a)
Investment: The act of allocating money to buy a monetary asset, in order to generate wealth in the future is referred to as investment.
Journal: Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.
Rules of Debit and Credit:
Following rules are followed for debiting and crediting different accounts while they occur in business transactions:
- Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
- Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.
To Journalize: The investment made by Company FM on January 1, 2016.
a)
![Check Mark](/static/check-mark.png)
Explanation of Solution
Prepare the
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
01.01.16 | Investment in Bonds | $80,000,000 | ||
Discount on bond investment | $14,000,000 | |||
Cash | $66,000,000 | |||
(To record the investment made ) |
Table (1)
- Investment in Bonds is an asset account. Since bonds investments are purchased, asset value increased, and an increase in asset is debited.
- Discount on Bond Investment is a contra-asset account. The contra-asset account generally has a credit balance. So, credit the discount, indicating a reduction in carrying amount of bonds to the cost.
- Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.
b)
To Journalize: The semiannual interest received by Company FM on June 30, 2016.
b)
![Check Mark](/static/check-mark.png)
Explanation of Solution
Prepare the journal entry to record the investment made by Company FM.
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
06.30.16 | Cash (2) | $3,200,000 | ||
Discount on bond investment (3) | $100,000 | |||
Interest revenue (1) | $3,300,000 | |||
(To record the investment made ) |
Table (2)
- Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
- Discount on Bond Investment is a contra-asset account. The contra-asset account generally has a credit balance. Since the discount amount is reduced, the account is debited.
- Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.
Working Note:
Calculate the interest revenue.
Calculate the cash received.
Calculate the discount on bond investment.
c)
To Journalize: The semiannual interest received by Company FM on December 31, 2016.
c)
![Check Mark](/static/check-mark.png)
Explanation of Solution
Prepare the journal entry to record the investment made by Company FM.
Date | Account Title | Post ref. | Debit ($) | Credit ($) |
12.31.16 | Cash (2) | $3,200,000 | ||
Discount on bond investment (5) | $110,000 | |||
Interest revenue (4) | $3,310,000 | |||
(To record the investment made ) |
Table (3)
- Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
- Discount on Bond Investment is a contra-asset account. The contra-asset account generally has a credit balance. Since the discount amount is reduced, the account is debited.
- Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.
Working Note:
Calculate the interest revenue.
Calculate the discount on bond investment.
d)
To Calculate: The amount of investment to be recorded in the balance sheet of Company FM on December 31, 2016.
d)
![Check Mark](/static/check-mark.png)
Explanation of Solution
1.
Calculate the amount of investment to be recorded in the balance sheet of Company FM on December 31, 2016.
Investment in Bonds$80,000,000
Less: Discount on bond investment $13,790,000
Amortized Cost$66,210,000
Hence, the amount of investment to be recorded in the balance sheet of Company FM on December 31, 2016 is $66,210,000.
Working Note:
Calculate the discount on bond investment.
2.
Prepare the journal to update the fair value adjustment.
The
Date | Account Titles and Explanations | Post. Ref. | Debit ($) | Credit ($) |
12.31.16 | Fair-value adjustment (7) | $3,790,000 | ||
Unrealized holding gain—OCI | $3,790,000 | |||
(To record unrealized gain on equity securities) |
Table (4)
Explanation:
- Fair Value Adjustment is a contra-asset account which serves the purpose of valuation allowance account. The account is adjusted to update the fair value as on December 31, 2016.
- Unrealized Holding Gain–OCI is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since gain has occurred and gains increase
stockholders’ equity value, it is credited.
Working Notes:
Compute the unrealized gain as on December 31, 2016, by adjusting the cost to the fair value.
Details | Amount ($) |
Fair value adjustment balance as on January 1, 2016 | 70,000,000 |
Adjustment needed to update fair value (Balancing figure) (7) | 3,790,000 |
Fair value adjustment balance needed on December 31, 2016 | 66,210,000 |
Table (5)
Explanation:
Available-for-sale (AFS) securities: These are short-term or long-term investments in debt and equity securities with an intention of holding the investment for some strategic purposes like meeting liquidity needs, or manage interest risk.
The bonds invested by Company FM are available for sale securities; hence the value is calculated at the amortized cost instead of the fair value, to get the market updates. The amortized cost is adjusted to the fair value using the adjusting entry.
e)
To Explain: The effect of investment by Company FM on December 31, 2016, in the statement of cash flows.
e)
![Check Mark](/static/check-mark.png)
Explanation of Solution
Statement of cash flows: This statement reports all the cash transactions which are responsible for inflow and outflow of cash, and result of these transactions is reported as ending balance of cash at the end of reported period.
The cash flow statement would be as below if the Company FM follows the direct method.
Cash flows from operating activities: | ||
$3,200,000 | ||
Cash inflow from interest | $3,200,000 | |
Net cash flow used for operating activities | $6,400,000 |
Table (6)
Cash flows from investing activities: | ||
Investment in Bonds | $66,000,000 |
Table (7)
The cash flow statement would be as below if the Company FM follows the indirect method.
Cash flows from operating activities: | ||
Cash inflow from interest | $3,300,000 | |
Cash inflow from interest | $3,310,000 | |
Net cash flow used for operating activities | $6,610,000 |
Table (8)
The Net cash flow used for operating activities would require an adjustment for $210,000
Cash flows from investing activities: | ||
Investment in Bonds | $66,000,000 |
Table (9)
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