Chapter 13, Problem 5P

To determine

Journalize the purchase of bonds, interest payment, partial sale of the investment on January 1, 2019, and the retirement of the bond issue on December 31, 2019.

Explanation of Solution

On January 1, 2019, Corporation M purchased 10%, bond with a face value of $500,000 for $475,413.60. The bond carries 10% interest rate, and it will be paid semiannually on June 30 and December 31, until the maturity date of December 31, 2021. The effective interest rate is 12%.

During January 1, 2021, Corporation M sold one-fourth of the bonds for $127,000. Corporation M uses effective interest rate for amortization.

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

Corporation M
Bond investment interest income and Discount amortization Schedule (Partial)
Effective interest rate method
Date	Cash (Debit) (a)	Interest income (Credit) (b)	Investment in debt securities Debit (Credit) (c)	Carrying value of debt securities (d)
January 1, 2019				$475,413.60
June 30, 2019	$25,000.00	$28,524.82	$3,524.82	$478,938.42
December 31, 2019	$25,000.00	$28,736.31	$3,736.31	$482,674.73
June 30, 2020	$25,000.00	$28,960.48	$3,960.48	$486,635.21
December 31, 2020	$25,000.00	$29,198.11	$4,198.11	$490,833.32
January 1, 2021	$127,000.00	$0.00	-$122,708.33	$368,124.99
June 30, 2021	$18,750.00	$22,087.50	$3,337.50	$371,462.49
December 31, 2021	$393,750.00	$22,287.51	-$371,462.49	$0.00

Table (1)

Note:

1.

$\text{Cash }\left(\text{a}\right)\text{ = Bonds outstanding}\times \text{10\%}\times \frac{\text{6 months}}{\text{12 months}}$

(10% is bonds stated interest rate). On January 1, 2021 the one-fourth of the bond sold for $127,000. 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. $\text{Investment in debt securities }\left(\text{c}\right)\text{=Amount of interest income}\left(\text{b}\right)-\text{Cash }\left(\text{a}\right)$, Where (c) represents an amount of amortization of discount. On January 1, 2018, the one-fourth value of the bond $122,708.33 sold for $127,000 as calculated below:

$\begin{array}{c}\begin{array}{l}\text{Value of bond sold on}\\ \text{January 1, 2021 is credited}\\ \text{in investment in debt securities}\end{array}\}=\frac{\begin{array}{l}\text{Value of bond on }\\ \text{December 31, 2020}\end{array}}{4}\\ =\frac{\$490,833.32}{4}\\ =\$122,708.33\end{array}$

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

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 M.

Record the purchase of held-to maturity debt securities.

Date	Account Title and Explanation	Debit	Credit
January 1, 2019	Investment in Held-to-Maturity Debt Securities	$475,413.60
	Cash		$475,413.60
	(To record the purchase of held-to-maturity securities at discount)

Table (2)

Explanation:

• Cash is an asset and decreased. Therefore, credit the cash account.
• Investment in held-to-maturity debt securities is an asset. It is increased here due to purchase of bond.

Record the interest income earned on June 30, 2019 and December 31, 2019.

Date	Account Title and Explanation	Debit	Credit
June 30, 2019	Cash	$25,000.00
	Investment in Held-to-Maturity Debt Securities	$3,524.82
	Interest income		$28,524.82
	(To record the interest and amortization)

Table (3)

Date	Account Title and Explanation	Debit	Credit
December 31, 2019	Cash	$25,000.00
	Investment in Held-to-Maturity Debt Securities	$3,736.31
	Interest income		$28,736.31
	(To record the interest and amortization)

Table (4)

Record the interest income earned on June 30, 2020 and December 31, 2020.

Date	Account Title and Explanation	Debit	Credit
June 30, 2020	Cash	$25,000.00
	Investment in Held-to-Maturity Debt Securities	$3,960.48
	Interest income		$28,960.48
	(To record the interest and amortization)

Table (5)

Date	Account Title and Explanation	Debit	Credit
December 31, 2020	Cash	$25,000.00
	Investment in Held-to-Maturity Debt Securities	$4,198.11
	Interest income		$29,198.11
	(To record the interest and amortization)

Table (6)

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.

Record the sale of one-fourth of bond for $127,000 on January 1, 2021.

Date	Account Title and Explanation	Debit	Credit
January 1, 2021	Cash	$127,000.00
	Investment in Held-to-Maturity          Debt Securities		$122,708.33
	Gain on sale of debt securities          (Balancing figure)		$4,291.67
	(To record the sale of one-fourth of the bond at gain)

Table (7)

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 sale of one-fourth of the bond. Therefore, debit the investment in held-to-maturity debt securities account.
• Gain on sale of debt securities is an income. It increases the equity. Therefore, it is credited.

Record the interest income earned on June 30, 2021 and December 31, 2021.

Date	Account Title and Explanation	Debit	Credit
June 30, 2021	Cash	$18,750.00
	Investment in Held-to-Maturity Debt Securities	$3,337.50
	Interest income		$22,087.50
	(To record the interest and amortization)

Table (8)

Date	Account Title and Explanation	Debit	Credit
December 31, 2021	Cash	$18,750.00
	Investment in Held-to-Maturity Debt Securities	$3,537.51
	Interest income		$22,287.51
	(To record the interest and amortization)

Table (9)

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.

Record the cash received on maturity date.

Date	Account Title and Explanation	Debit	Credit
December 31, 2021	Cash	$375,000.00
	Investment in Held-to-Maturity Debt Securities		$375,000.00
	(To record the cash received on retirement of bond)

Table (10)

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 retirement of bond. Therefore, it is credited.