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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Premium Amortization on Bond Investment and Partial Sale of the Investment Using the Effective Interest Method On January 1, 2019, Hyde Corporation purchased bonds with a face value of $300,000 for $308,373.53. The bonds are due June 30, 2022, carry a 13% stated interest rate, and were purchased to yield 12%. Interest is payable semiannually on June 30 and December 31. On March 31, 2020, in contemplation of a major acquisition, the company sold one-half the bonds for $159,500 including accrued interest; the remainder were held until maturity.

Required:

Prepare the journal entries to record the purchase of the bonds, each interest payment, the partial sale of the investment on March 31, 2020, and the retirement of the bond issue on June 30, 2022.

To determine

Prepare the journal entries to record the bond purchase, interest payment, sale of investment partially on March 31, 2020, and the retirement of the bond on June 30, 2022.

Explanation

Effective interest rate of bond amortization:

Effective interest rate method of amortization is a process of amortizing premium on bond or discount on bond, which allocates the different amount of interest expense in each period of interest payment, but at a constant percentage rate.

On January 1, 2019, Corporation H purchased 13%, bond with a face value of $300,000 for $308,373.53. The bond carries 13% interest rate, and it will be paid semiannually on June 30 and December 31, until the maturity date of June 30, 2022. The effective interest rate is 12%.

During March 31, 2019, Corporation H sold one-half of the bonds for $159,500. Corporation H uses effective interest rate for amortization.

Prepare a schedule of bond investment interest income and premium amortization.

Corporation H
Bond investment interest income and Premium amortization Schedule (Partial)
Effective interest rate method
DateCash (Debit) (a)Interest income (Credit) (b)Investment in debt securities (Credit) (c)Carrying value of debt securities (d)
January 1, 2019   $308,373.53
June 30, 2019$19,500.00$18,502.41$997.59$307,375.94
December 31, 2019$19,500.00$18,442.56$1,057.44$306,318.50
March 31, 2020$159,500.00$4,594.78$153,159.25$153,159.25
June 30, 2020$9,750.00$9,189.56$560.44$152,598.81
December 31, 2020$9,750.00$9,155.93$594.07$152,004.74
June 30, 2021$9,750.00$9,120.28$629.72$151,375.02
December 31, 2021$9,750.00$9,082.50$667.50$150,707.52
June 30, 2022$159,750.00$9,042.48$150,707.52$0.00

Table (1)

Note:

1. Cash (a) = Bonds outstanding×13%×6 months12 months  (13% is bonds stated interest rate). On March 31, 2020 the half of the bond sold for $159,500. Thus increases the cash.

2. Interest income (b)=Previous carrying value×12%×6 months12 months (12% is effective interest rate).

3. Investment in debt securities (c)=Cash (a)Amount of interest income(b), Where (c) represents an amount of amortization of premium. On March 31, 2020, $153,159.25=($159,500sold$4,594.78interest income $1,745.97gain)

4. Carrying value of debt securities (d) = [Previous carrying value (d)Investment in debt securities (c)]

5. Refer journal entry as on March 31, 2020, and respective working notes for interest income, investment in debt securities, and carrying value as of March 31, 2020.

Procedure to be followed to prepare journal entries:

  • Increase in assets, increase in expenses, decrease in revenue, and decrease in liabilities should be debited.
  • Decrease in assets, increase in revenue, decrease in expenses, and increase in liabilities should be credited.

Prepare journal entries in the books of Corporation H.

Record the purchase of held-to maturity debt securities.

DateAccount Title and ExplanationDebitCredit
January 1, 2019Investment in Held-to-Maturity Debt Securities$308,373.53 
         Cash $308,373.53
 (To record the purchase of held-to-maturity securities at premium)  

Table (2)

Record the interest income earned on June 30, 2019 and December 31, 2019.

DateAccount Title and ExplanationDebitCredit
June 30, 2019Cash$19,500.00 
 

         Investment in Held-to-Maturity Debt

         Securities

$18,502.41
          Interest income $997.59
 (To record the interest and amortization)  

Table (3)

DateAccount Title and ExplanationDebitCredit
December 31, 2019Cash$19,500.00 
          Investment in Held-to-Maturity Debt Securities $18,442.56
          Interest income $1,057.44
 (To record the interest and amortization)  

Table (4)

Record the sale of half of the bond on March 31, 2020.

Step 1: Determine the amount of amortization.

Amortization= ([Face value of half of the bond sold×stated interest rate×(Number of month from January to March12months)][Carrying value of debt on December 31, 20192×Effectiveinterest rate ×(Number of month from January to March12months)])=([$150,000×0.13×312][$306,318

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