Chapter 14, Problem 14.23P

Report bonds at fair value; quarterly reporting

• LO14–6

Appling Enterprises issued 8% bonds with a face amount of $400,000 on January 1, 2018. The bonds sold for $331,364 and mature in 2037 (20 years). For bonds of similar risk and maturity the market yield was 10%. Interest is paid semiannually on June 30 and December 31. Appling determines interest expense at the effective rate. Appling elected the option to report these bonds at their fair value. The fair values of the bonds at the end of each quarter during 2018 as determined by their market values in the over-the-counter market were the following:

March 31	$350,000
June 30	340,000
September 30	335,000
December 31	342,000

General (risk-free) interest rates did not change during 2018.

Required:

1. By how much will Appling’s comprehensive income be increased or decreased by the bonds (ignoring taxes) in the March 31 quarterly financial statements?

2. By how much will Appling’s comprehensive income be increased or decreased by the bonds (ignoring taxes) in the June 30 quarterly financial statements?

3. By how much will Appling’s comprehensive income be increased or decreased by the bonds (ignoring taxes) in the September 30 quarterly financial statements?

4. By how much will Appling’s comprehensive income be increased or decreased by the bonds (ignoring taxes) in the December 31 annual financial statements?

To determine

Bonds

Bonds are a kind of interest bearing notes payable, usually issued by companies, universities and governmental organizations. It is a debt instrument used for the purpose of raising fund of the corporations or governmental agencies. If selling price of the bond is equal to its face value, it is called as par on bond. If selling price of the bond is lesser than the face value, it is known as discount on bond. If selling price of the bond is greater than the face value, it is known as premium on bond.

To Calculate: The increase/decrease amount of A’s comprehensive income in the March 31 quarterly financial statement.

Explanation of Solution

Calculate increase/decrease amount of A’s comprehensive income in the March 31 quarterly financial statement.

Particulars	Amount
Interest expense – Net income(1)	$8,284
Add: Unrealized holding loss – Other comprehensive income (OCI)(4)	$10,352
Decrease in comprehensive income	$18,636

Table (1)

Working notes:

Calculate the interest expense on the bond as on March 31, 2018.

$\begin{array}{c}\text{Interest expense}=\text{Price of bonds}\times \text{Market interest rate}\times \text{Interest time period}\\ =\$331,364\times 10\%\times \frac{3}{12}\\ =\$8,284\end{array}$

Hence, interest expense amount is $8,284.

(1)

Calculate discount on bonds payable on March 31, 2018.

$\begin{array}{c}\text{Discount on bonds payable }=\text{Interest expense –}\text{Interest payable}\\ =\$8,284-\left(\$400,000\times 8\%\times \frac{3}{12}\right)\\ =\$8,284-\$8,000\\ =\$284\end{array}$

Hence, discount on bonds payable amount is $284.

(2)

Calculate the book value of bonds at March 31, 2018.

$\begin{array}{c}\begin{array}{l}\text{Book value of bonds }\\ \text{at March 31, 2018 }\end{array})\text{= }\left(\begin{array}{l}\text{Book value of bonds at January 1, 2018 }\\ \text{+ Discount on bonds payable on March 31, 2018 }\\ \text{+ Accrued interest payable on March 31, 2018}\end{array}\right)\\ =\$331,364+\$284+\$8,000\\ =\$339,648\end{array}$

Hence, book value of bonds amount is $339,648.

(3)

Calculate the amount of fair value adjustment on March 31, 2018.

$\begin{array}{c}\text{Fair value adjustment = }\left(\begin{array}{l}\text{Book value of bonds at March 31, 2016 }\\ \text{–}\text{Fair value of bonds at March 31, 2016}\end{array}\right)\\ =\$339,648-\$350,000\\ =\$\left(10,352\right)\end{array}$ (4)

Therefore, decrease in other comprehensive income amount is $18,636 for March 31 quarterly financial statements.

To determine

To Calculate: The increase/decrease amount of A’s comprehensive income in the June 30 quarterly financial statement.

Explanation of Solution

Calculate increase/decrease amount of A’s comprehensive income in the June 30 quarterly financial statement.

Particulars	Amount
Interest expense – Net income(5)	$8,284
Add: Unrealized holding gain – Other comprehensive income (OCI)(8)	$(2,284)
Decrease in comprehensive income	$6,000

Table (2)

Working notes:

Calculate the interest expense on the bond as on June 30, 2018.

$\begin{array}{c}\text{Interest expense}=\text{Price of bonds}\times \text{Market interest rate}\times \text{Interest time period}\\ =\$331,364\times 10\%\times \frac{3}{12}\\ =\$8,284\end{array}$

Hence, interest expense amount is $8,284.

(5)

Calculate discount on bonds payable on June 30, 2016.

$\begin{array}{c}\text{Discount on bonds payable }=\text{Interest expense + Interest payable –}\text{Cash paid}\\ =\$8,284+\$8,000-\left(\$400,000\times 8\%\times \frac{6}{12}\right)\\ =\$8,284+\$8,000-\$16,000\\ =\$284\end{array}$

Hence, discount on bonds payable amount is $284.

(6)

Calculate the book value of bonds at June 30, 2018.

$\begin{array}{c}\begin{array}{l}\text{Book value of bonds }\\ \text{at June 30, 2018 }\end{array})\text{= }\left(\begin{array}{l}\text{Book value of bonds at March 31, 2018 }\\ \text{+ Discount on bonds payable on June 30, 2018 }\\ \text{– Accrued interest payable on March 31, 2018}\end{array}\right)\\ =\$339,648+\$284-\$8,000\\ =\$331,932\end{array}$

Hence, book value of bonds amount is $331,932.

(7)

Calculate the amount of fair value adjustment on June 30, 2016.

$\begin{array}{c}\text{Fair value adjustment = }\left(\begin{array}{l}\left(\begin{array}{l}\text{Book value of bonds at June 30, 2016 }\\ \text{–Fair value of bonds at June 30, 2016}\end{array}\right)\\ \text{–Fair}\text{value adjustment at March}\text{31,2016}\end{array}\right)\\ =\left(\$331,932-\$340,000\right)-\$\left(10,352\right)\\ =\$2,284\end{array}$ (8)

Therefore, decrease in other comprehensive income amount is $6,000 for June 30 quarterly financial statements.

To determine

To Calculate: The increase/decrease amount of A’s comprehensive income in the September 30 quarterly financial statement.

Explanation of Solution

Calculate increase/decrease amount of A’s comprehensive income in the September 30 quarterly financial statement.

Particulars	Amount
Interest expense – Net income(9)	$8,298
Unrealized holding gain – Other comprehensive income (OCI)(12)	$(13,298)
Decrease in comprehensive income	$5,000

Table (3)

Working notes:

Calculate the interest expense on the bond as on September 30, 2018.

$\begin{array}{c}\text{Interest expense}=\left(\$331,364+\$284+\$284\right)\times 10\%\times \frac{3}{12}\\ =\$8,298\end{array}$

Hence, interest expense amount is $8,298.

(9)

Calculate discount on bonds payable on September, 2018.

$\begin{array}{c}\text{Discount on bonds payable }=\text{Interest expense –}\text{Interest payable}\\ =\$8,298-\left(\$400,000\times 8\%\times \frac{3}{12}\right)\\ =\$8,298-\$8,000\\ =\$298\end{array}$

Hence, discount on bonds payable amount is $298.

(10)

Calculate the book value of bonds at September 30, 2018.

$\begin{array}{c}\begin{array}{l}\text{Book value of bonds }\\ \text{at September 30, 2018 }\end{array})\text{= }\left(\begin{array}{l}\text{Book value of bonds at June 30, 2018 }\\ \text{+ Discount on bonds payable on September 30, 2018 }\\ \text{+ Accrued interest payable on September 30, 2018}\end{array}\right)\\ =\$331,932+\$298+\$8,000\\ =\$340,230\end{array}$

Hence, book value of bonds amount as on 30^th September is $340,230.

(11)

Calculate the amount of fair value adjustment on September 30, 2018.

$\begin{array}{c}\text{Fair value adjustment = }\left(\begin{array}{l}\text{Book value of bonds at September 30, 2016 }\\ \text{–}\text{Fair value of bonds at September 30, 2016}\\ –\text{Fair}\text{adjustment}\text{value}\text{balance}\end{array}\right)\\ =\$340,230-\$335,000-\left(-\$10,352+\$2,284\right)\\ =\$\left(13,298\right)\end{array}$ (12)

Therefore, decrease in other comprehensive income amount is $5,000 for September 30 quarterly financial statements.

To determine

To Calculate: The increase/decrease amount of A’s comprehensive income in the December 31 quarterlyfinancial statement.

Explanation of Solution

Calculate increase/decrease amount of A’s comprehensive income in the December 31 quarterly financial statement.

Particulars	Amount
Interest expense – Net income(13)	$8,298
Add: Unrealized holding loss – Other comprehensive income (OCI)(16)	$14,702
Decrease in comprehensive income	$23,000

Table (4)

Working notes:

Calculate the interest expense on the bond as on December 31, 2018.

$\begin{array}{c}\text{Interest expense}=\left(\$331,364+\$284+\$284\right)\times 10\%\times \frac{3}{12}\\ =\$8,298\end{array}$

Hence, interest expense amount is $8,298.

(13)

Calculate discount on bonds payable on December 31, 2018.

$\begin{array}{c}\text{Discount on bonds payable }=\text{Interest expense + Interest payable –}\text{Cash paid}\\ =\$8,298+\$8,000-\left(\$400,000\times 8\%\times \frac{6}{12}\right)\\ =\$8,298+\$8,000-\$16,000\\ =\$298\end{array}$

Hence, discount on bonds payable amount is $298.

(14)

Calculate the book value of bonds at December 31, 2018.

$\begin{array}{c}\begin{array}{l}\text{Book value of bonds }\\ \text{at December 31, 2018 }\end{array})\text{= }\left(\begin{array}{l}\text{Book value of bonds at September 30, 2018}\\ \text{+ Discount on bonds payable on December 31, 2018 }\\ \text{– Accrued interest payable on September 30, 2018}\end{array}\right)\\ =\$340,230+\$298-\$8,000\\ =\$332,528\end{array}$

Hence, value of the bonds as on 31^st December 2018 is $332,528.

(15)

Calculate the amount of fair value adjustment on December 31, 2018.

$\begin{array}{c}\text{Fair value adjustment = }\left(\begin{array}{l}\left(\begin{array}{l}\text{Book value of bonds at December 31, 2016 }\\ \text{–Fair value of bonds at December 31, 2016}\end{array}\right)\\ \text{–Fair}\text{value adjustment balance}\end{array}\right)\\ =\left(\$332,528-\$342,000\right)-\left(-\$10,352+\$2,284+\$13,298\right)\\ =\$\left(14,702\right)\end{array}$

Hence, fair value adjustment amount is $14,702.

(16)

To Calculate: The increase/decrease amount of A’s comprehensive income in the December 31 annual financial statement.

Calculate increase /decrease amount of A’s comprehensive income in the December 31 annual financial statement.

Particulars	Amount
First quarter interest expense	$8,284
Second quarter interest expense	$8,284
Third quarter interest expense	$8,298
Fourth quarter interest expense	$8,298
First quarter unrealized holding loss – OCI	$10,352
Second quarter unrealized holding gain – OCI	$(2,284)
Third quarter unrealized holding gain – OCI	$(13,298)
Fourth quarter unrealized holding loss – OCI	$14,702
Decrease in 2016 comprehensive income	$42,636

Table (5)

Therefore, decrease in other comprehensive income amount is $42,636 for December 31 annual financial statements.