Held-to-maturity financial assets Example

Held-to-maturity financial assets Example – Held-to-maturity financial assets have passed the SPPI test (solely payment of principal and interest) and the business model test (Held to collect). Held-to-maturity financial assets are measured at amortized cost, using the effective interest method, less any impairment.

Only debt investments 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 initially recognized at cost including any transaction costs. When the market interest rate differs from the stated interest rate of the securities, purchase price of the investment is different from its face value which result in recognition of a discount or a premium.

Balance sheet presentation

At the end of each accounting period, held to maturity investments are reported on a balance sheet at their amortised cost. Amortized cost is the carrying amount of a financial asset/liability determined by reducing the cost of the 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.

IFRS Definition- Amortised cost: The amount at which the financial asset or financial liability is measured at initial recognition minus the principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount and, for financial assets, adjusted for any loss allowance.

The effective interest rate method uses the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. Held-to-maturity financial assets Example

Impairment – At initial recognition of a financial asset, an entity recognises a loss allowance equal to 12-month expected credit losses.

After initial recognition, the three stages under the proposals would be applied each reporting date as follows:

• Stage 1: Credit risk has not increased significantly since initial recognition – continue recognising the (updated) 12-month expected credit losses
• Stage 2: Credit risk has increased significantly since initial recognition – recognise lifetime expected losses, with interest revenue being calculated based on the gross amount of the asset
• Stage 3: There is objective evidence of impairment as at the reporting date – recognise lifetime expected losses, with interest revenue being based on the net amount of the asset (that is, based on the impaired amount of the asset).

See also Impairment – Expected credit losses on financial assets, Effective interest method, or amortised costs.

Accounting policy example

Financial assets are recognized initially at fair value, normally being the transaction price plus, in the case of financial assets not at fair value through profit or loss, directly attributable transaction costs. The subsequent measurement of financial assets depends on their classification, as set out below. The group derecognizes financial assets when the contractual rights to the cash flows expire or the financial asset is transferred to a third party.

Accounting example and journal entries

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 have an effective interest rate of 7%.

HMI Ltd. intends to hold the bonds to maturity, so it classified them as held to maturity and the acquisition is recorded as follows:

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 which equals $6.51 million ($92.98 × 7%). The coupon payment (i.e. 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 the periodic amortization of discount.

Interest income is recognized using the following journal entry:

At 31 December 20X0, the bonds will appear on balance sheet 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.

Held-to-maturity financial assets Held-to-maturity financial assets Example
Held-to-maturity financial assets are measured at amortized cost, using the effective interest method, less any impairment. Held-to-maturity financial assets Example

Derived from BP Plc’s Financial Statements 2017

https://www.bp.com/en/global/corporate/investors/results-and-reporting/annual-report.html

See also: Classification of financial assets and financial liabilities

Held-to-maturity financial assets Example