Held-to-maturity security reporting

CFA Level II FRA
#1

I understand that AFS and held-for-trading securities are reported at fair value at end of each period, but for held-to-maturity security, I am a little bit confused. I saw two method reading the material.

  1. It’s reported at historical cost.

  2. It’s reported at amortized cost using effecitve interst rate method.

Which one is correct? Thanks.

#2

The second one is correct, you intially record it on the books as the price you paid, and you add the discount/ premium during the life of the security, with any interest income / dividends recognized in the P/L

#3

Thanks. The first one is acutally from the anwser to the question in the text book.

So assuming the second one is correct, when the bond is bought at the premium (stated rate is larger than the effective interest rate), the interest recieved would be larger than the interest income (interst received = par value * stated rate; interest income = par value * effective interest rate), right?

On the balance sheet, the carrying value of the held-to-maturity security would be reduced by the amortization amount.

How about on the income statement? Of course, we will record the interest income (using effective interest rate), and how is the amortization on the income statement treated?

Thanks.

#4

This is true for US GAAP, but not necessarily for IFRS.

Under IFRS you initially record it at fair market value; any difference between what you paid and fair market value is shown as a gain/loss on that year’s income statement. If you paid too much, you record a loss; if you got a bargain, you record a gain.

#5

The amortization is included in the effective interest rate method calculation; you don’t need to do anything else. The difference between the coupon amount and the interest income is the amortization.

#6

Thanks!

#7

My pleasure.

#8

Techincally they are both right- to report at historic cost means to initially value the asset at its original cost and then to depreciate it over the life of the trade. Use of the effective interest method incorporates ammortisation (which is grouped in the same category as depreciation technically since you spread the cost of the asset over the life of the trade).

Note that if the asset is recorded at premium - you ammortise (or ‘depreciate’ that premium) over the asset’s life. If the asset was inititally issued at discount - the discount would be ammortised again over the life of the trade.

To make it simple, go with method 2 above - however they are both correct.

hope that helps