Held to Maturity Investment
A held to maturity investment is the investment made by a company which it intends to hold till maturity while it has the capacity to honor such intention.
Only debt securities 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 reported on balance sheet at its amortized cost. Amortized cost is the carrying amount of the financial asset determined by reducing the initial 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. Interest income is recognized on held to maturity investments using the effective rate of interest method.
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 had an effective interest rate of 7%.
HMI Ltd. intends to hold the bonds to maturity so they classified them as held to maturity and the acquisition is recorded as follows:
|Investment in Bonds of BD Ltd.||100 million|
|Discount on Bonds||7.02 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 and it equaled $6.51 million ($92.98 multiplied by 7%). 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 amortization of discount. Interest income is recognized as follows:
|Interest Receivable||6 million|
|Discount on Bonds||0.51 million|
|Interest Income||6.51 million|
At 31 December 20X0, the bonds will appear 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.
Written by Obaidullah Jan