Amortized cost begins with the investment's acquisition basis and changes through interest amortization, principal collections and write-offs. A separate credit-loss allowance reduces that gross balance to the amount reported on the balance sheet.
To identify investments eligible for amortized cost under U.S. generally accepted accounting principles (U.S. GAAP), the preparer evaluates both the instrument and the investor's circumstances. A maturity date establishes a repayment date but cannot establish management's investment strategy or funding capacity.
- Held-to-maturity (HTM): debt securities supported by positive intent and ability to retain them through maturity.
- Available-for-sale (AFS): debt securities classified as neither HTM nor trading.
- Trading securities: securities acquired and held primarily for sale in the near term.
The HTM classification assumes no election or specialized requirement overrides amortized-cost measurement, such as an applicable fair value option. Management reassesses the classification at each reporting date using its plans, funding arrangements and relevant sales history.
A debt security represents a creditor relationship, although some instruments issued in share form also meet the applicable definition.
Common mistakes
- Maturity substituted for intent. A three-year bond earmarked for sale in six months does not qualify merely because its contract has a maturity date.
- Acquisition costs omitted. Excluding the $500 brokerage cost understates the illustrated initial basis by $500 and produces an inconsistent acquisition yield.
- Purchased interest counted twice. Recording the full $6,000 receipt as revenue overstates the April purchaser's interest revenue by $1,500.
Bottom line
- HTM requires an eligible debt security and positive intent and ability to retain it through maturity.
- Measurement classification and current or noncurrent presentation require separate assessments.
- Initial basis includes applicable acquisition costs; purchased accrued interest is accounted for separately.
- Coupon cash uses face amount, while effective-interest revenue uses the appropriate beginning amortized-cost balance and periodic yield.
Exam shortcut
Mark the instrument type, holding strategy and funding facts before calculating anything. Then separate purchase price, acquisition costs and purchased interest. Convert the coupon, yield and payment count to the same interval. Check whether the yield is nominal or effective before dividing an annual rate. Build the gross investment schedule first. Check the amortization sign and reconcile its final precollection balance to principal.
The full lesson (about 5,798 words, 39 min read) adds 5 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.E2
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