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# Held to Maturity Securities

It was noted earlier that certain types of financial instruments have a fixed maturity date; the most typical of such instruments are "bonds." The held to maturity securities are to be accounted for by the amortized cost method.

To elaborate, if you or I wish to borrow money we would typically approach a bank or other lender and they would likely be able to accommodate our request. But, a corporate giant's credit needs may exceed the lending capacity of any single bank or lender. Therefore, the large corporate borrower may instead issue "bonds," thereby splitting a large loan into many small units. For example, a bond issuer may borrow \$500,000,000 by issuing 500,000 individual bonds with a face amount of \$1,000 each (500,000 X \$1,000 = \$500,000,000). If you or I wished to loan some money to that corporate giant, we could do so by simply buying ("investing in") one or more of their bonds.

The specifics of bonds will be covered in much greater detail in a subsequent chapter, where we will look at a full range of issues from the perspective of the issuer (i.e., borrower). However, for now we are only going to consider bonds from the investor perspective. You need to understand just a few basics: (1) each bond will have an associated "face value" (e.g., \$1,000) that corresponds to the amount of principal to be paid at maturity, (2) each bond will have a contract or stated interest rate (e.g., 5% - meaning that the bond pays interest each year equal to 5% of the face amount), and (3) each bond will have a term (e.g., 10 years - meaning the bonds mature 10 years from the designated issue date). In other words, a \$1,000, 5%, 10-year bond would pay \$50 per year for 10 years (as interest), and then pay \$1,000 at the stated maturity date 10 years after the original date of the bond.

## The Issue Price

How much would you pay for the above 5%, 10-year bond: Exactly \$1,000, more than \$1,000, or less than \$1,000? The answer to this question depends on many factors, including the credit-worthiness of the issuer, the remaining time to maturity, and the overall market conditions. If the "going rate" of interest for other bonds was 8%, you would likely avoid this 5% bond (or, only buy it if it were issued at a deep discount). On the other hand, the 5% rate might look pretty good if the "going rate" was 3% for other similar bonds (in which case you might actually pay a premium to get the bond). So, bonds might have an issue price that is at their face value (also known as "par"), or above (at a premium) or below (at a discount) face. The price of a bond is typically stated as percentage of face; for example 103 would mean 103% of face, or \$1,030. The specific calculations that are used to determine the price one would pay for a particular bond are revealed in a subsequent chapter.

## Recording the Initial Investments

An Investment in Bonds account (at the purchase price plus brokerage fees and other incidental acquisition costs) is established at the time of purchase. Importantly, premiums and discounts are not recorded in separate accounts:

## Illustration of Bonds Purchased at Par

 1-1-X3 Investment in Bonds 5,000 Cash 5,000 To record the purchase of five \$1,000,5%, 3-year bonds at par interest payable semiannually

The above entry reflects a bond purchase as described, while the following entry reflects the correct accounting for the receipt of the first interest payment after 6 months.

 6-30-X3 Cash 125 Interest Income 125 To record the receipt of an interest payment (\$5,000 par X .05 interest X 6/12 months)

Now, the entry that is recorded on June 30 would be repeated with each subsequent interest payment - continuing through the final interest payment on December 31, 20X5. In addition, at maturity, when the bond principal is repaid, the investor would make this final accounting entry:

 12-31-X5 Cash 5,000 Investment in Bonds 5,000 To record the redemption of bond investment at maturity

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