Types of debt securities in accounting
Companies can invest in debt and equity securities. In this article we will discuss the three types of debt securities: held-to-maturity, trading and available for sale.
1. Three types of debt securities
Companies can invest in debt securities issued by other entities. There may be various reasons why one company may want to invest in debt securities of another company. For example, a company-investor may be interested in earning interest or realizing capital gains. The company-investor may also want to exercise some contractual influence on another company whose debt securities it holds.
Investments in debt securities represent assets on the balance sheet because the company-investor expects to receive future economic benefits from such investments. Such investments are recorded on the asset side of the balance sheet.
Companies can classify debt securities as follows:
- Held-to-maturity securities
- Trading
- Available for sale
Held-to-maturity Debt Securities
Held-to-maturity debt securities are those that a company has a positive intent and ability to hold to maturity. Only debt securities can be classified as held-to-maturity securities (equity securities don’t have maturity and thus, can’t be classified as held-to-maturity). It is important to note that if a company plans to keep a debt security for an indefinite period of time (but not until maturity), such security can’t be classified as held-to-maturity. These securities are recorded on the balance sheet at amortized costs.
Trading Debt Securities
Trading debt securities are bought and held primarily for sale in the short run to generate income on short-term price changes. These securities are recorded on the balance sheet at fair values. Any unrealized holding gains or losses related to changes in fair values of trading debt securities are recorded in the income statement.
Available for Sale Debt Securities
All other securities not classified as held-to-maturity or trading securities represent available for sale debt securities. These securities are recorded on the balance sheet at fair values. Any unrealized holding gains or losses related to changes in fair values of available for sale debt securities are recorded in other comprehensive income until such securities are sold.