Held to Maturity Investment

A held-to-maturity investment is an investment in debt securities where the investing company has a positive intent and ability to hold them till maturity.

The held-to-maturity classification is allowed only under US GAAP. A similar investment would most likely be classified as a financial asset carried at amortized cost under IFRS. Even under US GAAP, the held-to-maturity classification is restrictive, i.e. a company must be certain that it will hold the security till maturity unless there is a significant change in interest rates, credit risk, foreign exchange risk, etc. If a company sells a held-to-maturity investment before maturity without there being a significant change in circumstances, it may result in the company not being able to classify any future securities as held-to-maturity for a certain period.

Only debt investments can be classified as held-to-maturity because they have a definite maturity. Equity securities, on the other hand, have no maturity and hence they cannot be classified as held-to-maturity.

A held-to-maturity investment is initially recognized at cost plus any transaction costs. When the market interest rate differs from the stated interest rate of the securities, the market price is different from the face value. This results in recognition of discount or premium.

Presentation in an income statement

In accounting for a held-to-maturity investment, we first need to determine the effective interest rate, which is the rate at which the sum of issue price and transaction costs is equal to the present value of future coupon payments. In each period, interest income on held-to-maturity investments is recognized in the income statement. It equals the product of opening carrying amount and the (periodic) effective interest rate.

Interest Income = Opening Carrying Value × Effective Interest Rate

The interest cash inflow (called coupon) equals the product of the face value of the security and the periodic stated interest rate (also called coupon rate):

Coupon = Par Value × Periodic Stated Interest Rate

The difference between the coupon and interest income represents the amortization of bond discount or premium.

Presentation in a balance sheet

In the balance sheet, the held-to-maturity investments are carried at their amortized cost. Amortized cost equals the issue price of the security plus applicable transaction costs adjusted for principal repayments and any unamortized bond discount or premium.

Accounting example and journal entries

On 1 January 20X0, HMI Ltd. purchased 1 million $100-par 10-year debt securities of BD Ltd. carrying annual coupons of 6% for $92.98 million. The bonds have an effective interest rate of 7%.

The HMI Ltd.’s investment committee minutes show that the company intends to hold these till maturity. Also, the company has the ability to honor this commitment. Hence, it classifies the securities as held-to-maturity.

Investment in Bonds of BD Ltd.100 M
Cash92.98 M
Discount on Bonds7.02 M

The investment will be reported in the balance sheet at $92.98 million ($100 million face value minus $7.02 million unamortized discount).

For the year ended 31 December 20X0, the interest income on the bonds would equal $6.51 million ($92.98 × 7%).

The coupon payment (i.e. interest receivable) for the period amounts to $6 million (the contractual coupon rate of 6% applied to the face value of bonds of $100 million).

The excess of interest income over interest receivable is the periodic amortization of discount.

Interest income is recognized using the following journal entry:

Interest Receivable6 M
Discount on Bonds0.51 M
Interest Income6.51 M

At 31 December 20X0, the bonds will appear in the balance sheet at $93.49 million ($92.98 million plus $0.51 million, or equivalently $100 million minus 6.51 million).

As the bonds approach their maturity, their gross carrying amount will revert to their face value.

by Obaidullah Jan, ACA, CFA and last modified on

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