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3.4 Accounting for debt securities
Publication date: 31 May 2022
us Loans & investments guide
When a reporting entity acquires a debt security, it should be classified into one of three categories and recognized as an asset on the balance sheet. See LI 3.3 for information on classifying a debt security.
The accounting treatment and related disclosures depend on whether the security is classified as held to maturity, available for sale, or trading.
3.4.1 Held-to-maturity debt securities
Held-to-maturity debt securities are reported at amortized cost. This is due to the securities being held to collect contractual cash flows. As such, it would not be appropriate for an investor to recognize interim fluctuations in fair value through a fair value model since those fluctuations will not be realized by the investor.
Held-to-maturity securities are subject to an ongoing impairment evaluation under ASC 326-20, as discussed in LI 7. Interest income, which includes dividends on instruments that are accounted for as debt securities, such as preferred stock, and the amortization of any premiums and discounts, should be included in net income. ASC 320 does not address the methods of recognizing and measuring interest income each period. See LI 6 for information on recognizing interest income on held-to-maturity debt securities.
Held-to-maturity debt securities are considered monetary assets. The amount to be received at maturity is fixed and does not depend on future prices. Therefore, foreign currency transaction gains or losses are recognized in the income statement. See FX 4.8 for additional information on foreign currency denominated debt securities.
3.4.2 Trading debt securities
Debt securities classified as trading are reported at fair value, with unrealized gains and losses recorded in net income each period.
Debt securities classified as trading should be measured at fair value in the currency in which the debt securities are denominated and remeasured into the investor’s functional currency using the spot exchange rate at the balance sheet date. See FX 4.8 for additional information on foreign currency denominated debt securities.
Generally, impairment testing is not necessary for trading debt securities because they are recorded at fair value; therefore, carrying value is always fair value. However, a reporting entity that separately presents interest income on trading securities would have to consider the impact of any impairments on interest income.
3.4.3 Available-for-sale debt securities
Debt securities classified as available for sale are reported at fair value and subject to impairment testing. Ignoring the impact of hedge accounting, other than impairment losses, unrealized gains and losses are reported, net of the related tax effect, in other comprehensive income (OCI). Upon sale, realized gains and losses are reported in net income.
There are two methods of accounting for an unrealized gain or loss on a security during the period in which it is sold.
- View A — First report the unrealized gain or loss as a component of other comprehensive income and then determine the reclassification adjustment
- View B — Determine the reclassification adjustment by reference to the unrealized gain reported in the previous reporting period
We believe that both View A and View B are acceptable alternatives under the provisions of ASC 320 and ASC 220, Comprehensive Income. A reporting entity should make a policy decision regarding the methodology it elects to follow. The policy should be applied consistently and disclosed in the financial statements, if material.
Interest income, including amortization of any premium or discount, should be included in net income. See LI 6 for information on recognizing interest income on available-for-sale debt securities.
Example LI 3-1 illustrates the accounting for the purchase and sale of an available-for-sale debt security.
EXAMPLE LI 3-1
Accounting for an available-for-sale debt security
Accounting for an available-for-sale debt security
ABC Corp acquires a debt security on 1/1/20X6 for $100. Upon acquisition, ABC Corp documents its designation of that security as available for sale.
ABC Corp sells the security for $150 on 2/1/20X7.
The following table summarizes the fair value of the security over the holding period.
Date |
Fair value |
|
1/1/20X6 |
$100 |
|
12/31/20X6 |
$130 |
|
2/1/20X7 |
$150 |
How should ABC Corp record its (1) acquisition of the debt security, (2) subsequent changes in fair value, and (3) disposition of the debt security?
Analysis
To recognize the debt security upon acquisition, ABC Corp should record the following journal entry.
Dr. Debt security — cost basis |
$100 |
|
Cr. Cash |
$100 |
In accordance with ASC 320, ABC Corp would measure the available-for-sale security at fair value on a quarterly basis and record any unrealized gains or losses in other comprehensive income. To recognize the change in the fair value of the debt security from 1/1/20X6 to 12/31/20X6, ABC Corp should record the following journal entry (note for simplicity purposes the effect of taxes has been ignored and a single journal entry is shown rather than four quarterly journal entries).
Dr. Debt security — unrealized gain |
$30 |
|
Cr. Other comprehensive income |
$30 |
There are two methods of accounting for the unrealized gain on the security during the period from 12/31/20X6 to 2/1/20X7.
To recognize the unrealized gain of $20 under View A, ABC Corp should record the following journal entry.
Dr. Debt security — unrealized gain |
$20 |
|
Cr. Other comprehensive income |
$20 |
Under View B, no journal entry would be required because the $20 unrealized gain is not recognized in other comprehensive income.
The accounting based on each view is illustrated in the following table (the effect of taxes has been ignored for simplicity).
View A |
View B |
||||
20X6 |
20X7 |
20X6 |
20X7 |
||
Other comprehensive income: |
|||||
Unrealized gain on securities |
$30 |
$20 |
$30 |
$0 |
|
Less: reclassification adjustment for gains included in net income |
— |
(50) |
— |
(30) |
|
Other comprehensive income |
$30 |
$(30) |
$30 |
$(30) |
|
The journal entry to recognize the sale of the debt security on 2/1/20X7 will depend on the methodology used to record the unrealized holding gain from 12/31/20X6 to 2/1/20X7 (i.e., View A or View B).
Under View A, ABC Corp should record the following journal entry:
Dr. Cash |
$150 |
|
Cr. Debt security — cost basis |
$100 |
|
Cr. Debt security — unrealized gain |
$50 |
Dr. Other comprehensive income |
$50 |
|
Cr. Realized gain on sale of debt security |
$50 |
Under View B, ABC Corp should record the following journal entry:
Dr. Cash |
$150 |
|
Cr. Debt security — cost basis |
$100 |
|
Cr. Debt security — unrealized gain |
$30 |
|
Cr. Realized gain on sale of debt security |
$20 |
Dr. Other comprehensive income |
$30 |
|
Cr. Realized gain on sale of debt security |
$30 |
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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