Accounting for Debt Investment
Overview
Sometimes, the company may have extra cash on hand that is not required in the operation for a period of time. In this case, it may use such excess cash to make the debt investment in order to earn extra revenue for the business. Likewise, the debt investment journal entry will be required from the date of the investment until the end of debt maturity or when the company sells it back.
The corporate or government bond is the common debt investment that the company usually makes in the business. Likewise, there are usually three stages of journal entry for this type of debt investment, including the journal entry at the first date of investment, for the interest accrued and payment, and at the end of maturity or when the company sells it back.
Debt investment journal entry
At the acquisition date of debt investment
The company can make the journal entry for debt investment by debiting the debt investments account and crediting the cash account.
| Account | Debit | Credit |
|---|---|---|
| Debt investments | $$$ | |
| Cash | $$$ |
The debt investments account is an asset account on the balance sheet. The balance of this account will be carried forward until the end of the debt maturity or when the company sells the investment.
Interest accrued and payment from debt investment
The company will earn interest income from the debt investment through the passage of time. Likewise, at the period end adjusting entry, the company will need to record the accrued interest to recognize the interest income for the period.
| Account | Debit | Credit |
|---|---|---|
| Interest receivable | $$$ | |
| Interest income | $$$ |
When the company receives the interest payment from the debt investment, it can make the journal entry as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | $$$ | |
| Interest receivable | $$$ |
This journal entry is made to recognize the cash inflow from the interest of debt investment as well as to eliminate the interest receivable that the company has recorded previously.
At the end of debt maturity
At the end of the debt maturity when the company receives the principal payment back, it can record the cash received with debt investments account in the journal entry as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | $$$ | |
| Debt investments | $$$ |
This journal entry is made to eliminate the debt investment since its maturity has already ended and the company has already received the cash principal back. Likewise, this debt investment will be removed from the balance sheet.
Debt investment journal entry example
For example, on January 1, 2020, the company ABC purchases a corporate bond for $10,000. The bond has a 5-year maturity with the 6% of annual interest, in which the company will receive the interest payment on Jan 1, every year for 5 years period. The company ABC has fiscal year-end on December 31.
What is the journal entry for the above investment:
- on January 1, 2020, when the company purchases the bond
- on December 31, 2020, when the company makes the period end adjusting entry
- on January 1, 2021, when the company receives the first interest payment
- at the end of the bond maturity when the company receives the principal payment back.
Solution
On January 1, 2020
On January 1, 2020, the company ABC can make the journal entry for the acquisition of debt investment as below:
| Account | Debit | Credit |
|---|---|---|
| Debt investments | 10,000 | |
| Cash | 10,000 |
On December 31, 2020
The company ABC can make the December 31 adjusting entry for the accrued interest of $600 (10,000 x 6%) from debt investment as below:
| Account | Debit | Credit |
|---|---|---|
| Interest receivable | 600 | |
| Interest income | 600 |
This journal entry is made to recognize the $600 interest that the company ABC has earned from debt investment in 2020. If this journal entry is not made, both total assets in the balance sheet as well as total revenues in the income statement will be understated by $600.
On January 1, 2021
On January 1, 2021, when the company receives the interest payment from debt investment, it can make the journal entry as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 600 | |
| Interest receivable | 600 |
In this journal entry, there is no interest income account as the company ABC has already recorded it in 2020. Similarly, the company has not earned the interest income in 2021 yet as it is still the beginning of 2021.
At the end of the bond maturity
At the end of the bond maturity, the company can make the journal entry after receiving principal payment back as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 10,000 | |
| Debt investments | 10,000 |
The debt investments of $10,00 will be removed from the balance sheet after this journal entry.
Sale of debt investment
Sometimes, the company may need to sell the debt investment back before maturity. In this case, there may be a gain or loss as a result of the sale of debt investment. Likewise, the company needs to recognize such gain or loss in the income statement.
Gain on sale of debt investment
The company makes a gain on the sale of debt investment when the net proceeds (sale price less brokerage fees) it receives is more than the cost of the debt.
In this case, the company can make the journal entry for a gain on sale of debt investment as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | $$$ | |
| Gain on sale of debt investments | $$$ | |
| Debt investments | $$$ |
Gain on sale of debt investment is usually recorded as the other revenues in the income statement.
Loss on sale of debt investment
On the other hand, the company makes a loss on the sale of debt investment when the net proceeds (sale price less brokerage fees) it receives is less than the cost of the debt.
Likewise, the company can make the journal entry for a loss on sale of debt investment as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | $$$ | |
| Loss on sale of debt investments | $$$ | |
| Debt investments | $$$ |
Loss on sale of debt investment is usually recorded as the other expenses in the income statement.
Sale of debt investment example
For example, instead of waiting for the end of bond maturity, the company ABC in the above example decides to sell the bond on Jan 1, 2021, after receiving the interest payment. The company ABC receives the net proceeds of $9,500 (the selling price less the brokerage fees) for the sale.
In this case, the company ABC will need to record the loss of $500 (10,00 – 9,500) as the other expenses in the income statement since the cost of the bond is $10,000. Likewise, the company can make the journal entry for the sale of debt investment as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 9,500 | |
| Loss on sale of debt investments | 500 | |
| Debt investments | 10,000 |
