Chapter 12, Problem 12.23E

a)

To determine

Investments: Companies invest in stocks and bonds of other companies or governmental entity to deploy their excess fund, and/or for a specific business strategy.

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

Trading securities: These are short-term investments in debt and equity securities with an intention of trading and earning profits due to changes in market prices.

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.

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.

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 Explain: How to classify this investment on Company T’s balance sheet as held-to-maturity securities, trading securities, available-for-sale securities, significant-influence investments, or other.

Explanation of Solution

The investments, being recorded under the fair value method, the accounting for the held-to-maturity securities would be similar to the accounting for trading securities. In the balance sheet of Company T, the securities would be shown at the fair value, and the unrealized gains or losses would also be shown in the income statement in the corresponding period.

b)

To determine

To journalize: The purchase $240,000,000 of 6% bonds in the books of Company T.

Explanation of Solution

Prepare journal entry for purchase of $240,000,000 of 6% bonds for $200,000,000.

Date	Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
07.01.16	Investment in Bonds		240,000,000
	Discount on Bond Investment (1)			40,000,000
	Cash			200,000,000
	(To record purchase of investment)

Table (1)

• Investment in Bonds is an asset account. Since bonds investments are purchased, asset value increased, and an increase in asset is debited.
• Discount on Bond Investment is a contra-asset account. The contra-asset account generally has a credit balance. So, credit the discount, indicating a reduction in carrying amount of bonds to the cost.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Working Notes:

Compute the discount amount on bonds.

$\begin{array}{c}\text{Discount = Face amount of bonds – Price of bonds}\\ \text{=\$240,000,000–\$200,000,000}\\ \text{=\$40,000,000}\end{array}$ (1)

c)

To determine

To journalize: The receipt of semiannual interest on December 31, 2016 in the books of Company T.

Explanation of Solution

Prepare journal entry for semiannual interest on December 31, 2016.

Date	Account Titles and Explanation	Post Ref.		Debit ($)		Credit ($)
12.31.16	Cash    (2)				7,200,000
	Discount on Bond Investment  (4)				800,000
	Interest Revenue   (3)					8,000,000
	(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.
• Discount on Bond Investment is a contra-asset account. The contra-asset account generally has a credit balance. Since the discount amount is reduced, the account 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, 2016.

$\begin{array}{c}\text{Interest received =}\left(\begin{array}{l}\text{Face amount of bonds}\times \\ \text{Stated interest rate}\times \\ \text{Semiannual interest time period}\end{array}\right)\\ \text{=\$240,000,000 × }\frac{6}{\text{100}}\times \frac{6}{12}\\ \text{=\$7,200,000}\end{array}$ (2)

Calculate interest revenue on December 31, 2016.

$\begin{array}{c}\text{Interest revenue = }\left(\begin{array}{l}\text{Outstanding balance on bonds }\times \\ \text{Effective interest rate}\times \\ \text{Semiannual interest time period}\end{array}\right)\\ \text{=\$200,000,000 × }\frac{8}{\text{100}}\times \frac{6}{12}\\ \text{=\$8,000,000}\end{array}$ (3)

Calculate discount amortized on December 31, 2016.

$\begin{array}{c}\text{Discount amortized = Interest revenue – Interest received }\\ \text{= \$8,000,000}\text{– \$7,200,000}\\ \text{= \$800,000}\end{array}$ (4)

Note: Refer to Equations (2) and (3) for the value and computations of interest revenue and interest received.

d)

To determine

To journalize: The fair value changes to be recorded in the books of Company T.

Explanation of Solution

Prepare journal entry to record the fair value changes, as the cost of bond is $240 million, less the discount on the bonds $39.2 million $\left(\$40,000,000-\$800,000\right)$, and the fair value is $210 millions.

Date	Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
12.31.16	Fair-value adjustment		9,200,000
	Unrealized holding gain—NI			9,200,000
	(To record unrealized gain on equity 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 December 31, 2016.
• Unrealized Holding Gain–NI 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, it is credited.

Working Notes:

Compute the unrealized gain as on December 31, 2017, by adjusting the cost of $200,800,000 to the fair value of $210,000,000.

Details	Amount ($)
Cost of the bonds after discount	200,800,000
Adjustment needed to update fair value (Balancing figure)	9,200,000
Fair value of the bonds as on December 31, 2016	210,000,000

Table (4)

e)

To determine

To indicate: The amount of investment value as on December 31, 2016 in the books of Corporation T

Explanation of Solution

Determine the amount of investment value as on December 31, 2016.

Particulars	Amount ($)	Amount ($)
Investment in bonds		$240,000,000
Less: Unamortized discount:
Discount on bonds	$40,000,000
Less: Amortized discount in the year	(800,000)	(39,200,000)
Amortized cost		$200,800,000

Table (5)

f) 1.

To determine

To journalize: The adjusting entry as at December 31, 2016, if the fair value adjustment was $9,200,000, fair value of shares was $200,00,000, and the cost of shares was $240,000,000.

Explanation of Solution

Prepare journal entry to adjust the securities to fair value as on December 31, 2016.

Date	Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
12.31.16	Unrealized Holding Loss–NI		20,000,000
	Fair Value Adjustment			20,000,000
	(To record unrealized loss on equity securities)

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 December 31, 2016.

Working Notes:

Compute the unrealized gain (loss) as on December 31, 2016, by adjusting the cost of shares was $240,000,000 to the fair value of $200,00,000.

Details	Amount ($)
Adjustment needed to update fair value	9,200,000
Adjustment needed to update fair value (Balancing figure)	20,000,000
Fair value balance as on December 31, 2016 $\left(\$190,000,000–\$200,800,000\right)$	10,800,000

Table (7)

f) 2.

To determine

To journalize: The sale of bonds on January 2, 2017 in the books of Corporation T

Explanation of Solution

Prepare the journal entry for sale of bonds.

Date	Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
01.02.17	Cash		190,000,000
	Discount on Bond Investment		39,200,000
	Fair Value Adjustment		10,800,000
	Investment in Bonds			240,000,000
	(To record sale of bonds)

Table (8)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Discount on Bond Investment is a contra-asset account. The contra-asset account generally has a credit balance. Since the discount amount is closed on the sale date, the account is debited to make the discount balance zero.
• 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.
• Investment in Bonds is an asset account. Since stock investments are sold, asset value decreased, and a decrease in asset is credited.

Working Notes:

Refer to requirement 3 for value and computation of discount amortized.

Compute the fair value adjustment on sale of bonds.

Step 1: Compute the book value of bonds as on January 2, 2017.

Particulars	Amount ($)
Investment in bonds	$240,000,000
Less: Unamortized discount	(39,200,000)
Book value as on January 2, 2017	$200,800,000

Table (9)

Step 2: Compute fair value adjustment on sale of bonds as on January 2, 2017.

Particulars	Amount ($)
Cash proceeds from sale of bonds	$190,000,000
Less: Book value as on January 2, 2017 (Table-5)	(200,800,000)
Fair Value Adjustment	$(10,800,000)

Table (10)