Chapter 12, Problem 12.12E

Available -for-sale securities

• LO12-1, LO12-4

Colah Company purchased $1 million of Jackson, Inc., 5% bonds at par on July 1, 2018, with interest paid semi-annually. Colah determined that it should account for the bonds as an available-for-sale investment. At December 31, 2018, the Jackson bonds had a fair value of $1.2 million. Colah sold the Jackson bonds on July 1, 2019 for $900,000.

Required:

1. 1. Prepare Colah’s journal entries to record:
   1. a. The purchase of the Jackson bonds on July 1
   2. b. Interest revenue for the last half of 2018
   3. c. Any year-end 2018 adjusting entries
   4. d. Interest revenue for the first half of 2019
   5. e. Any entries necessary upon sale of the Jackson bonds on July 1, 2019, including updating the fair-value adjustment, recording any reclassification adjustment, and recording the sale
2. 2. Fill out the following table to show the effect of the Jackson bonds on Colah’s net income, other comprehensive income, and comprehensive income for 2018, 2019, and cumulatively over 2018 and 2019.

	2018	2019	Total
Net Income
OCI
Comprehensive Income

To determine

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.

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

To Prepare: The journal entries for Company C.

Explanation of Solution

(a)

Prepare journal entry for purchase of $1,000,000 of 5% bonds at par.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2018
July	1	Investment in Corporation J Bonds		1,000,000
		Cash			1,000,000
		(To record purchase of investment)

Table (1)

Investment in Corporation J Bonds is an asset account. Since bonds investments are purchased, asset value increased, and an increase in asset is debited.

• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

(b)

Prepare journal entry for semiannual interest on December 31, 2018.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2018
December	31	Cash		25,000
		Interest Revenue			25,000
		(To record receipt of interest)

Table (2)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Calculate interest received on December 31, 2018.

$\begin{array}{c}\text{Interest received =}\left(\begin{array}{l}\text{Face amount of bonds}\times \\ \text{Stated interest rate}\times \\ \text{Semiannual interest time period}\end{array}\right)\\ \text{=\$1,000,000 × }\frac{5}{\text{100}}\times \frac{6}{12}\\ \text{=\$25,000}\end{array}$

(c)

Prepare journal entry to adjust the AFS securities to fair value as on December 31, 2018.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2018
December	31	Fair Value Adjustment		200,000
		Unrealized Holding Gain–OCI			200,000
		(To record unrealized gain on AFS securities)

Table (3)

• 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 sale date.
• 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, stockholders’ equity value is credited.

Working Notes:

Compute the unrealized gain (loss) as on December 31, 2018 by adjusting the cost of $1,000,000 to the fair value of $1,200,000.

Details	Amount ($)
Fair value adjustment balance as on July 1, 2018	$0
Adjustment needed to update fair value (Balancing figure)	200,000
Fair value adjustment balance needed on December 31, 2018 $\left(\$1,000,000–\$1,200,000\right)$	$200,000

Table (4)

(d)

Prepare journal entry for semiannual interest on June 30, 2019.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2019
June	30	Cash		25,000
		Interest Revenue			25,000
		(To record receipt of interest)

Table (5)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Calculate interest received on June 30, 2019.

$\begin{array}{c}\text{Interest received =}\left(\begin{array}{l}\text{Face amount of bonds}\times \\ \text{Stated interest rate}\times \\ \text{Semiannual interest time period}\end{array}\right)\\ \text{=\$1,000,000 × }\frac{5}{\text{100}}\times \frac{6}{12}\\ \text{=\$25,000}\end{array}$

(e)

Prepare journal entry to adjust the AFS securities to fair value as on July 1, 2019.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2019
July	1	Unrealized Holding Loss–OCI		300,000
		Fair Value Adjustment			300,000
		(To record unrealized loss on AFS securities)

Table (6)

• Unrealized Holding Loss–OCI is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since loss has occurred and losses decrease stockholders’ equity value, stockholders’ equity value is debited.
• 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 sale date.

Working Notes:

Compute the unrealized gain (loss) as on July 1, 2019 by adjusting the cost of $1,000,000 to the fair value of $900,000 as on sale date.

Details	Amount ($)
Fair value adjustment balance as on December 31, 2018 (Table-5)	$200,000
Adjustment needed to update fair value (Balancing figure)	(300,000)
Fair value adjustment balance needed on July 1, 2019 $\left(\$900,000–\$1,000,000\right)$	$(100,000)

Table (7)

Step 2: Prepare journal entry to reverse the effect of fair value changes as on sale date.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2019
July	1	Fair Value Adjustment		100,000
		Reclassification Adjustment–OCI			100,000
		(To record the reversal effect of fair value adjustment)

Table (8)

• Fair Value Adjustment is a contra-asset account which serves the purpose of valuation allowance account. The account is credited to reverse the effect of balance of unrealized holding gains and losses and close this account.
• Reclassification Adjustment–OCI is an adjustment entry made to reverse the effect of fair value changes or unrealized holding gains and losses. Thus, the fair value adjustment account becomes zero.

Working Notes:

Calculate the unrealized holding gain (loss) on date of sale of bonds.

Details	Amount ($)
Unrealized gain as on December 31, 2018	$200,000
Unrealized loss as on July 1, 2019	(300,000)
Net unrealized holding gain (loss) as on July 1, 2019	$(100,000)

Table (9)

Step 3: Prepare journal entry for sale of bonds.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2019
July	1	Cash		900,000
		Loss–NI		100,000
		Investment in Corporation J Bonds			1,000,000
		(To record sale of bonds)

Table (10)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Loss–NI is an expense account. Since losses and expenses decrease equity, equity value is increased, and decrease in equity is debited.
• Investment in Corporation J Bonds is an asset account. Since investments are sold, asset value decreased, and a decrease in asset is credited.

Working Notes:

Calculate the realized gain (loss) on sale of bonds.

Security	Sale Proceeds	–	Cost	=	Realized Gain (Loss)
Corporation J	$900,000	–	$1,000,000	=	$(100,000)

Table (11)

To determine

To complete: The format of table with the information deduced

Explanation of Solution

Complete the following table:

Details	2018	2019	Total
Net income	$25,000 (interest revenue)	$(75,000) $\left(\$25,000+\$\left(100,000\right)\right)$ (interest revenue + unrealized loss)	$(50,000)
OCI	$200,000 (Unrealized holding gain)	$(200,000) $\left(\$\left(300,000\right)+\$100,000\right)$ (Unrealized holding loss +Reclassification adjustment)	0
Comprehensive income (Total)	$225,000	$(275,000)	$(50,000)

Table (12)