How to Account for Debt Securities

August 17, 2018

US Treasury bills are short-term obligations sold at a price less than their face value. Treasury notes and bonds are long-term obligations that make semi-annual coupon interest payments. What is the proper way to record activity on these investments?

On a non-interest-bearing note, such as a Treasury bill, the difference between the face value and the purchase price is interest income. A discount is recorded when the amount paid is less than the face value and a premium when the amount paid is more than the face value (FASB Codification 835-30-25-5). At the time of purchase, a note with no periodic interest payments is valued at the present value of the future principal payments (face value). The present value calculation for notes paying periodic interest includes adding the present value of the future interest payments and the present value of the future principal payments. Since they are purchased at a discount, Treasury bills are effectively sold at their present value.

To recognize interest income consecutively over the life of a Treasury obligation, the interest method should be used. The interest method is used to amortize the discount or premium and recognize interest income (FASB Codification 835-30-35-1). The prevailing market rate for similar securities, also called the effective interest rate, at the time of purchase should be used when performing the interest method.  Interest income is calculated by multiplying the purchase price by the effective interest rate. The interest income is added to the principle and carried to the next period’s beginning balance. This process is continued for every period until maturity. At maturity, the discount or premium will be fully amortized and the book value of the Treasury obligation will equal the face value of the Treasury obligation. Illustration provided at (FASB Codification 835-30-55-5).

Nonprofits must record investments at a fair market value on the statement of financial position (FASB Codification 958-320-35-1). Discounts and premiums are presented as either a deduction or addition of the Treasury obligation face value on the financial statements (FASB Codification 835-30-45-1A). Unrealized gains and losses from changes in fair market value are included in earnings (FASB Codification 320-10-35-1). Investment gains and losses are reported on the statement of activities as an increase or decrease to net assets (FASB Codification 958-320-45-1).

For example, consider the purchase of a two-year Treasury bill for $907, which has a face value of $1,000.  The prevailing market rate at the time of issuance is 5% (compounded annually).

Journal entry to record the initial purchase:

Dr. Investment in T-bill                                   907

Cr. Cash                                                           907

The interest rate method calculation is:

PeriodBeginning balance      (a)Interest Income    (b)=a*5%Ending balance (C) =a+b

Journal entry to record the accrued interest at the end of year 1:

Dr. Investment in T-bill                                   45

Cr. Interest Income                                          45

At the end of the first year, assume interest rates have increased and the market value for a 1-year Treasury bill is now $934. After the first year, the book value of the Treasury bill purchased is $952 (purchase price of $907 plus year 1 accrued interest of $45), producing an unrealized loss of $18.

Journal entry to record the unrealized loss on the Treasury bill:

Dr. Unrealized loss                                           18

Cr. Investment in T-bill                                   18

Journal entry to record the accrued interest at the end of year 2:

Dr. Investment in T-bill                                   48

Cr. Interest Income                                          48

Journal entry to record receipt of face value at maturity:

Dr. Cash                                                         1,000

Cr. Investment in T-bill                                   982*

Cr. Realized gain                                           18

*Ending book value is $1,000 face value less the $18 unrealized loss recorded after year 1.

For more information about accounting practices for debt securities, contact Aprio’s experienced advisors.

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