How to record investment in debt security

Introduction

In the security market, the investment in debt security is considered a lower risk investment compared to equity or stock investment. Likewise, we usually make investments in debt security if we are unwilling to take a high-risk investment or if we want to diversify our investment portfolio.

In accounting, the investment in debt security is recorded as an investment asset on the balance sheet with its cost or purchase price that includes any brokerage or commission fees. And as debt investments usually come with the interest, we also need to record the interest that we receive from the investment during the period or at the end of the period to the income statement.

Although we usually invest in debt security in order to earn the interest as extra revenue until its maturity, we may decide to sell them back before their maturity. This usually happens when we are in urgent need of cash or when there is a significant change in the market interest rate. In this case, there is usually a gain or loss on the sale of the debt security that we also need to record to the income statement.

Purchase of investment in debt security

We can record the purchase of investment in debt security with the journal entry of debiting the debt investment account and crediting the cash account.

In this journal entry, the debt investment is recorded on the date of the purchase and at its cost or purchase price which includes any commissions or fees. And, this journal entry for the purchase of investment in debt security will increase one asset (debt investment) on the balance sheet while decreasing another asset (cash) at the same time. Hence, there is zero impact on the total assets of the balance sheet.

Interest on investment in debt security

As mentioned, debt security such as bonds, promissory notes, or commercial papers usually come with an interest attached in order to encourage the investors to buy.

In this case, as investors, we can record the interest that we receive from the investment in debt security by debiting the cash account and crediting the interest income account as in the journal entry below:

In this journal entry, both total assets on the balance sheet and total revenues on the income statement increase by the same amount as the cash and interest income increase.

Receive principal at maturity

When we receive the principal back at the maturity of the debt security that we have invested, we can record the principal cash received as a debit to the cash account and a credit to the debt investment account as in the journal entry below:

Investment in debt security example

For example, on January 1, we purchase a $100,000 commercial paper with an interest of 5% per annum and a maturity of 3 months. We will receive both interest and principal at the end of this debt maturity which is March 31.

In this case, we can record the investment in debt security of the $100,000 commercial paper on January 1 with the journal entry below:

In this journal entry, our investment assets on the balance sheet will increase by $100,000 while our cash balance decrease will by the same amount on January 1.

Later, on March 31, when we receive both the $100,000 principal and the $1,250 interest, we can record the journal entry below:

* ($100,000 x 5%) x 3/12 = $1,250

Sale of investment in debt security before maturity

As mentioned, we may sell the debt security back to the market before its maturity which results in a gain or loss for the transaction. In this case, we need to record any gain or loss as a result of sale to the income statement for the period.

Gain on sale of investment in debt security

We will have a gain on the sale of investment in debt security when the sale price of the debt investment is more than the cost that we purchased.

In this case, we can record the gain on the sale of investment in debt security with the journal entry of debiting the cash account and crediting the gain on sale of investment account and the debt investment account.

In this journal entry, the gain on sale of investment account is a revenue account on the income statement that we usually record under the other revenues section.

Loss on sale of investment in debt security

On the other hand, we will have a loss on the sale of investment in debt security when the sale price of the debt investment is less than the cost that we purchased.

In this case, we can record the loss on the sale of investment in debt security with the journal entry of debiting the cash account and the loss on sale of investment account and crediting the debt investment account.

In this journal entry, loss on sale of investment account is an expense account on the income statement that is usually recorded under the other expenses section.

Sale of investment in debt security example

For example, on January 1, we purchase a $50,000 debt security which is a type of corporate bond that has a 10-years maturity and give a 6% interest per annum. The interest is payable annually.

However, on June 30, as we are in urgent need of cash for our business operation, we decide to sell this $50,000 corporate bond that we purchased as a debt investment on January 1 for only $49,000. This results in us making a loss of $1,000 on the sale of the investment in this security.

In this case, we can record the purchase of the $50,000 debt security on January 1 with the journal entry below:

January 1:

And then, on June 30, when we sell the debt security for $49,000, we can record the $1,000 loss with the debit of the loss on sale of investment as in the journal entry below:

June 30: