Chapter 15, Problem 1PA

Soto Industries Inc. is an athletic footware company that began operations on January 1, Year 1. The following transactions relate to debt investments acquired by Soto Industries Inc., which has a fiscal year ending on December 31:

Instructions

1. 1. Journalize the entries to record these transactions.
2. 2. If the bond portfolio is classified as available for sale, what impact would this have on financial statement disclosure?

To determine

Journalize the bond investment transactions in the books of Company G.

Explanation of Solution

Bond investment: Bond investments are debt securities which pay a fixed interest revenue to the investor.

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.

Prepare journal entry for purchase of $100,000 bonds of Company W, at face amount with an accrued interest of $500.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
April	1	Investments–Company W Bonds		100,000
		Interest Receivable		500
		Cash			100,500
		(To record purchase of Company W bonds for cash)

Table (1)

• Investments–Company W Bonds is an asset account. Since bonds investments are purchased, asset value increased, and an increase in asset is debited.
• Interest Receivable is an asset account. Since interest to be received has increased, asset value increased, and an increase in asset is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Prepare journal entry for purchase of $210,000 bonds of Company B, at face amount with an accrued interest of $700.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
June	1	Investments–Company B Bonds		210,000
		Interest Receivable		700
		Cash			210,700
		(To record purchase of Company B bonds for cash)

Table (2)

• Investments–Company B Bonds is an asset account. Since bonds investments are purchased, asset value increased, and an increase in asset is debited.
• Interest Receivable is an asset account. Since interest to be received has increased, asset value increased, and an increase in asset is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Prepare journal entry to record the interest revenue received from Company W bonds.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
September	1	Cash		3,000
		Interest Receivable			500
		Interest Revenue			2,500
		(To record receipt of interest revenue)

Table (3)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Interest Receivable is an asset account. Since interest to be received is received, asset value decreased, and a decrease in asset is credited.
• Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Compute amount of interest received from Company W.

$\begin{array}{c}\text{Interest received = }\left\{\begin{array}{l}\text{Amount of debt investment × }\\ \text{Rate of interest}\times \\ \text{Time period}\end{array}\right\}\\ \text{= \$100,000×6\%}\times \frac{6}{12}\\ \text{= \$3,000}\end{array}$

Prepare journal entry for $40,000 bonds of Company W sold at 97%, with an accrued interest of $200.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
September	30	Cash		39,000
		Loss on Sale of Investments		1,200
		Interest Revenue			200
		Investments–Company W Bonds			40,000
		(To record sale of M City bonds)

Table (3)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Loss on Sale of Investments is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.
• Investments–Company W Bonds is an asset account. Since bond investments are sold, asset value decreased, and a decrease in asset is credited.

Working Notes:

Calculate the cash received from the sale of bonds.

Particulars	Amount ($)
Cash proceeds from sale of  $40,000 bonds $\left(\text{\$40,000×97\%}\right)$	38,800
Add: Accrued interest revenue	200
Cash received	$39,000

Table (4)

Calculate the realized gain (loss) on sale of $40,000 bonds.

Particulars	Amount ($)
Cash proceeds from sale of  $40,000 bonds $\left(\text{\$40,000×97\%}\right)$	38,800
Cost of bonds sold	(40,000)
Gain (loss) on sale of bonds	$(1,200)

Table (5)

Prepare journal entry to record the interest revenue received from Company B bonds.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
November	1	Cash		4,200
		Interest Receivable			700
		Interest Revenue			3,500
		(To record receipt of interest revenue)

Table (6)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Interest Receivable is an asset account. Since interest to be received is received, asset value decreased, and a decrease in asset is credited.
• Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Compute amount of interest received from Company B.

$\begin{array}{c}\text{Interest received = }\left\{\begin{array}{l}\text{Amount of debt investment × }\\ \text{Rate of interest}\times \\ \text{Time period}\end{array}\right\}\\ \text{= \$210,000×4\%}\times \frac{6}{12}\\ \text{= \$4,200}\end{array}$

Prepare journal entry for accrued interest.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
December	31	Interest Receivable		1,200
		Interest Revenue			1,200
		(To record interest accrued)

Table (7)

• Interest Receivable is an asset account. Since interest to be received has increased, asset value increased, and an increase in asset is debited.
• Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Prepare journal entry for accrued interest.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
December	31	Interest Receivable		1,400
		Interest Revenue			1,400
		(To record interest accrued)

Table (8)

• Interest Receivable is an asset account. Since interest to be received has increased, asset value increased, and an increase in asset is debited.
• Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Prepare journal entry to record the interest revenue received from Company W bonds.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 2
May	1	Cash		1,800
		Interest Receivable			1,200
		Interest Revenue			600
		(To record receipt of interest revenue)

Table (9)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Interest Receivable is an asset account. Since interest to be received is received, asset value decreased, and a decrease in asset is credited.
• Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Compute amount of interest received from Company W.

$\begin{array}{c}\text{Interest accrued = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Amount of debt investment bought–}\\ \text{Amount of debt investment sold}\end{array}\right)\text{ × }\\ \text{Rate of interest}\times \text{Time period }\end{array}\right\}\\ \text{= }\left(\text{\$100,000–\$40,000}\right)\text{×6\%}\times \frac{6}{12}\\ \text{= \$1,800}\end{array}$

Prepare journal entry to record the interest revenue received from Company B bonds.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 2
May	1	Cash		4,200
		Interest Receivable			1,400
		Interest Revenue			1,800
		(To record receipt of interest revenue)

Table (10)

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Interest Receivable is an asset account. Since interest to be received is received, asset value decreased, and a decrease in asset is credited.
• Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Compute amount of interest received from Company B.

$\begin{array}{c}\text{Interest received = }\left\{\begin{array}{l}\text{Amount of debt investment × }\\ \text{Rate of interest}\times \\ \text{Time period}\end{array}\right\}\\ \text{= \$210,000×4\%}\times \frac{6}{12}\\ \text{= \$4,200}\end{array}$

To determine

Explain the impact of bonds, if the portfolio is classified as available-for-sale investment.

Explanation of Solution

Available-for-sale investments are reported at fair value. If the bond portfolio is classified as available-for-sale investment, the bond portfolio should be reported at fair value. The changes in the cost and fair value would be adjusted using the valuation account and unrealized gain (loss) account.