Chapter 12, Problem 12.16P

1.

To determine

Investment: The act of allocating money to buy a monetary asset, in order to generate wealth in the future is referred to as investment.

Journal: Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.

To Journalize: The purchase of bonds of Company C by Company I on January 1, 2018.

Explanation of Solution

Prepare the journal entry to record the investment made in Company C.

Date	Account Title	Debit ($)	Credit ($)
01.01.18	Investment in bonds	$150,000
	Discount on bond investment		$10,658
	Cash		$139,342
	(To record the purchase of bonds)

Table (1)

• Investments is being made, this increases the assets; hence debit the investment.
• Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.

2.

To determine

To Journalize: The entries related to the bonds of Company C, assuming Company I accounts for the bonds as held-to-maturity.

Explanation of Solution

Held-to-maturity security: The debt securities which are held by the investor with the intent to hold the investment till its maturity are referred to as held-to-maturity securities.

Prepare the journal entry to record the investment made in Company C.

Date	Account Title	Debit ($)	Credit ($)
01.01.18	Investment in bonds	$150,000
	Discount on bond investment		$10,658
	Cash		$139,342
	(To record the purchase of bonds)

Table (2)

• Investments is being made, this increases the assets; hence debit the investment.
• Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.

Prepare the journal entry to record the semiannual interest received from Company C on June 30, 2018.

Date	Account Title	Debit ($)	Credit ($)
06.30.18	Cash (1)	$4,500
	Discount on bond investment (3)	$377
	Interest revenue   (2)		$4,877
	(To record the interest from bonds)

Table (3)

• Cash is received, cash is an asset which is being increased; hence debit the cash account.

• Discount on bonds investment, is a liability which is decreased; hence debit the discount on bonds investment account.
• Interest revenue is a gain, which increases the stockholder's equity; hence credit the interest revenue account.

Working Notes:

Calculate the cash received.

$\begin{array}{c}\text{Cash = }\left(\text{Cost }\times \text{Effective Rate of Interest}\right)÷2\\ \text{= }\left(\$150,000\times 6\%\right)÷2\\ =\$9,000÷2\\ =\$4,500\end{array}$ (1)

Calculate the interest revenue.

$\begin{array}{c}\text{Interest revenue = }\left(\begin{array}{l}\text{Cost of invesetment }-\\ \text{Discount on investment}\end{array}\right)\times \left(\begin{array}{l}\text{Effective Rate}\\ \text{of Interest}\end{array}\right)\times \left(\text{Time period}\right)\\ \text{= }\left(\$150,000-\$10,658\right)\times \frac{7}{100}\times \frac{6}{12}\\ =\$136,342\times \frac{7}{100}\times \frac{6}{12}\\ =\$4,877\end{array}$ (2)

Calculate the discount on bond investment.

$\begin{array}{c}\text{Discount on bond investment = Interest revenue}-\text{Cash}\\ \text{= }\$4,877-\$4,500\\ =\$377\end{array}$ (3)

Prepare the journal entry to record the semiannual interest received from Company C on December 31, 2018.

Date	Account Title	Debit ($)	Credit ($)
12.31.18	Cash  (1)	$4,500
	Discount on bond investment   (5)	$390
	Interest revenue   (4)		$4,890
	(To record the interest from bonds)

Table (4)

• Cash is received, cash is an asset which is being increased; hence debit the cash account.
• Discount on bonds investment, is a liability which is decreased; hence debit the discount on bonds investment account.
• Interest revenue is a gain, which increases the stockholder's equity; hence credit the interest revenue account.

Working Notes:

Calculate the interest revenue.

$\begin{array}{c}\text{Interest revenue = }\left(\begin{array}{l}\text{Cost of invesetment }-\\ \text{Discount on investment}\end{array}\right)\times \left(\begin{array}{l}\text{Effective Rate}\\ \text{of Interest}\end{array}\right)\times \left(\text{Time period}\right)\\ \text{= }\left(\$150,000-\left(\$10,658-\$377\right)\right)\times \frac{7}{100}\times \frac{6}{12}\\ =\$139,719\times \frac{7}{100}\times \frac{6}{12}\\ =\$4,890\end{array}$ (4)

Calculate the discount on bond investment.

$\begin{array}{c}\text{Discount on bond investment = Interest revenue}-\text{Cash}\\ \text{= }\$4,890-\$4,500\\ =\$390\end{array}$ (5)

3.

To determine

To Journalize: The entries related to the bonds of Company C, assuming Company I accounts for the bonds as fair value option.

Explanation of Solution

Fair value: Fair value is the price at which, both seller and buyer agree to exchange the asset. So, fair value is the selling price to the seller and the purchase price for the buyer.

Prepare the journal entry to record the investment made in Company C.

Date	Account Title	Debit ($)	Credit ($)
01.01.18	Investment in bonds	$150,000
	Discount on bond investment		$10,658
	Cash		$139,342
	(To record the purchase of bonds)

Table (5)

• Investments is being made, this increases the assets; hence debit the investment.
• Cash is being paid, cash is an asset which is being reduced; hence credit the cash account.

Prepare the journal entry to record the loss on the bonds of Company C.

Date	Account Title	Debit ($)	Credit ($)
06.30.18	Unrealized holding loss—NI	$9,420
	Fair value adjustment  (8)		$9,420
	(To record the loss through adjustment)

Table (6)

• Unrealized Holding Loss–NI 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 June 30, 2018.

Working Notes:

Compute the fair value of bond as on June 30, 2018.

Details	Amount ($)
Interest on the bond  (a)	$59,103
Value of the bonds  (b)	$71,916
Fair value of bonds on June 30, 2018 (6)	$130,299

Table (7)

(6)

Calculate the interest on the bond.

$\begin{array}{c}\text{Interest on the bond = }\left[\left(\text{Cost }\times \text{Effective Rate of Interest}\right)÷2\right]\times \text{Presetnt Annuity Value}\\ \text{= }\left[\left(\$150,000\times 6\%\right)÷2\right]\times 13.13394\\ =\left(\$9,000÷2\right)\times 13.13394\\ =\$59,103\left(\text{rounded}\right)\end{array}$ (a)

Calculate the value of the bond.

$\begin{array}{c}\text{Value of the bond = Cost}\times \text{Presetnt Annuity Value of \$1}\\ \text{= }\$150,000\times 0.47464\\ =\$71,916\end{array}$ (b)

Compute the value of bond as on June 30, 2018.

Details	Amount ($)
Value paid for the bonds	$139,342
Add: Discount on bond investment	$377
Value of bonds on June 30, 2018 (7)	$139,719

Table (8)

(7)

Compute the fair value of bond as on June 30, 2018.

Details	Amount ($)
Value of bonds on June 30, 2018 (7)	$139,719
Fair value of bonds on June 30, 2018 (6)	$130,299
Fair value adjustment (8)	$9,420

Table (9)

(8)

Prepare the journal entry to record the semiannual interest received from Company C on June 30, 2018.

Date	Account Title	Debit ($)	Credit ($)
06.30.18	Cash (1)	$4,500
	Discount on bond investment (3)	$377
	Interest revenue   (2)		$4,877
	(To record the interest from bonds)

Table (10)

• Cash is received, cash is an asset which is being increased; hence debit the cash account.

• Discount on bonds investment, is a liability which is decreased; hence debit the discount on bonds investment account.
• Interest revenue is a gain, which increases the stockholder's equity; hence credit the interest revenue account.

Prepare the journal entry to record the semiannual interest received from Company C on December 31, 2018.

Date	Account Title	Debit ($)	Credit ($)
12.31.18	Cash  (1)	$4,500
	Discount on bond investment   (5)	$390
	Interest revenue (4)		$4,890
	(To record the interest from bonds)

Table (11)

• Cash is received, cash is an asset which is being increased; hence debit the cash account.
• Discount on bonds investment, is a liability which is decreased; hence debit the discount on bonds investment account.
• Interest revenue is a gain, which increases the stockholder's equity; hence credit the interest revenue account. Investment is an asset, which is reduced; hence credit the investments account.

Prepare the journal entry to record the loss on the bonds of Company C.

Date	Account Title	Debit ($)	Credit ($)
06.30.18	Unrealized holding loss—NI	$9,420
	Fair value adjustment  (12)		$9,420
	(To record the loss through adjustment)

Table (12)

• Unrealized Holding Loss–NI 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 December 31, 2018.

Working Notes:

Compute the fair value of bond as on December 31, 2018.

Details	Amount ($)
Interest on the bond  (c)	$54,720
Value of the bonds  (d)	$67,920
Fair value of bonds on December 31, 2018 (9)	$122,640

Table (13)

(9)

Calculate the interest on the bond.

$\begin{array}{c}\text{Interest on the bond = }\left[\left(\text{Cost }\times \text{Effective Rate of Interest}\right)÷2\right]\times \text{Presetnt Annuity Value}\\ \text{= }\left[\left(\$150,000\times 6\%\right)÷2\right]\times 12.15999\\ =\left(\$9,000÷2\right)\times 12.15999\\ =\$54,720\left(\text{rounded}\right)\end{array}$ (c)

Calculate the value of the bond.

$\begin{array}{c}\text{Value of the bond = Cost}\times \text{Presetnt Annuity Value of \$1}\\ \text{= }\$150,000\times 0.45280\\ =\$67,920\end{array}$ (d)

Compute the value of bond as on December 31, 2018.

Details	Amount ($)
Value paid for the bonds	$139,719
Add: Discount on bond investment	$390
Value of bonds on December 31, 2018 (10)	$140,109

Table (14)

(10)

Compute the fair value of bond as on December 31, 2018.

Details	Amount ($)
Value of bonds on December 31, 2018 (10)	$140,109
Fair value of bonds on December 31, 2018 (9)	$122,640
Fair value adjustment (11)	$17,469

Table (15)

(11)

Compute the fair value of bond as on December 31, 2018.

Details	Amount ($)
Fair value adjustment (11)	$17,469
Fair value adjustment (8)	$9,420
Fair value adjustment to be recorded  (12)	$8,049

Table (16)

(12)