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.
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.
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.
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.
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 3-1ABC 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.