Held-to-maturity debt investments are accounted for using the amortized cost ; trading debt investments are carried at fair value and any changes in fair value are reported in income statement and the available for sale debt investments are carried at fair value and any changes in fair value are reported other comprehensive income.
Held to maturity debt investments are those debt securities for which the management has both the intent and ability to hold them till maturity. A typical debt instrument is issued against a sum of money called principal.
The bond-holder gets periodic cash flows in return which are either interest-only or a combination of interest and principal. Where the periodic cash flows are interest only, the principal is returned typically at the expiration of the debt. Debt instruments may have a myriad of cash flow patterns, however, the basic accounting approach when the debt is held till maturity is the same: amortized cost. Under the amortized cost method, the debt investment is initially recorded as an asset at its cost; any excess of the purchase price over par value is recorded as bond premium and any excess of par value over bond price is recorded as a bond discount.
The bond premium and bond discount are amortized over the bond life using the effective interest rate method. The interest income equals the carrying value of the bond multiplied by the prevailing interest rate and it is recognized income statement.
Any changes in fair value are ignored. At the time of sale, any difference between carrying value of the debt and the sale proceeds is recognized as gain or loss. You first need to find the effective interest rate on your bond. The effective interest rate equals the yield to maturity on your bond at time 0. The effective interest rate works out to 5.
Factors Affecting the Price of a Bond
You will recognize the debt investment as an asset as follows:. On 30 June , you need to recognize the first interest income using the following journal entry:. When you receive the interest income, you will credit the accounts receivable account and debt cash. For the semi-annual period ending 31 December , you will recognize interest income as follows:.
With each period, the carrying value of your investment will get closer and closer to its par value such.
An amortization table helps us determine the periodic allocation of interest income, interest receivable and changes in carrying value of debt investment beforehand. You need to recognize any gain or loss on the sale in income statement:.
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Debt investments which are solely bought for the purpose of earning short-term gain are called trading debt investments. Trading debt investments are recognized at their cost on the balance sheet and any fluctuation in their value is simultaneously recognized in income statement.
Any interest earned is recognized as interest income when it is earned. What if the management purchased to benefit from expected decrease in interest rates. FCCBs are bond issues that typically have tenures of five to eight years, and can be converted into equity by investors after a certain date or if the share price of the company crosses a certain level over the conversion price.
Such bonds are treated as debt on company balance sheets, until and unless they are converted into equity. FCCBs are often structured to allow the borrower to pay the entire interest and principal on the instrument when it matures, in the form of a redemption premium. This makes these instruments akin to zero coupon bonds, and thus the accounting treatment of redemption premium becomes especially critical.
Bonds and their Types
In the absence of any specific guideline, most companies have used Accounting Standard AS 29 on provisions, contingent liabilities, read in conjunction with Section 78 of the Companies Act, , to arrive at an approach to account for redemption premium. Companies either reduce redemption premium from their share premium reserves separately reporting it as 'other liabilities' , or treat it as a contingent liability.
In reality however, although balance sheets carry the entire debt, the actual burden of servicing of the FCCB is not factored in at all. According to the exposure draft, redemption premium will be treated as an expense and be amortised over the life of the FCCB on a yield to maturity YTM basis.
Who Needs Equity? - CFO
However, if the FCCB gets converted subsequently, Crisil will adjust redemption premium proportionate to the extent of conversion directly through the reserves. In Crisil's opinion, payment of redemption premium at the end of an instrument's tenure is equivalent to back-ended payment of interest in a zero-coupon bond. The ICAI proposal, when implemented, will result in Indian companies' accounting closer to global best practices; as mentioned earlier, Crisil's approach has always been in line with these principles.
Related zero coupon convertible bond accounting treatment
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