Chapter 14, Problem 14.24P

(1)

To determine

Bonds

Bonds are a kind of interest bearing notes payable, usually issued by companies, universities and governmental organizations. It is a debt instrument used for the purpose of raising fund of the corporations or governmental agencies. If selling price of the bond is equal to its face value, it is called as par on bond. If selling price of the bond is lesser than the face value, it is known as discount on bond. If selling price of the bond is greater than the face value, it is known as premium on bond.

Accrued interest

The amount of interest that has already occurred, but the payment is not made yet, is known as accrued interest.

Straight line amortization bond

Straight line method of amortization is a process of amortizing premium on bond or discount on bond, which allocates the same amount of interest expense in each period of interest payment.

To Prepare: The appropriate journal entries for these long – term bond investments.

Explanation of Solution

Prepare necessary journal entries for long-term bond investment as on 1^st July 2016.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2016		Bonds Investment	16,000,000
July	1
		Discount on Bonds Investment		300,000
		Cash		15,700,000
		(To record the purchase of  B bonds)

Table (1)

Working note:

Calculate discount on bonds investment.

$\begin{array}{c}\text{Discount on bonds investment }=\text{Bonds investment –}\text{Cash paid}\\ =\$16,000,000-\$15,700,000\\ =\$300,000\end{array}$

Hence, discount on bonds investment amount is $300,000.

Journal entry for purchases of F bonds as son 1^st October 2016.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2016		Investment in Bonds	30,000,000
October	1
		Premium on Bonds Investment	1,160,000
		Interest Receivable	1,200,000
		Cash		32,360,000
		(To record the purchase of  F bonds)

Table (2)

Working notes:

Calculate the amount of interest receivable for 4 months (from June 1 to October 1).

$\begin{array}{c}\text{Interest receivable = Bond investment }\times \text{ 12\% }\times \frac{4}{12}\\ =\$30,000,000\times 12\%\times \frac{4}{12}\\ =\$1,200,000\end{array}$

Hence, interest receivable amount is $1,200,000.

Calculate the amount of cash paid.

$\begin{array}{c}\text{Cash paid = }\left(\begin{array}{l}\text{Bonds investment + Premium on bonds investment }\\ \text{+ Interest receivable}\end{array}\right)\\ =\$30,000,000+1,160,000+\$1,200,000\\ =\$32,360,000\end{array}$

Hence, cash paid amount is $32,360,000.

Journal entry for interest received on F bonds as son 31^st December 2016.

Date		Account Title and Explanation			Debit ($)	Credit ($)
2016		Cash			1,800,000
December	1
			Premium on Bonds Investment			20,000
			Interest Receivable			1,200,000
			Interest Revenue			580,000
				(To record interest received on F bonds)

Table (3)

Working notes:

Calculate the amount of cash received.

$\begin{array}{c}\text{Cash received = \$30,000,000 }\times \text{ 6\%}\\ \text{= \$1,800,000}\end{array}$

Hence, cash received amount is $1,800,000.

Calculate premium on bonds investment.

$\begin{array}{c}\text{ Premium on bonds investment per month}=\frac{\text{Total bond}\text{investment}\text{premium }}{\text{Number of premium in months}}\\ =\frac{\$1,160,000}{116\text{months}\left(10\text{years}\text{–}\text{4}\text{months}\right)}\\ =\$10,000\end{array}$

$\begin{array}{c}\text{Premium on bonds investment for 2 months = \$10,000 }\times \text{ 2 months}\\ \text{= \$20,000}\end{array}$

Hence, premium on bonds investment amount for two months is $20,000.

Calculate the interest revenue on the bond investment.

$\begin{array}{c}\text{Interest}\text{Revenue}=\left(\begin{array}{l}\text{Cash received}-\text{Premium}\text{on}\text{bond}\text{investment }\\ \text{– Interest revenue}\end{array}\right)\\ =\$1,800,000-\$20,000-\$1,200,000\\ =\$580,000\end{array}$

Hence, Interest revenue amount is $580,000.

Journal entry for interest accrued for B bonds as on 31^st December 2016.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2016		Interest Receivable	800,000
December	31
		Discount on Bonds Investment	7,500
		Interest Revenue		807,500
		(To record the interest accrued for B bonds)

Table (4)

Working notes:

Calculate the amount of interest receivable.

$\begin{array}{c}\text{Interest receivable = \$16,000,000}\times \text{10\%}\times \frac{6}{12}\\ =\$800,000\end{array}$

Hence, interest receivable amount is $800,000.

Calculate discount on bonds investment.

$\begin{array}{c}\text{ Discount on bonds investment per month}=\frac{\text{Total bond}\text{investment}\text{discount }}{\text{Number of discount in months}}\\ =\frac{\$300,000}{\text{240 months}\left(20\text{years}\right)}\\ =\$1,250\end{array}$

$\begin{array}{c}\text{Discount on bonds investment for 6 months = \$1,250 }\times \text{ 6 months}\\ \text{= \$7,500}\end{array}$

Hence, discount on bond investment amount is $7,500.

Calculate the amount of interest revenue.

$\begin{array}{c}\text{Interest revenue = Interest receivable + Discount on bond investment}\\ \text{= \$800,000 +\$7,500}\\ \text{=\$807,500}\end{array}$

Hence, interest revenue amount is $807,500.

Journal entry for interest accrued for F bonds as on 31^st December 2016.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2016		Interest Receivable	300,000
December	31
		Premium on Bonds Investment		10,000
		Interest Revenue		290,000
		(To record the interest accrued for F bonds)

Table (5)

Working notes:

Calculate the amount of interest receivable.

$\begin{array}{c}\text{Interest receivable = \$30,000,000}\times \text{12\%}\times \frac{1}{12}\\ =\$300,000\end{array}$

Hence, interest receivable amount is $300,000.

Calculate the amount of interest revenue.

$\begin{array}{c}\text{Interest revenue = Interest receivable – Premium on bond investment}\\ \text{= \$300,000 –\$10,000}\\ \text{=\$290,000}\end{array}$

Hence, interest revenue amount is $290,000.

Explanation:

Journal entry for interest received on B bonds as on 1^st January 2017.

Date		Account Title and Explanation			Debit ($)	Credit ($)
2017		Cash			800,000
January	1
			Interest Receivable			800,000
				(To record interest received on B bonds)

Table (6)

Working note:

Calculate the amount of interest received (cash received).

$\begin{array}{c}\text{Interest}\left(\text{cash }\right)\text{received = \$16,000,000}\times \text{10\%}\times \frac{6}{12}\\ =\$800,000\end{array}$

Hence, cash received amount is $800,000.

Journal entry for interest received on F bonds as on 1^st June 2017.

Date		Account Title and Explanation			Debit ($)	Credit ($)
2017		Cash			1,800,000
June	1
			Premium on Bonds Investment			50,000
			Interest Receivable			3,000,000
			Interest Revenue			1,450,000
				(To record interest received on F bonds)

Table (7)

Working notes:

Calculate the amount of cash received.

$\begin{array}{c}\text{Cash received = \$30,000,000 }\times \text{ 6\%}\\ \text{= \$1,800,000}\end{array}$

Hence, cash received amount is $1,800,000.

Calculate premium on bonds investment.

$\begin{array}{c}\text{Premium on bonds investment for 5 months = \$10,000 }\times \text{ 5 months}\\ \text{= \$50,000}\end{array}$

Hence, premium on bonds investment amount is $50,000.

Calculate the interest revenue on the bond investment.

$\begin{array}{c}\text{Interest}\text{Revenue}=\left(\begin{array}{l}\text{Cash received}-\text{Premium}\text{on}\text{bond}\text{investment }\\ \text{– Interest revenue}\end{array}\right)\\ =\$1,800,000-\$50,000-\$300,000\\ =\$1,450,000\end{array}$

Hence, interest revenue amount is $1,450,000.

Journal entry for interest received on B bonds as on 1^st July 2017.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2017		Cash	800,000
July	1
		Discount on Bonds Investment	7,500
		Interest Revenue		807,500
		(To record the interest accrued for B bonds)

Table (8)

Journal entry for interest accrued for F bonds as on 1^st September 2017.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2017		Interest Receivable	450,000
September	1
		Premium on Bonds Investment		15,000
		Interest Revenue		435,000
		(To record the interest accrued for F bonds)

Table (9)

Working notes:

Calculate the amount of interest receivable.

$\begin{array}{c}\text{Interest receivable = \$15,000,000}\times \text{12\%}\times \frac{3}{12}\\ =\$450,000\end{array}$

Hence, interest receivable amount is $450,000.

Calculate premium on bonds investment.

$\begin{array}{c}\text{Premium on bonds investment = \$10,000 }\times 3\text{months }\times \frac{\text{15}}{30}\\ \text{= \$15,000}\end{array}$

Hence, premium on bonds investment amount is $15,000.

Calculate the amount of interest revenue.

$\begin{array}{c}\text{Interest revenue = Interest receivable – Premium on bond investment}\\ \text{= \$450,000 –\$15,000}\\ \text{=\$435,000}\end{array}$

Hence, interest revenue amount is $435,000.

Journal entry for sale of F bonds as on 1^st September 2017.

Date		Account Title and Explanation			Debit ($)	Credit ($)
2017		Cash			15,600,000
September	1
		Loss on Sale of Investment			375,000
			Premium on Bonds Investment			525,000
			Bond Investment			15,000,000
			Interest Receivable			450,000
				(To record sale of F bonds)

Table (10)

Working notes:

Calculate the amount of cash received.

$\begin{array}{c}\text{Cash received = }\left(\text{\$15,000,000}\times \text{101\% }\right)\text{+}\text{\$450,000}\\ \text{= \$15,600,000}\end{array}$

Hence, cash received amount is $15,600,000.

Calculate premium on bonds investment.

$\begin{array}{c}\text{Premium on bonds investment = }\left[\left(\begin{array}{l}\text{\$1,160,000 –\$20,000 }\\ \text{–\$10,000–\$50,000}\end{array}\right)\times \frac{15}{30}\right]-\$15,000\\ =\$525,000\end{array}$

Hence, premium on bonds investment amount is $525,000.

Calculate loss on sale of investment.

$\begin{array}{c}\text{Loss on sale of investment = }\left(\begin{array}{l}\text{Bond investment }\\ \text{+ Premium on bond investment }\\ \text{+ Interets receivable – Cash received}\end{array}\right)\\ =\$15,000,000+\$525,000+\$450,000-\$15,600,000\\ =\$375,000\end{array}$

Hence, loss on sale of investment amount is $375,000.

Journal entry for interest received on F bonds as on 1^st December 2017.

Date		Account Title and Explanation			Debit ($)	Credit ($)
2017		Cash			900,000
December	1
			Premium on Bonds Investment			30,000
			Interest Revenue			870,000
				(To record interest received on F bonds)

Table (11)

Working notes:

Calculate the amount of cash received.

$\begin{array}{c}\text{Cash received = \$15,000,000 }\times \text{ 6\%}\\ \text{= \$900,000}\end{array}$

Hence, cash received amount is $900,000.

Calculate premium on bonds investment.

$\begin{array}{c}\text{Premium on bonds investment = \$10,000}\times \text{ 6 months}\times \frac{15}{30}\\ \text{= \$30,000}\end{array}$

Hence, premium on bonds investment amount is $30,000.

Calculate the interest revenue on the bond investment.

$\begin{array}{c}\text{Interest}\text{Revenue}=\text{Cash received}-\text{Premium}\text{on}\text{bond}\text{investment}\\ =\$900,000-\$30,000\\ =\$870,000\end{array}$

Hence, interest revenue amount is $870,000.

Journal entry for interest accrued for B bonds as on 31^st December 2017.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2017		Interest Receivable	800,000
December	31
		Discount on Bonds Investment	7,500
		Interest Revenue		807,500
		(To record the interest accrued for B bonds)

Table (12)

Working notes:

Calculate the amount of interest receivable.

$\begin{array}{c}\text{Interest receivable = \$16,000,000}\times \text{10\%}\times \frac{6}{12}\\ =\$800,000\end{array}$

Hence, interest receivable amount is $800,000.

Calculate discount on bonds investment.

$\begin{array}{c}\text{Discount on bonds investment for 6 months = \$1,250 }\times \text{ 6 months}\\ \text{= \$7,500}\end{array}$

Hence, discount on bonds investment amount is $7,500.

Calculate the amount of interest revenue.

$\begin{array}{c}\text{Interest revenue = Interest receivable + Discount on bond investment}\\ \text{= \$800,000 +\$7,500}\\ \text{=\$807,500}\end{array}$

Hence, interest revenue amount is $807,500.

Journal entry for interest accrued for F bonds as on 31^st December 2017.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2017		Interest Receivable	150,000
December	31
		Premium on Bonds Investment		5,000
		Interest Revenue		145,000
		(To record the interest accrued for F bonds)

Table (13)

Working notes:

Calculate the amount of interest receivable.

$\begin{array}{c}\text{Interest receivable = \$15,000,000}\times \text{12\%}\times \frac{1}{12}\\ =\$150,000\end{array}$

Hence, interest receivable amount is $150,000.

Calculate premium on bonds investment.

$\begin{array}{c}\text{Premium on bonds investment = \$10,000}\times \text{ 1 month}\times \frac{15}{30}\\ \text{= \$5,000}\end{array}$

Hence, premium on bonds investment amount is $5,000.

Calculate the amount of interest revenue.

$\begin{array}{c}\text{Interest revenue = Interest receivable – Premium on bond investment}\\ \text{= \$150,000 –\$5,000}\\ \text{=\$145,000}\end{array}$

Hence, interest revenue amount is $145,000.

J ournal entry for interest received on B bonds as on 1^st January 2018.

Date		Account Title and Explanation			Debit ($)	Credit ($)
2018		Cash			800,000
January	1
			Interest Receivable			800,000
				(To record interest received on B bonds)

Table (14)

Working note:

Calculate the amount of interest received (cash received).

$\begin{array}{c}\text{Interest}\left(\text{cash }\right)\text{received = \$16,000,000}\times \text{10\%}\times \frac{6}{12}\\ =\$800,000\end{array}$

Hence, cash received amount is $800,000.

Journal entry for interest accrued for F bonds as on 28^th February 2018.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2018		Interest Receivable	300,000
February	28
		Premium on Bonds Investment		10,000
		Interest Revenue		290,000
		(To record the interest accrued for F bonds)

Table (14)

Working notes:

Calculate the amount of interest receivable.

$\begin{array}{c}\text{Interest receivable = \$15,000,000}\times \text{12\%}\times \frac{2}{12}\\ =\$300,000\end{array}$

Hence, interest receivable amount is $300,000.

Calculate premium on bonds investment.

$\begin{array}{c}\text{Premium on bonds investment = \$10,000 }\times 2\text{months }\times \frac{\text{15}}{30}\\ \text{= \$10,000}\end{array}$

Hence, premium on bonds investment amount is $10,000.

Calculate the amount of interest revenue.

$\begin{array}{c}\text{Interest revenue = Interest receivable – Premium on bond investment}\\ \text{= \$300,000 –\$10,000}\\ \text{=\$290,000}\end{array}$

Hence, interest revenue amount is $290,000.

Journal entry for sale of F bonds as on 28^th February 2018.

Date		Account Title and Explanation			Debit ($)	Credit ($)
2018		Cash			15,750,000
February	28
		Loss on Sale of Investment			195,000
			Premium on Bonds Investment			495,000
			Bond Investment			15,000,000
			Interest Receivable			450,000
				(To record sale of F bonds)

Table (15)

Working notes:

Calculate the amount of cash received.

$\begin{array}{c}\text{Cash received = }\left(\text{\$15,000,000}\times \text{102\% }\right)\text{+}\text{\$450,000}\\ \text{= \$15,750,000}\end{array}$

Hence, cash received amount is $15,750,000.

Calculate premium on bonds investment.

$\begin{array}{c}\text{Premium on bonds investment = }\left(\begin{array}{l}\text{\$1,160,000 –\$20,000 –\$10,000–\$50,000}\\ -\$15,000-\$525,000-\$30,000\\ -\$5,000-\$10,000\end{array}\right)\\ =\$495,000\end{array}$

Hence, premium on bonds investment amount is $495,000.

Calculate loss on sale of investment.

$\begin{array}{c}\text{Loss on sale of investment = }\left(\begin{array}{l}\text{Bond investment + Premium on bond investment }\\ \text{+ Interets receivable – Cash received}\end{array}\right)\\ =\$15,000,000+\$495,000+\$450,000-\$15,750,000\\ =\$195,000\end{array}$

Hence, loss on sale of investment amount is $195,000.

Journal entry for interest accrued for B bonds as on 31^st December 2018.

Date		Account Title and Explanation	Debit ($)	Credit ($)
2018		Interest Receivable	800,000
December	31
		Discount on Bonds Investment	7,500
		Interest Revenue		807,500
		(To record the interest accrued for B bonds)

Table (16)

Working notes:

Calculate the amount of interest receivable.

$\begin{array}{c}\text{Interest receivable = \$16,000,000}\times \text{10\%}\times \frac{6}{12}\\ =\$800,000\end{array}$

Hence, interest receivable amount is $800,000.

Calculate discount on bonds investment.

$\begin{array}{c}\text{Discount on bonds investment for 6 months = \$1,250 }\times \text{ 6 months}\\ \text{= \$7,500}\end{array}$

Hence, discount on bonds investment amount is $7,500.

Calculate the amount of interest revenue.

$\begin{array}{c}\text{Interest revenue = Interest receivable + Discount on bond investment}\\ \text{= \$800,000 +\$7,500}\\ \text{=\$807,500}\end{array}$

Hence, interest revenue amount is $807,500.

(2)

To determine

To Calculate: The earnings increase in each of the three years for L as a result of long-term bond investment.

Explanation of Solution

Calculate earnings in 2016.

$\begin{array}{c}\text{Earnings in 2016 = }\left(\begin{array}{l}\text{Interest revenue on December 1, 2016 }\\ \text{+ Interest revenue on December 31, 2016}\end{array}\right)\\ \text{= \$580,000 +}\left(\$807,500+\$290,000\right)\\ =\$1,677,500\end{array}$

Therefore, earnings amount as on 2016 is $1,677,500.

Calculate earnings in 2017.

$\text{Earnings in 2017 = }\left(\begin{array}{l}\text{Interest revenue on June 1, 2017 }\\ \text{+}\text{Interest revenue on July 1, 2017}\\ \text{Interest revenue on September 1, 2017 }\\ \text{+ Interest revenue on December 1, 2016 }\\ \text{+ Interest revenue on December 31, 2016 }\\ \text{–}\text{Loss on sale of investment}\end{array}\right)$

$\begin{array}{c}\text{Earnings in 2017= }\left(\begin{array}{l}\text{\$1,450,000 +\$807,500 +\$435,000 +\$870,000 }\\ \text{+}\left(\$807,500+\$145,000\right)-\$\left(375,000\right)\end{array}\right)\\ =\$4,140,000\end{array}$

Therefore, earnings amount as on 2017 is $4,140,000.

Calculate earnings in 2018.

$\begin{array}{c}\text{Earnings in 2018 = }\left(\begin{array}{l}\text{Interest revenue on February 28, 2018 }\\ \text{+ Interest revenue on December 31, 2018}\\ –\text{Loss}\text{on}\text{sale of}\text{investment}\end{array}\right)\\ \text{= \$290,000 +}\$807,500+\$\left(195,000\right)\\ =\$902,500\end{array}$

Therefore, earnings amount as on 2018 is$902,500