Held to Maturity Investment

A held to maturity investment is a debt investment made by a company which it intends to hold till maturity, and it has the capacity to honor such intention.

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 including any transaction costs. When the market interest rate differs from the stated interest rate of the securities, purchase price of the investment is different from its face value which result in recognition of discount or premium.

Balance sheet presentation

At the end of each accounting period, held to maturity investments are reported on a balance sheet at their amortized cost. Amortized cost is the carrying amount of a financial asset/liability determined by reducing the cost of the investment by the amount of principal repayments and any impairment losses recognized and adjusting it for amortization of discount or premium using the effective rate of interest method.

Income statement presentation

Interest income is recognized on held to maturity investments using the effective rate of interest method. Under this method, interest income is calculated using the following formula:

Interest Income = Opening Carrying Value × Periodic Market Interest Rate

The interest cash inflow (called coupon) equals the product of the face value of the held to maturity security and periodic quoted interest rate:

Coupon = Par Value × Periodic Quoted Interest Rate

The difference between coupon and interest income recognized is the periodic amortization of bond discount or premium.

Accounting example and journal entries

On 1 January 20X0, HMI Ltd. purchased 1 million $100 bonds of BD Ltd. carrying annual coupons at the rate of 6% and a maturity of 10 years, for $92.98 million. The bonds have an effective interest rate of 7%.

HMI Ltd. intends to hold the bonds to maturity, so it classified them as held to maturity and the acquisition is recorded as follows:

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

The bonds will be reported on balance sheet at $92.98 million ($100 million face value minus $7.02 million discount on bonds).

For the year ended 31 December 20X0, the interest income on the bonds would equal the product of the bonds' carrying amount and effective rate of interest which equals $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 face value of bonds of $100 million). The difference between interest income and interest receivable is the periodic amortization of discount.

Interest income is recognized using the following journal entry:

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

At 31 December 20X0, the bonds will appear on balance sheet at $93.49 million ($92.98 million plus $0.51 million).

The discount on bonds recognized at the acquisition of bonds will expire over the 10-year life of the bonds.

by Obaidullah Jan, ACA, CFA and last modified on

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