
we compute the interest revenue we'll
take the bond carrying value as of the
beginning of this period ninety two
thousand two seventy eight multiplied by
the market rate multiplied by one half
for six months therefore interest
revenue is four thousand six hundred and
fourteen well this is the interest
revenue
that you are going to be recording the
cash that you received only four
thousand the difference between them is
the amount you're going to be amortizing
so the difference is the amount you're
going to be amortizing which is 614
the difference between them now you're
going to take the 614 dollars and add it
to the previous carrying value and the
carrying value goes up to 92 000 894 and
this process would repeat itself well
july january 1st
second interest payment is four thousand
dollar notice the cash is always the
same
interest revenue based on the previous
carrying value times ten percent times
the market rate the difference between
them is the discount bond then the bond
carrying value will go up to ninety
three thousand five thirty seven and if
we keep going through this process until
january first twenty x five by the time
the bond matures notice it goes up it
goes back to 100 000. before we proceed
any further i would like to remind you
whether you are an accounting student or
a cpa candidate to take a look at my
website foreheadlectures.com
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following now let's take a look at the
first journal entry that's going to take
place july 1st 20
20 x 0 which is this
period right here this period right here
well what did we do on july 1st we
received cash of 4 000
we're gonna credit interest revenue
4614 which we computed earlier the
difference will be the debt investment
so notice what we do we're going to
increase our debt investment by 604
and period after period what's going to
happen the amount that we amortize
it's going to increase our
carrying value until the carrying value
becomes 100 000. and this is what we
meant by keep your bond if it's held to
maturity at maturity
as amortized cost why because at the end
of the life of the bond you're going to
get 100 000. now on the way there it
might fluctuate but we will ignore those
fluctuation let's take a look at the
second payment that let's take that
takes place on january 1st well before
we get to january first we have december
31st as year end this is what we're
going to be assuming so by year end we
have to accrue
the 4 000 that we're going to be
receiving on january 1st we're going to
have to accrue the interest revenue of
4645 computed as the prior carrying
value times 10 percent times one-half
and the difference will be that
investment increasing our carrying value
what's reported on the financial
statement on the balance sheet we're
going to have
interest receivable right here four
thousand dollar we're going to have an
investment in bonds at 93 537 december
31st
20x0 on the income statement we're going
to report interest revenue
4614 received in cash
46.45
we accrued we accrued
right here we accrued right here
together we would report interest
revenue of nine thousand two hundred and
fifty nine dollars
what happened if adam company sell its
investments on november first twenty x
four so november first is some place in
here toward the end of the life of the
bond which is not a big deal the bond
almost
almost mature
at 99.8 percent it means 100 000 times
0.998
plus
a crude interest because the investor
would like to get the accrued interest
now the first thing we have to do if
that's the case when when we retire a
bond
we have to do we have to bring the
carrying value because the carrying
value as of july was 99 048 dollars why
do we need to do so because the carrying
value
will determine whether we have a gain or
a loss because we sold this investment
well we're going to take the carrying
value from 99 000 48 bring it to
november first carrying value how so
well we have to prorate the 600
this
952 dollars of
discount so that the amount of discount
from july to january is 952 we're going
to take this amount multiplied by 4 6
which is for july august september and
october 4 month and that's going to give
us 635
the first thing we do is we update the
carrying value of the bond we debit the
investment credit interest revenue for
6.35 so now our bond is up to date now
we can determine whether we have a gain
or a loss we sold the bond not including
the interest for 99
800 which is 100 000
times point nine nine eight
then the bond carrying value is
was july first ninety nine thousand
eighty four dollars plus six thirty five
the carrying value is ninety nine
thousand six eighty three well we sold
it for more than the carrying value for
117 dollars we have again let's
journalize the entry to determine
the full default the full picture cash
that we will receive is 102 74 417. hold
on a second we only sold it for
99 800
999 800 well we also have to receive
4 000 prorated for 612 why because when
we sell the bond remember whoever
whoever buys the bond will get the
interest well for selling the bond we
want the cash now because by the time
the bond make that makes the next
interest payment when they pay the 4 000
we no longer have the bond therefore we
want our money that accrued from july
until november 1st from july 1st to
november 1st and that's 4 000 times 46
and this is why if we take 99 800 plus
260
and that should give you the amount of
the cash we are going to be receiving
we
credit the debt investment for the full
amount of the carrying value we computed
the carrying value now we remove it and
again takes a credit we record the gain
on sale of the investment this is an
actual realized gain of 117
dollars what should you do now as an
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