Chapter 13, Problem 10P

Investment in Available-for-Sale Bonds The following information relates to Starr Company’s investment in available-for-sale bonds for 2019:

Required:

1. 1. Prepare journal entries to record the previous information for 2019. Use the effective interest method and round all amounts to the nearest dollar. Assume that Starr prepares semiannual financial statements.
2. 2. Show the items of income or loss from investment transactions that Starr reports for each 2019 semiannual income statement.
3. 3. Show how the investment items are reported on each of the 2019 semiannual balance sheets, assuming that management expects to dispose of all investments with in one year of purchase.

To determine

Record the journal entries in the books of Company S for the year 2019.

Explanation of Solution

Investment: It refers to the process of using the currently held excess cash to earn profitable returns in future. The investments can be made in equity securities such as shares or debt securities such as bonds.

Record the journal entries in the books of Company S for the year 2019.

Date	Account Title and Explanation	Debit ($)	Credit ($)
January 1, 2019	Investment in Available-for-sale Securities	29,100
	Cash		29,100
	(To record the purchase of Available-for-sale securities at discount)
January 1, 2019	Investment in Available-for-sale Securities	40,400
	Cash		40,400
	(To record the purchase of Available-for-sale securities at premium)
June 30, 2019	Cash $\left(\$30,000\times 0.08\times \frac{1}{2}\right)$	1,200
	Investment in Available-for-    sale Securities	255
	Interest income     $\left(\$29,100\times 0.10\times \frac{1}{2}\right)$		1,455
	(To record the earned interest and amortization of discount)
June 30, 2019	Cash $\left(\$40,000\times 0.10\times \frac{1}{2}\right)$	2,000
	Investment in Available-for-    sale Securities		20
	Interest income     $\left(\$40,400\times 0.098\times \frac{1}{2}\right)$		1,980
	(To record the earned interest and amortization of premium)
June 30, 2019	Allowance for change in fair value of investment (1)	225
	Unrealized holding gain/loss:     Available-for-sale securities		225
	(To adjust the allowance and the unrealized gain on holding the Securities)
July 1, 2019	Investment in Available-for-sale Securities	23,000
	Cash		23,000
	(To record the purchase of Available-for-sale securities at discount)
November 30, 2019	Interest receivable $\left(\$25,000\times 0.11\times \frac{5}{12}\right)$	1,146
	Investment in Available-for-    sale Securities	4
	Interest income     $\left(\$23,000\times 0.12\times \frac{5}{12}\right)$		1,150
	(To record the interest earned for 5 months)
November 30, 2019	Cash $\left(\$22,750+\$1,146\right)$	23,896
	Loss on sale of Available-for-sale Securities	254
	Investment in Available-for-sale Securities		23,004
	Interest receivable		1,146
	(To record the sale of Corporation W's bond on loss)
December 31, 2019	Cash $\left(\$30,000\times 0.08\times \frac{1}{2}\right)$	1,200
	Investment in Available-for-sale Securities	268
	Interest income     `    $\left(\$29,355\times 0.10\times \frac{1}{2}\right)$		1,468
	(To record the earned interest and amortization of discount)
December 31, 2019	Cash $\left(\$40,000\times 0.10\times \frac{1}{2}\right)$	2,000
	Investment in Available-for-sale Securities		21
	Interest income     $\left(\$40,380\times 0.098\times \frac{1}{2}\right)$		1,979
	(To record the earned interest and amortization of premium)
December 31, 2019	Cash	40,800
	Gain on sale of Available-for-sale Securities $\left(\$40,800-\$40,359\right)$		441
	Investment in Available-for-sale Securities $\left(\$40,380-\$21\right)$		40,359
	(To record the sale of Company M's bond at gain)
December 31, 2019	Unrealized holding gain/loss: Available-for-sale securities	420
	Allowance for change in fair     value     of investment		420
	(To reverse the allowance and  the unrealized gain, that has been allowed earlier on June 30, 2019)
December 31, 2019	Unrealized holding gain/loss: Available-for-sale securities	628
	Allowance for change in fair     value     of investment		628
	(To adjust the allowance and the unrealized loss on holding the Securities)

Table (1)

Working note (1):

Calculate the allowance for change in fair value of investment:

Security	Book value	Fair value	Change in fair value
Corporation B’s bond of $30,000	$29,355 (2)	$29,160	$(195)
Corporation M’s bond of $40,000	$40,380 (3)	$40,800	$420
Total	$69,735	$69,960	$225

Table (2)

Working note (2):

Calculate the book value of Corporation B:

$\begin{array}{c}\text{Book value of Corporation B}=\left(\text{Fair value of the bond}+\text{Amortization of discount}\right)\\ =\left(\$29,100+\$255\right)\\ =\$29,355\end{array}$

Working note (3):

Calculate the book value of Corporation M:

$\begin{array}{c}\text{Book value of Corporation M}=\left(\text{Fair value of the bond}-\text{Amortization of premium}\right)\\ =\left(\$40,400-\$20\right)\\ =\$40,380\end{array}$

To determine

Show the items that would be reported as income or loss from the investment in the income statement.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Income statement
For semi-annual period ended
Particulars	06/30/2019	12/31/2019
Interest income	$3,435(4)	$4,597(5)
Loss on sale of securities	-	($254)
Gain on sale of securities	-	$441

Table (3)

Working note (4):

Calculate the amount of interest income for 06/30/2019:

$\begin{array}{c}\text{Interest income}=\left(\$1,455+\$1,980\right)\\ =\$3,435\end{array}$

Working note (5):

Calculate the amount of interest income for 12/31/2019:

$\begin{array}{c}\text{Interest income}=\left(\$1,150+\$1,468+\$1,979\right)\\ =\$4,597\end{array}$

To determine

Show the way in which the investments items are reported in the 2019 semi-annual balance sheets.

Explanation of Solution

Balance sheet: Balance Sheet is one of the financial statements that summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Show the way in which the investments items are reported in the 2019 semi-annual balance sheets.

Balance sheet  (Partial)
Particulars	06/30/2019	12/31/2019
Current assets:
Investment in available-for-sale securities	$69,735	$29,623
Add(Less): Allowance for change in fair value of investment	$225	$(823)
Investment in available-for-sale securities	$69,960	$28,800
Shareholders’ equity:
Accumulated other comprehensive income:
Unrealized holding gain/loss:
Available for sale securities	$225	($823)

Table (4)