Chapter 12, Problem 12.5E

(1)

To determine

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.

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

Answer to Problem 12.5E

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

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2018
July	1	Investment in Bonds		240,000,000
		Discount on Bond Investment			40,000,000
		Cash			200,000,000
		(To record purchase of investment)

Table (1)

Explanation of Solution

• 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.

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

(2)

To determine

To journalize: The receipt of semiannual interest on December 31, 2018 in the books of Corporation T

Answer to Problem 12.5E

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

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
2018
December	31	Cash		7,200,000
		Discount on Bond Investment		800,000
		Interest Revenue			8,000,000
		(To record receipt of interest)

Table (2)

Explanation of Solution

• 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, 2018.

$\begin{array}{c}\text{Interest received =}\left(\begin{array}{l}\text{Face amount of bonds}\times \\ \text{Stated interest rate}\times \\ \text{Semiannual interest time period}\end{array}\right)\\ \text{=\$240,000,000 × }\frac{6}{\text{100}}\times \frac{6}{12}\\ \text{=\$7,200,000}\end{array}$ (1)

Calculate interest revenue on December 31, 2018.

$\begin{array}{c}\text{Interest revenue = }\left(\begin{array}{l}\text{Outstanding balance on bonds }\times \\ \text{Effective interest rate}\times \\ \text{Semiannual interest time period}\end{array}\right)\\ \text{=\$200,000,000 × }\frac{8}{\text{100}}\times \frac{6}{12}\\ \text{=\$8,000,000}\end{array}$ (2)

Calculate discount amortized on December 31, 2018.

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

Note: Refer to Equations (1) and (2) for the value and computations of interest revenue and interest received.

(3)

To determine

To prepare: The journal entry to adjust the trading securities to fair value as on December 31, 2018 in the books of Corporation T

Answer to Problem 12.5E

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

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2018
December	31	Fair Value Adjustment		9,200,000
		Unrealized Holding Gain–NI			9,200,000
		(To record unrealized gain on trading securities)

Table (3)

Explanation of Solution

• 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 the reported date.
• 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, stockholders’ equity value is credited.

Working Notes:

Compute the unrealized gain (loss) as on December 31, 2018.

Step 1: Determine the amortized cost of bonds as on December 31, 2018.

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 (4)

Step 2: Compute the unrealized gain (loss) as on December 31, 2018 by adjusting the amortized cost of $200,800,000 (Refer to Table-4) to the fair value of $210,000,000.

Details	Amount ($)
Fair value adjustment balance as on July 1, 2018	$0
Adjustment needed to update fair value (Balancing figure)	9,200,000
Fair value adjustment balance needed on December 31, 2018 $\left(\$210,000,000–\$200,800,000\right)$	$9,200,000

Table (5)

(4)

To determine

To journalize: The sale of bonds on January 2, 2019 in the books of Corporation T

Explanation of Solution

Explanation

Step 1: Prepare journal entry to adjust the trading securities to fair value as on January 2, 2019.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2019
January	2	Unrealized Holding Loss–NI		20,000,000
		Fair Value Adjustment			20,000,000
		(To record unrealized loss on trading 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 sale date.

Working Notes:

Compute the unrealized gain (loss) as on January 2, 2019 by adjusting the amortized cost of $200,800,000 (Refer to Table-4) to the fair value of $190,000,000.

Details	Amount ($)
Fair value adjustment balance as on December 31, 2018 (Table-5)	$9,200,000
Adjustment needed to update fair value (Balancing figure)	(20,000,000)
Fair value adjustment balance needed on January 2, 2019 $\left(\$190,000,000–\$200,800,000\right)$	$(10,800,000)

Table (7)

Step 2: Prepare journal entry for sale of bonds.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
2019
January	2	Cash		190,000,000
		Fair Value Adjustment		10,800,000
		Discount on Bond Investment		39,200,000
		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.
• Fair Value Adjustment is a contra-asset account which serves the purpose of valuation allowance account. The account is debited because the sale proceeds adjusted to fair value on the date of sale, realizes loss.
• 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.
• Investment in Bonds is an asset account. Since 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 gain (loss) on sale of bonds.

Step 1: Compute the book value of bonds as on January 2, 2019.

Particulars	Amount ($)
Investment in bonds	$240,000,000
Less: Unamortized discount	(39,200,000)
Book value as on January 2, 2019	$200,800,000

Table (9)

Step 2: Compute gain or loss on sale of bonds as on January 2, 2019.

Particulars	Amount ($)
Cash proceeds from sale of bonds	$190,000,000
Less: Book value as on January 2, 2019 (Table-9)	(200,800,000)
Gain (loss) on sale of investment	$(10,800,000)

Table (10)