Discuss the accounting for debt securities held to maturity and arguments against this approach

Answer 1

The accounting for debt securities held to maturity relies on the acquisition cost method in that both the initial amount recorded and adjustments for amortization each period rely on the initial purchase price. The amount that results from the application of this measurement approach is sometimes called amortized cost. U.S. GAAP and IFRS require firms to account for debt securities designated as held to maturity at amortized cost, except that they are also subject to impairment. That is, firms do not recognize increases in fair value (unrealized gains) but might recognize decreases in fair value (unrealized losses). If a held-to-maturity security is deemed to be impaired, the investor recognizes (debits) an impairment loss (included in net income) and reduces (credits) the balance sheet carrying value of the investment.

The argument for measuring held-to-maturity debt securities at amortized cost and ignoring most changes in fair value during the contractual term of the debt is that changes in fair value are not relevant if the firm has the intention and ability to hold the securities to maturity; firms would recognize impairment losses because of conservatism and because impairments due to changes in default risk reflect changes in the amount the investor is likely to receive.

The counter argument is, first, that any change in economic circumstances—changes in interest rates, or the credit risk of the borrower, or the investor's need for cash—could change the investor's willingness or ability to hold the securities until maturity; and second, if a held-to-maturity security is deemed to be impaired, the investor recognizes (debits) an impairment loss (included in net income) and reduces (credits) the balance sheet carrying value of the investment. Second, that the fair value of the security reflects the economic opportunity cost of continuing to hold the securities.