Chapter 13, Problem 1P

To determine

Prepare the journal entries to record the bond purchase, interest payment, sale of investment partially on March 31, 2017, and the retirement of the bond on June 30, 2019.

Explanation of Solution

Effective interest rate of bond amortization:

Effective interest rate method of amortization is a process of amortizing premium on bond or discount on bond, which allocates the different amount of interest expense in each period of interest payment, but at a constant percentage rate.

On January 1, 2016, Corporation H purchased 13%, bond with a face value of $300,000 for $308,373.53. The bond carries 13% interest rate, and it will be paid semiannually on June 30 and December 31, until the maturity date of June 30, 2019. The effective interest rate is 12%.

During March 31, 2016, Corporation H sold one-half of the bonds for $159,500. Corporation H uses effective interest rate for amortization.

Prepare a schedule of bond investment interest income and premium amortization.

Corporation H
Bond investment interest income and Premium amortization Schedule (Partial)
Effective interest rate method
Date	Cash (Debit) (a)	Interest income (Credit) (b)	Investment in debt securities (Credit) (c)	Carrying value of debt securities (d)
January 1, 2016				$308,373.53
June 30, 2016	$19,500.00	$18,502.41	$997.59	$307,375.94
December 31, 2016	$19,500.00	$18,442.56	$1,057.44	$306,318.50
March 31, 2017	$159,500.00	$4,594.78	$153,159.25	$153,159.25
June 30, 2017	$9,750.00	$9,189.56	$560.44	$152,598.81
December 31, 2017	$9,750.00	$9,155.93	$594.07	$152,004.74
June 30, 2018	$9,750.00	$9,120.28	$629.72	$151,375.02
December 31, 2018	$9,750.00	$9,082.50	$667.50	$150,707.52
June 30, 2019	$159,750.00	$9,042.48	$150,707.52	$0.00

Table (1)

Note:

1. $\text{Cash }\left(\text{a}\right)\text{ = Bonds outstanding}\times \text{13\%}\times \frac{\text{6 months}}{\text{12 months}}$  (13% is bonds stated interest rate). On March 31, 2017 the half of the bond sold for $159,500. Thus increases the cash.

2. $\text{Interest income }\left(\text{b}\right)\text{=Previous carrying value}\times \text{12\%}\times \frac{\text{6 months}}{\text{12 months}}$ (12% is effective interest rate).

3. $\text{Investment in debt securities }\left(\text{c}\right)\text{=Cash }\left(\text{a}\right)-\text{Amount of interest income}\left(\text{b}\right)$, Where (c) represents an amount of amortization of premium. On March 31, 2017, $\$153,159.25=\left(\$159,500\text{sold}-\$4,594.78\text{interest income }-\$1,745.97\text{gain}\right)$

4. $\text{Carrying value of debt securities }\left(\text{d}\right)\text{ = }\left[\begin{array}{l}\text{Previous carrying value }\left(\text{d}\right)-\\ \text{Investment in debt securities }\left(\text{c}\right)\end{array}\right]$

5. Refer journal entry as on March 31, 2017, and respective working notes for interest income, investment in debt securities, and carrying value as of March 31, 2017.

Procedure to be followed to prepare journal entries:

• Increase in assets, increase in expenses, decrease in revenue, and decrease in liabilities should be debited.
• Decrease in assets, increase in revenue, decrease in expenses, and increase in liabilities should be credited.

Prepare journal entries in the books of Corporation H.

Record the purchase of held-to maturity debt securities.

Date	Account Title and Explanation	Debit	Credit
January 1, 2016	Investment in Held-to-Maturity Debt Securities	$308,373.53
	Cash		$308,373.53
	(To record the purchase of held-to-maturity securities at premium)

Table (2)

Record the interest income earned on June 30, 2016 and December 31, 2016.

Date	Account Title and Explanation	Debit	Credit
June 30, 2016	Cash	$19,500.00
	Investment in Held-to-Maturity Debt          Securities		$18,502.41
	Interest income		$997.59
	(To record the interest and amortization)

Table (3)

Date	Account Title and Explanation	Debit	Credit
December 31, 2016	Cash	$19,500.00
	Investment in Held-to-Maturity Debt Securities		$18,442.56
	Interest income		$1,057.44
	(To record the interest and amortization)

Table (4)

Record the sale of half of the bond on March 31, 2017.

Step 1: Determine the amount of amortization.

$\begin{array}{c}\text{Amortization= }\left(\begin{array}{l}\left[\begin{array}{l}\text{Face value of half of the bond sold}\times \text{stated interest rate}\times \\ \left(\frac{\text{Number of month from January to March}}{12\text{months}}\right)\end{array}\right]-\\ \left[\begin{array}{l}\frac{\text{Carrying value of debt on December 31, 2016}}{2}\times \text{Effective}\\ \text{interest rate }\times \left(\frac{\text{Number of month from January to March}}{12\text{months}}\right)\end{array}\right]\end{array}\right)\\ =\left(\left[\$150,000\times 0.13\times \frac{3}{12}\right]-\left[\frac{\$306,318.50}{2}\times 0.12\times \frac{3}{12}\right]\right)\\ =\$280.22\end{array}$

Step 2: Determine the amount of interest income received from unsold bonds for 3 months.

$\begin{array}{c}\text{Interest income = Face value of bond}\times \text{Interest rate }\times \frac{\text{Number of months accrued}}{12\text{months}}\\ =\$150,000\times 13\%\times \frac{3}{12}\\ =\$4,875\end{array}$

Step 3: Determine the amount of investment in debt securities as on March 31, 2017.

$\begin{array}{c}\begin{array}{l}\text{Investment in held-to-}\\ \text{maturity debt securities }\end{array}\}\text{= }\left[\begin{array}{l}\frac{\text{Carrying value of securities as on December 31, 2016}}{2}-\\ \text{Amortization of premium of 3months}\end{array}\right]\\ =\frac{\$306,318.50}{2}-\$280.22\\ =\$152,879.03\end{array}$

Step 4: Record the entry.

Date	Account Title and Explanation	Debit	Credit
March 31, 2017	Interest income	$280.22
	Investment in Held-to-Maturity Debt Securities		$280.22
	(To record the amortization)

Table (5)

Date	Account Title and Explanation	Debit	Credit
March 31, 2017	Cash	$159,500.00
	Investment in Held-to-Maturity          Debt Securities		$152,879.03
	Interest income		$4,875.00
	Gain on sale of debt securities          (Balancing figure)		$1,745.97
	(To record the sale of half of the bonds on gain)

Table (6)

Record the interest income earned on June 30, 2017 and December 31, 2017.

Date	Account Title and Explanation	Debit	Credit
June 30, 2017	Cash	$9,750.00
	Investment in Held-to-Maturity Debt Securities		$560.44
	Interest income		$9,189.56
	(To record the interest and amortization)

Table (7)

Date	Account Title and Explanation	Debit	Credit
December 31, 2017	Cash	$9,750.00
	Investment in Held-to-Maturity Debt Securities		$594.07
	Interest income		$9,155.93
	(To record the interest and amortization)

Table (8)

Record the interest income earned on June 30, 2018 and December 31, 2018.

Date	Account Title and Explanation	Debit	Credit
June 30, 2018	Cash	$9,750.00
	Investment in Held-to-Maturity Debt          Securities		$629.72
	Interest income		$9,120.28
	(To record the interest and amortization)

Table (9)

Date	Account Title and Explanation	Debit	Credit
December 31, 2018	Cash	$9,750.00
	Investment in Held-to-Maturity Debt          Securities		$667.50
	Interest income		$9,082.50
	(To record the interest and amortization)

Table (10)

Record the interest income earned on June 30, 2019.

Date	Account Title and Explanation	Debit	Credit
June 30, 2019	Cash	$9,750.00
	Investment in Held-to-Maturity Debt          Securities		$707.52
	Interest income		$9,042.48
	(To record the interest and amortization)

Table (11)

Record the cash received on maturity date.

Date	Account Title and Explanation	Debit	Credit
June 30, 2019	Cash	$150,000.00
	Investment in Held-to-Maturity          Debt Securities		$150,000.00
	(To record the cash received on maturity date)

Table (12)

Explanation:

• Cash is an asset and increased. Therefore, debit the cash account.
• Investment in held-to-maturity debt securities is an asset. It is decreased here due to amortization of premium. Therefore, debit the investment in held-to-maturity debt securities account.
• Interest income is an income. It increases the equity. Therefore, it is credited.