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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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Discount Amortization on Bond Investment and Partial Sale of Investment Using Effective Interest Method On January 1, 2019, Mark Corporation purchased bonds with a face value of $500,000 for $475,413.60. The bonds are due December 31, 2021, carry a 10% stated rate, and were purchased to yield 12%. Interest is payable semiannually on June 30 and December 31. On January 1, 2021, in contemplation of a major acquisition, one-fourth of the bonds were sold for $127,000. The remainder were held until maturity.

Required:

Prepare journal entries to record the purchase of the bonds, each interest payment, the partial sale of the investment on January 1, 2021, and the retirement of the bond issue on December 31, 2021.

To determine

Journalize the purchase of bonds, interest payment, partial sale of the investment on January 1, 2019, and the retirement of the bond issue on December 31, 2019.

Explanation

On January 1, 2019, Corporation M purchased 10%, bond with a face value of $500,000 for $475,413.60. The bond carries 10% interest rate, and it will be paid semiannually on June 30 and December 31, until the maturity date of December 31, 2021. The effective interest rate is 12%.

During January 1, 2021, Corporation M sold one-fourth of the bonds for $127,000. Corporation M uses effective interest rate for amortization.

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

Corporation M
Bond investment interest income and Discount amortization Schedule (Partial)
Effective interest rate method
DateCash (Debit) (a)Interest income (Credit) (b)Investment in debt securities Debit (Credit) (c)Carrying value of debt securities (d)
January 1, 2019   $475,413.60
June 30, 2019$25,000.00$28,524.82$3,524.82$478,938.42
December 31, 2019$25,000.00$28,736.31$3,736.31$482,674.73
June 30, 2020$25,000.00$28,960.48$3,960.48$486,635.21
December 31, 2020$25,000.00$29,198.11$4,198.11$490,833.32
January 1, 2021$127,000.00$0.00-$122,708.33$368,124.99
June 30, 2021$18,750.00$22,087.50$3,337.50$371,462.49
December 31, 2021$393,750.00$22,287.51-$371,462.49$0.00

Table (1)

Note:

1.

Cash (a) = Bonds outstanding×10%×6 months12 months

(10% is bonds stated interest rate). On January 1, 2021 the one-fourth of the bond sold for $127,000. 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)=Amount of interest income(b)Cash (a), Where (c) represents an amount of amortization of discount. On January 1, 2018, the one-fourth value of the bond $122,708.33 sold for $127,000 as calculated below:

Value of bond sold onJanuary 1, 2021 is creditedin investment in debt securities}=Value of bond on December 31, 20204=$490,833.324=$122,708.33

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

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 M.

Record the purchase of held-to maturity debt securities.

DateAccount Title and ExplanationDebitCredit
January 1, 2019Investment in Held-to-Maturity Debt Securities$475,413.60 
         Cash $475,413.60
 (To record the purchase of held-to-maturity securities at discount)  

Table (2)

Explanation:

  • Cash is an asset and decreased. Therefore, credit the cash account.
  • Investment in held-to-maturity debt securities is an asset. It is increased here due to purchase of bond.

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

DateAccount Title and ExplanationDebitCredit
June 30, 2019Cash$25,000.00 
 Investment in Held-to-Maturity Debt Securities$3,524.82 
          Interest income $28,524

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