A bank classifies $50 million of Treasuries as held-to-maturity at par, then sells $2 million in Year 3 to cover a deposit run. That single trade taints the rest of the portfolio, forces $48 million to AFS at fair value, and locks the bank out of HTM for two more fiscal years. Amortized cost is a promise, and GAAP enforces it across the whole book.
Trading and AFS measure debt at fair value because the entity might sell. HTM measures at amortized cost because the entity has committed not to sell. Banks use HTM for regulatory capital relief, a 300 basis-point rate move would crater book equity if those bonds were marked to market every quarter. In exchange, GAAP enforces a strict promise: classify as HTM, hold to maturity. That promise drives every rule below.
HIGH-FREQUENCY: HTM is the only debt classification that ignores fair value entirely. Choices that reduce carrying amount for rate-driven fair-value declines are wrong.
Both prongs must hold at every reporting date. Positive intent means you affirmatively plan to hold to maturity, not "we don't currently plan to sell." Ability means liquidity, regulatory capital...
Common mistakes
- Using straight-line amortization on a premium bond. Effective-interest produces accelerating amortization ($16,678 in Year 1 rising to ~$19,500 in Year 5), not even per year. Trap: choices with identical amortization each year are wrong unless the immateriality exception applies.
- Reducing gross HTM Investment for the CECL allowance. The allowance is a separate contra-asset. Recording the day-one entry as Credit HTM Investment understates gross investment. Trap: $1,077,059 in HTM Investment at purchase instead of $1,083,059.
- Treating fair-value declines as HTM impairments. An HTM bond whose fair value drops because rates rose generates no entry. Only credit deterioration drives a CECL adjustment, and only the allowance moves. Trap: choices that record a fair-value loss are AFS thinking applied to HTM.
Bottom line
- Only debt securities qualify for amortized cost; the entity needs positive intent AND ability to hold to maturity, tested at every reporting date. Equity securities never qualify.
- Carrying amount on day one equals purchase price. Each period cash interest is received, but interest revenue equals carrying amount times the effective (market) yield; the gap amortizes premium or discount.
- Premium amortization decreases carrying amount toward face; discount amortization increases it toward face. Either way carrying amount lands at face value at maturity.
- ASC 326 (CECL) requires a lifetime expected credit loss allowance at purchase, recorded as a separate contra-asset and charged to credit loss expense, with bidirectional adjustments.
Exam shortcut
When a stem reports a debt security at amortized cost, ignore every fair-value number unless the question asks about reclassification or impairment. Build the 5-column amortization table fast: beginning CA, interest revenue (CA × effective yield), cash coupon, amortization (revenue − coupon), ending CA. The gap between cash and revenue is always the amortization.
The full lesson (about 4,205 words, 28 min read) adds 8 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.E2
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