Under FASB 115, a part of US GAAP (Generally Accepted Accounting Principles), a company must classify all of the debt securities it owns into one of three categories. If the company intends to hold the debt until it matures, it must be classified as a "held-to-maturity" security. If the company acquires the debt with the intent to resell it in the short-term, then it must be listed as a "trading security. " If the debt is acquired without the intent to resell it in the short-term, nor the intent to hold it to maturity, it should be classified as "available-for-sale" . Each of these three classifications is treated differently for accounting purposes, both prior to sale and during the sale.
A bond certificate
A bond certificate issued via the South Carolina Consolidation Act of 1873. How the sale of a bond is recorded on a company's books depends on how the debt is initially classified by the acquiring investor. Debt securities can be classified as "held-to-maturity," a "trading security," or "available-for-sale. "
Held-to-Maturity
When debt is acquired and is intended to be held until maturity, it is recorded first by debiting a "Debt Investment Account," and then by crediting "Cash" for the amount the debt was purchased. For example, if a company purchased $1000 in debt securities, the transaction would be recorded like this:
Investments - Corporate Debt : $1000
Cash : $1000.
While the market value of the debt may vary over time, the company does not need to adjust the value of the debt on its books. Once the company sells the bond, it must report any gains or losses on the sale of the debt. So, in the example above, if the company sold the debt for $1200, it would need to make the following journal entry.
Investments : $1000
Net Gain on Sale : $200
Cash : $1200
If the company sold the debt for $800, it would need to make the following journal entry:
Investments : $1000
Cash : $800
Net Loss on Sale : $200
Trading Securities
If a company acquires debt that it intends to sell in the short-term, it must still record the sale. If a company acquired debt for $1000, and this debt is classified as a trading security, the company would still need to make the first journal entry in the aforementioned manner.That being said, the value of the debt on the owner's books must be adjusted to match the market value of the debt. For example, if the market value of the debt declined $200 from its original value to $800, a company would need to make the following journal entry:
Unrealized loss on trading security : $200
Investments : $200
The unrealized loss would be included on the company's income statement for the period it was recorded. If immediately after the accounting period, the company sold the debt for $800, it would need to make the following journal entry:
Cash : $800
Investments : $800
Because both the loss and the decrease in the debt asset's value were already recorded in the prior accounting period, the company would not have to make any additional adjustments.
Available-for-Sale
If a company acquires debt that is available-for-sale, it would still need to make a first journal entry in the same way that it would if the debt was "held-to-maturity" or a "trading security. " It would also need to adjust the value of its debt asset in relation to its current market value. Using the same example above, assume a debt asset was acquired for $1000 but declined in value by $200. In the case of an available-for-sale asset, the following journal entry should be made in the following accounts:
(Equity) Unrealized loss on security investment : $200
(Asset) Investments : $200
Unlike trading securities, the unrealized gain is recorded in the equity section of the balance sheet and does not effect the current year income statement at all. This is because, unlike trading securities, the loss from an available-for-sale security is not expected to be realized in the near future. Returning to the example, assume that the debt asset is sold immediately after the end of the accounting period where it first recognized the unrealized loss. The asset is sold for $800. In such a case, the following entries would be appropriate:
(Asset) Cash : $800
(Income Statement) Loss on Investment : $200
(Asset) Investments : $800
(Equity) Unrealized loss on security investment : $200
The result of the journal entry is that the unrealized loss is realized, so the company's profit for the period is decreased by $200. The debt asset, as well as the unrealized loss, is removed from the company's books.