Reclassification of Investments

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turbo989

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Just trying to wrap my head around this. I doubt you are asked to do this on the exam but…
Say you are changing Available-For-Sale to Held-To-Maturity. Any Unrealized G/L in OCI needs to be amortized out over the remaning life. Where does this go? Does this hit your Income Statement as a loss?
Also FMV becomes your new amortized cost on the BS. Do you have to figure out where your amortization would have been as if you had it held to maturity this entire time? I guess I am confused as to how you can figure out what the amortization value is when you are bringing it over at FMV rather than the initial pemium/discount which is easy to create an amortization schedule.
There are no examples of this in the curriciulum so I think it is more “trivial pursuit” than doing calculations.
 
In BS Asset position the bond reclassified from AFS to HTM remains on same position - financial assets.
The difference is measuring. After reclassification from AFS to HTM, the bond fair value (market value) becomes new book value from which new classification measuring is starting . Amortization of discount or premium should be done via P/L after reclassification, no longer in OCI.
Remember, while bond is classified as AFS there is not amortization in P/L than each market price appreciation/depreciation is shown in OCI as an offset account of mentioned asset position account.
Each collected cash flow (coupon or dividend) should appear in P/L no matter of classification method.
 
But what do you do with the OCI G/L that is already accounted for (the MTM)?. It says it needs to be “amortized out” of OCI. How is that done? It hits P&L which makes sense, but how is that calculated?
Say a bond lost $50 in MTM value which previously was recorded as a loss in OCI (direct to equity). Now you want to move that bond to HTM. How do you amortize that $50 loss to P&L?
I know the current FMV becomes the new Book Value, then you start amortizing the premium/discount like a normal HTM bond. But there is an unrealized loss sitting there in OCI and I do not know what you do with it besides “amortize” it over life.
EDIT:
“Any unrealized gain/loss previously recognized in OCI are amortized to P/L over remaining term of security’s life using effective interest rate method.”
and
“Differences between new Fair Value and par value are also amortized remaining term of security’s life” - but no hit to P&L
It just seems weird to me amortizing anything other than to a bond premium/discount to par. This is amortizting original price to FMV @ time of transfer using effective interest rate method.
 
turbo989 wrote:
But what do you do with the OCI G/L that is already accounted for (the MTM)?. It says it needs to be “amortized out” of OCI. How is that done? It hits P&L which makes sense, but how is that calculated?
Click to expand...
The Securities FV Adjustment balance (G/L) as well as (historical) purchasing price are shown as new book value of security and amortized in P/L over the remaining life of the bonds (note that only fixed income security may be classified as HTM).
turbo989 wrote:
Say a bond lost $50 in MTM value which previously was recorded as a loss in OCI (direct to equity). Now you want to move that bond to HTM. How do you amortize that $50 loss to P&L?
I know the current FMV becomes the new Book Value, then you start amortizing the premium/discount like a normal HTM bond. But there is an unrealized loss sitting there in OCI and I do not know what you do with it besides “amortize” it over life.
Click to expand...
There is only one amount of revalued value of bond, thus as mentioned above the revalued vale of a security (purchasing price - unrealized loss+unrealized gain), evidented as new asset value which is starting point for measuring as HTM.
Here is a template of booking entries for reclassification AFS(OCI) to HTM which I found:
Held-to-Maturity Securities (DR) 110.000
Unrealized Holding Gain or Loss-OCI (CR) 10,000
Available-for-Sale Securities (CR) 100,000

Note that bond is starting amortize from the new value, 110.000 (original vale + change in its value brought from OCI), not from purchasing value of 100.000.
Also, note that OCI is a BS position (part of equity, in Europe we call it a revaluation reserve account), not a P/L position, maybe this is what makes a confusion..
turbo989 wrote:
EDIT:
“Any unrealized gain/loss previously recognized in OCI are amortized to P/L over remaining term of security’s life using effective interest rate method.”
and
“Differences between new Fair Value and par value are also amortized remaining term of security’s life” - but no hit to P&L
It just seems weird to me amortizing anything other than to a bond premium/discount to par. This is amortizting original price to FMV @ time of transfer using effective interest rate method.
Click to expand...
Please, see above explanation. This is all the same issue.
 
I am sorry for confusing. Here is what is stated in IFRS 9 about this issue, “Where the financial asset is derecognized, the cumulative gain or loss previously recognized in OCI is reclassified from equity to profit or loss “.

I have no idea what is Yankee approach, but obviously is different from European.
 
“Where the financial asset is derecognized, the cumulative gain or loss previously recognized in OCI is reclassified from equity to profit or loss “.
That last part makes sense, but when it is reclassified to P/L for that years is it done all at once? How much is done each year? Maybe I am looking beyond the scope of the curriculum.
 
I tried draw booking entries on paper and IMO it can be done only via P/L in fact an offset account of previously OCI (G/L) entries is an asset in BS. Bond with value adjusted for each OCI offset entry. Thus a security book value had been adjusted already for any gain or loss in OCI. Maybe, there is an another approach for G/L amortization directly from OCI to P/L periodically but I am not familiar with this approach.
 
Under US GAAP, you would amortize the balance in OCI into interest income over the life of the loan. ASC 320-10-35-10 is the exact FASB guidance. It is only a few sentences. I would paste if I could, but for some reason cannot.
 
Hi, @Flashback.
What about taxes then?
Suppose, you buy a bond at par and classify it as AFS, so all m-t-m’s will fall into the OCI. If market rates go down, your bond will appreciate and you will show a positive unrealized gain in the OCI statement.
Then you re-classify your bond into an HTM one. Your book value is at premium, so you’ll receive interest income less than coupon payment until the bond matures and you’ll pay less income tax due to the lower intereset income received. The unrealized gain isn’t taxed at all, and it’s accrued into the retained earnings.
How do you think, is that fair? Will IRS accuse me of hiding part of the interest income from taxation due to such re-classification?
 
The unrealized gain in OCI will amortize into interest income and perfectly (in theory) offset the amortization of your premium. In other words you will have two offsetting amortizations.
In your example above, lets’ say the bond has appreciated $3. When you switch to HTM, you will have a $3 premium in your assets, which represents the diff between FV and Par. You will also have $3 in OCI. Both amortize into Interest Income, and offfset.
 
In AFS category, a deferred tax should be recognized on unrealized gain/losses.
A DT appear as each net unrealized loss gain has been recorded in OCI.
At the moment of derecognition (reclassication to HTM), deferred taxes have been transeferred to current tax liability or current tax credit (in case of unrealized losses).
This above was “school” sample assuming no taxes.
 
40yoCFAcandidate wrote:
The unrealized gain in OCI will amortize into interest income and perfectly (in theory) offset the amortization of your premium. In other words you will have two offsetting amortizations.
In your example above, lets’ say the bond has appreciated $3. When you switch to HTM, you will have a $3 premium in your assets, which represents the diff between FV and Par. You will also have $3 in OCI. Both amortize into Interest Income, and offfset.
Click to expand...
40yo (peer):)
I found your explanation among other post right now. Thanks, didn’t know for this approach.
 
40yoCFAcandidate wrote:
The unrealized gain in OCI will amortize into interest income and perfectly (in theory) offset the amortization of your premium. In other words you will have two offsetting amortizations.
In your example above, lets’ say the bond has appreciated $3. When you switch to HTM, you will have a $3 premium in your assets, which represents the diff between FV and Par. You will also have $3 in OCI. Both amortize into Interest Income, and offfset.
Click to expand...
See.. this makes sense. lol
 
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