OCW041: Debt Held to Maturity

Amortized Cost Method

Debt held to maturity is shown on the balance sheet at the amortized acquisition cost.

Learning Objectives

Explain how a company would apply the amortized cost method to a debt held to maturity

Key Takeaways

Key Points

  • To find the the amortized acquisition cost the securities are amortized like a mortgage or a bond.
  • All changes in market value are ignored for debt held to maturity.
  • Debt held to maturity is classified as a long-term investment and it is recorded at the market value (original cost) on the date of acquisition.

Key Terms

  • acquisition: The thing acquired or gained; a gain.
  • maturity: Date when payment is due

Debt Held to Maturity

The definition of a debt is held-to-maturity is a debt which the company has both the ability and intent to hold until maturity. Debt held to maturity is classified as a long-term investment and it is recorded at the market value (original cost) on the date of acquisition. All changes in market value are ignored for debt held to maturity.

Debt held to maturity is shown on the balance sheet at the amortized acquisition cost. To find the amortized acquisition cost the securities are amortized like a mortgage or a bond.

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Amortization Schedule: Debt held to maturity is shown on the balance sheet at the amortized acquisition cost. To find the amortized acquisition cost the securities are amortized like a mortgage or a bond.

Example:

Z company purchases 40,000 of the 8%, 5-year bonds of Tee Company for $43,412. The bonds provide a 6% return, with interested paid semiannually. Z Company has both the ability and intent to hold the securities until the maturity date.

The journal entry to record the purchase:

Investment in bonds debit ——— 40,000

Premium on bonds debit ———— 3,412

Cash credit ——————————43,412

The accounting records show the debt at the amortized cost (face amount plus premium/less discount) and the difference between the maturity value and the cost of the bonds is amortized to the income statement over the life of the bonds.

In order to record the interim interest revenue and report the investment on the balance sheet, it is necessary to prepare an amortization schedule for the debt.

The first interest payment is $1,600, but since the company paid a premium, the effective interest earned is $1,302 (net the amortization of the premium).

Example:

The Journal Entry:

Cash debit ———————$1,600

Premium on bonds credit —-$298

Interest revenue credit ——- 1,302

The Z Company’s investment in Tee company is shown on the balance sheet as follows:

Held-to-Maturity Investments

Corporate bonds —————— $40,000

Plus: unamortized premium —– 2,166

Book value (amortized cost)—- $42,166

Accounting for Interest Earned and Principal at Maturity

At maturity, firms should debit cash and credit held to maturity investments the balance of the principal payment.

Learning Objectives

Summarize the journal entry required to record a debt held to maturity

Key Takeaways

Key Points

  • When money is borrowed, interest is typically paid to the lender as a percentage of the principal, the amount owed to the lender.
  • Nominal, principal, par, or face amount is the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end of the term.
  • The issuer has to repay the nominal amount on the maturity date. As long as all due payments have been made, the issuer has no further obligations to the bond holders after the maturity date.

Key Terms

  • Interest: The price paid for obtaining, or price received for providing, money or goods in a credit transaction, calculated as a fraction of the amount of value of what was borrowed.
  • maturity: Date when payment is due
  • maturity date: the date on which a principal amount of a note, draft, acceptance bond, or other debt instrument becomes due or payable

Interest Defined

Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds.

When money is borrowed, interest is typically paid to the lender as a percentage of the principal, the amount owed to the lender. The percentage of the principal that is paid as a fee over a certain period of time (typically one month or year) is called the interest rate.

Principal At Maturity

Nominal, principal, par, or face amount —is the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end of the term. Some structured bonds can have a redemption amount which is different from the face amount and can be linked to performance of particular assets such as a stock or commodity index, foreign exchange rate, or a fund. This can result in an investor receiving less or more than his original investment at maturity.

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Principal is repaid at maturity: Some structured bonds can have a redemption amount which is different from the face amount and can be linked to performance of particular assets such as a stock or commodity index, foreign exchange rate, or a fund. This can result in an investor receiving less or more than his original investment at maturity

The issuer has to repay the nominal amount on the maturity date (which can be any length of time). As long as all due payments have been made, the issuer has no further obligations to the bond holders after the maturity date. The maturity can be any length of time, although debt securities with a term of less than one year are generally

Accounting for Interest Earned and Principal at Maturity

During the life of the debt held to maturity, the company holding the debt will record the interest received at the designated payment dates.

Journal

entry

Debit cash

Credit interest revenue

If a company paid $10,000 for 8% bonds, a journal entry is required to record the payment of principal at maturity.

Journal entry

Debit cash $10,000

Credit held to maturity investments $10,000

Remember the original entry debited the held to maturity investment account and credit cash.


Source: Accounting