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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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Held-to-Maturity Securities and Amortization of a Discount On January 1, 2019, Kelly Corporation acquired bonds with a face value of $500,000 for $483,841.79, a price that yields a 10% effective annual interest rate. The bonds carry a 9% stated rate of interest, pay interest semiannually on June 30 and December 31, are due December 31, 2022, and are being held to maturity

Required:

Prepare journal entries to record the purchase of the bonds and the first two interest receipts using the:

  1. 1. straight-line method of amortization
  2. 2. effective interest method of amortization

To determine

Record the journal entries for the purchase of bonds and the first two interest receipts using the following methods:

(1) Straight-line method of amortization

(2) Effective interest method of amortization

Explanation

Straight-line bond amortization:

The method of bond amortization by distributing the bond discount amount over the interest period equally is known as straight-line amortization of bond.

Effective interest amortization method: The amortization method which applies the market rate of interest to calculate the interest and the amortization of bond discount or premium for a particular period of time is known as effective interest amortization model.

(1)

Record the journal entries for the purchase of bonds and the first two interest receipts using the straight-line method of amortization:

To record the purchase of the bonds:

DateAccount Title and Explanation Debit ($) Credit ($)
January 1, 2019Investment in Held-to-Maturity Debt Securities483,841.79  
     Cash   483,841.79
 (To record the purchase of debt securities)  

Table (1)

  • Investment in Held-to-Maturity Debt Securities is an asset account and it is increased. Thus, debit investment in held-to-maturity debt securities with $483,841.79.
  • Cash is an asset account and it is decreased. Thus, credit cash with $483,841.79.

To record the interest receipts:

DateAccount Title and Explanation Debit ($) Credit ($)
June 30, 2019Cash (1)22,500.00 
 Investment in Held-to-Maturity Debt Securities (2)2,019.78  
     Interest income  24,519.78
 (To record the interest and amortization)  

Table (2)

  • Investment in Held-to-Maturity Debt Securities is an asset account and it is increased. Thus, debit investment in held-to-maturity debt securities with $2,019.78.
  • Cash is an asset account and it is increased. Thus, debit cash with $22,500.00.
  • Interest income is revenue and it increases the value of shareholders’ equity. Thus, credit interest income with $24,519.78.

Working note (1):

Calculate the amount of cash:

Cash=Face value×Interest rate×6 months12 months=$500,000×0.09×6 months12 months=$22,500.00

Working note (2):

Calculate the amount of investment in held-to-maturity debt securities:

Investment in held-to-maturity debt securities=(Face valuePurchase price)8 semi annual periods=($500,000.00$483,841.79)8=$2,019.78

To record the interest receipts:

DateAccount Title and Explanation Debit ($) Credit ($)
December 30, 2019Cash (1)22,500.00 
 Investment in Held-to-Maturity Debt Securities (2)2,019.78  
     Interest income  24,519.78
 (To record the interest and amortization)  

Table (3)

  • Investment in Held-to-Maturity Debt Securities is an asset account and it is increased. Thus, debit investment in held-to-maturity debt securities with $2,019.78.
  • Cash is an asset account and it is increased. Thus, debit cash with $22,500.00.
  • Interest income is revenue and it increases the value of shareholders’ equity. Thus, credit interest income with $24,519.78.

(2)

Record the journal entries for the purchase of bonds and the first two interest receipts using the effective interest method of amortization:

To record the purchase of the bonds:

DateAccount Title and Explanation Debit ($) Credit ($)
January 1, 2019Investment in Held-to-Maturity Debt Securities483,841.79  
     Cash   483,841.79
 (To record the purchase of debt securities)  

Table (4)

  • Investment in Held-to-Maturity Debt Securities is an asset account and it is increased. Thus, debit investment in held-to-maturity debt securities with $483,841

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