Accounting for Financial

Institutions
Lecture 19

By
Dr. Ahmed
Adel

Faculty of Commerce English Section

 Investments in
Securities

Faculty of Commerce English Section

 Why would financial institutions invest in
securities?

Financial institutions have different motivations for investing

in securities issued by other companies:
1. Earn a high rate of return (Interest Revenue + dividends).
2. Realize capital gains from selling investments.
3. Secure certain operating arrangements with other
companies.
 Types of security investments

Security investment can be classified into two main

categories

Securities

Debt investments Equity

investments
 Types of security investments

Financial institutions account for investments based on the

type of security and their intent with respect to the
investment.

Type of Security Management Intent Valuation Approach

Held to maturity Amortized cost

Debt Available for sale Fair value

Trading Fair value

 Types of security investments

Held-to-maturity: Debt securities that the financial

institution has a positive intent and ability to hold to maturity.

Trading: Debt securities bought and held primarily for sale

in the near future to generate income on short-term price
differences.

Available for sale: Debt securities not classified as held to

maturity or trading securities.
 Types of security investments

Amortized cost: is the acquisition cost adjusted for the

amortization of discount or premium, if appropriate.

Fair value: is the price that would be received to sell an

asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.
 Example 1: Held-to-maturity securities

Assume that the National Bank of Egypt purchased L.E.

100,000 of 8% bonds of Evermaster Corporation on January
1, 2013, paying L.E. 92,278. The bonds mature January 1,
2018 and yield 10%. Interest is payable each July 1 and
January 1. The National Bank of Egypt would record the
purchase of investments as follows:

Debt investments 92,278

Cash 92,278
Example 1: Held-to-maturity securities
 Example 1: Held-to-maturity securities
Financial institutions must amortize premium or discount
using the effective interest method.
Date Cash Interest Discount Carrying
received revenue amortization amount of
bond
1/1/2013

1/7/2013

1/1/2014

1/7/2014

1/1/2015

1/7/2015

1/1/2016

1/7/2016
 Example 1: Held-to-maturity securities
Financial institutions must amortize premium or discount
using the effective interest method.

Date Cash Interest Discount Carrying Unamortized

received revenue amortizatio amount of discount
n bond
1/1/2013 -- -- -- 92,278 7,722
1/7/2013 4,000 4,614 614 92,892 7,108
1/1/2014 4,000 4,645 645 93,537 6,463
1/7/2014 4,000 4,677 677 94,214 5,786
1/1/2015 4,000 4,711 711 94,925 5,075
1/7/2015 4,000 4,746 746 95,671 4,329
1/1/2016 4,000 4,783 783 96,454 3,546
1/7/2016 4,000 4,823 823 97,277 2,723
 Example 1: Held-to-maturity securities

Date Cash Interest Discount Carrying Unamortized

received revenue amortization amount of discount
bond
1/1/2017 4,000 4,864 864 98,141 1,859
1/7/2017 4,000 4,907 907 99,048 952
1/1/2018 4,000 4,952 952 100,000 --
40,000 47,722 7,722
 Example 1: Held-to-maturity securities
The National Bank of Egypt records the receipt of the first
semiannual interest payment on July 1, 2013 as follows:

Cash 4,000
Debt investments 614
Interest Revenue 4,614

The National Bank of Egypt accrues interest and amortize

the discount at December 31, 2013 as follows:

Interest Receivable 4,000

Debt investments 645
Interest Revenue 4,645
 Example 1: Held-to-maturity securities

On maturity date the entire discount or premium is amortized

and the following journal entry is recorded:

Cash 104,000
Interest receivable 4,000
Debt Investments 100,000
 Example 1: Held-to-maturity securities

Sometimes, a financial institutions sell held-to-maturity debt

securities so close to its maturity date.
Such a sale would be considered a sale at maturity and
would not question its original intent to hold the investment
to maturity.
Example: assume the National Bank of Egypt sells its
investment in Evermaster bonds on November 1, 2017 at
99 plus accrued interest.
 Example 1: Held-to-maturity securities

Sometimes, a financial institutions sell held-to-maturity debt

securities so close to its maturity date.
Such a sale would be considered a sale at maturity and
would not question its original intent to hold the investment
to maturity.
Example: assume the National Bank of Egypt sells its
investment in Evermaster bonds on November 1, 2017 at
99 plus accrued interest.
 Example 1: Held-to-maturity securities

The National Bank of Egypt has first to amortize the discount

for the period from July 1, 2017 to November 1, 2017,
calculated as follows:
Discount amortization = 952 x 4/6 = 635.
The following entry is to be recorded:

Debt investments 635

Interest Revenue 635
 Example 1: Held-to-maturity securities

The National Bank of Egypt has, then, to calculate the

realized gain or loss on the sale of investment as follows:

Selling price of investment (exclusive of 99,750

accrued interest)
Less: book value of bonds on Nov. 1 2017:
Amortized cost , July 1, 2017 99,048
Add: Discount amortized for the period July 635 (99,683)
1,2017 to Nov. 1, 2017

Gain on sale of bond 67

 Example 1: Held-to-maturity securities

To record the sale of the investment, the following journal

entry is made:

Cash 102,417
Interest revenue (4/6 x 4,000) 2,667
Debt Investments 99,683
Gain on sale of investments 67
 Example 2: Held-to-maturity securities

On January 1, 2013, Alexandria Bank purchased 12% bonds

having a maturity value of L.E. 300,000 for L.E. 322,744.44.
the bonds provide the bondholders with a 10% yield. They
are dated January 1, 2013, and mature January 1, 2018,
with interest receivable December 31 of each year.
Alexandria Bank uses the effective interest method to
allocate unamortized discount or premium. The bonds are
classified in the held-to-maturity category.
 Example 2: Held-to-maturity securities

Instructions:
1. Prepare the journal entry at the date of the bond
purchase.
2. Prepare a bond amortization schedule.
3. Prepare journal entries to record the first interest
payments.
4. Assume the bond was sold on October 1, 2017 for 99
plus accrued interest. Record the sale of the bond.
 Example 2: Held-to-maturity securities

January 1, 2013:

Debt investments 322,744.44

Cash 322,744.44
 Example 2: Held-to-maturity securities
Financial institutions must amortize premium or discount
using the effective interest method.
Date Cash Interest Premium Carrying
received revenue amortization amount of
bond
1/1/2013 -- -- -- 322,744.44
1/1/2014 36,000 32,274.44 3,725.56 319,018.88
1/1/2015 36,000 31,901.88 4,098.12 314,920.76
1/1/2016 36,000 31,492.07 4,507.92 310,412.83
1/1/2017 36,000 31,041.28 4,958.76 305,454
1/1/2018 36,000 30,545 5,454 300,000
 Example 2: Held-to-maturity securities
2- Entries to record interest accrual and collection on
December 31, 2013:

Interest Receivable 36,000

Interest Revenue 32,274.44
Debt investments 3,725.56
 Example 2: Held-to-maturity securities

Premium for the period from Jan 1, 2017 to October 1, 2017,

calculated as follows:
Premium amortization = 5,454 x 9/12 = 4,090.5
The following entry is to be recorded:

Interest Revenue 4,090.5

Debt investments 4,090.5
 Example 2: Held-to-maturity securities

Calculation of the realized gain or loss on the sale of

investment :

Selling price of investment (exclusive of 298500

accrued interest)
Less: book value of bonds on Oct. 1 2017:
Amortized cost , Jan 1, 2017 305,454
Less: Premium amortized for the period 4,090.5 (301363.5)
Jan 1,2017 to Oct. 1, 2017

Loss on sale of bond 2,863.5

 Example 2: Held-to-maturity securities

To record the sale of the investment, the following journal

entry is made:

Cash 325,500
Loss on sale of investment 2,863.5
Interest revenue (9/12 x 36,000) 27,000
Debt Investments 301,363.5