Debt Securities: Accounting Basics for Newbies

This section explains the accounting basics for debt securities, including that for acquisition, disposition, and any interest.

Acquisition.

Debt securities are recorded at cost when purchased. To illustrate, assume that Music City paid $29,500 plus a $500 brokerage fee on September 1, 2010, to buy Dell’s 7%, two-year bonds payable with a $30,000 par value. The bonds pay interest semiannually on August 31 and February 28. Music City intends to hold the bonds until they mature on August 31, 2012; consequently, they are classified as held-to-maturity (HTM) securities. The entry to record this purchase follows. (If the maturity of the securities was short term, and management’s intent was to hold them until they mature, then they would be classified as Short-Term Investments—HTM.)

 


Interest earned. Interest revenue for investments in debt securities is recorded when earned. To illustrate, on December 31, 2010, at the end of its accounting period, Music City accrues interest receivable as follows.
 




The $700 reflects 4/6 of the semiannual cash receipt of interest—the portion Music City earned as of December 31. Relevant sections of Music City’s financial statements at December 31, 2010, are shown in Exhibit 15.3.

EXHIBIT 15.3 Financial Statement Presentation of Debt Securities

On February 28, 2011, Music City records receipt of semiannual interest.

 

Disposition. When the bonds mature, the proceeds (not including the interest entry) are recorded as:
 




The cost of a debt security can be either higher or lower than its maturity value. When the investment is long term, the difference between cost and maturity value is amortized over the remaining life of the security. We assume for ease of computations that the cost of a long-term debt security equals its maturity value.

Example: What is cost per share? Answer: Cost per share is the total cost of acquisition, including broker fees, divided by number of shares acquired.