Chapter 15, Problem 1PB

Rekya Mart Inc. is a general merchandise retail company that began operations on January 1, Year 1. The following transactions relate to debt investments acquired by Rekya Mart 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 RM.

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 SB, at face amount with an accrued interest of $900.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
April	1	Investments–Company SB Bonds		90,000
		Interest Receivable		900
		Cash			90,900
		(To record purchase of Company SB bonds for cash)

Table (1)

• Investments–Company SB 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
May	16	Investments–Company G Bonds		42,000
		Interest Receivable		70
		Cash			42,070
		(To record purchase of Company G bonds for cash)

Table (2)

• Investments–Company G 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 SB bonds.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
August	1	Cash		2,700
		Interest Receivable			900
		Interest Revenue			1,800
		(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 SB.

$\begin{array}{c}\text{Interest received = }\left\{\begin{array}{l}\text{Amount of debt investment × }\\ \text{Rate of interest}\times \\ \text{Time period}\end{array}\right\}\\ \text{= \$90,000×6\%}\times \frac{6}{12}\\ \text{= \$2,700}\end{array}$

Prepare journal entry for $12,000 bonds of Company SB sold at 101%, with an accrued interest of $60.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
September	1	Cash		12,180
		Interest Revenue			60
		Gain on Sale of Investments			120
		Investments–Company SB Bonds			12,000
		(To record sale of Company SB bonds)

Table (4)

• Cash is an asset account. Since cash is received, asset account 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.
• Gain on Sale of Investments is an income account. Since income increases equity, equity value is increased, and an increase in equity is credited.
• Investments–Company SB 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  $12,000 bonds $\left(\text{\$12,000×101\%}\right)$	12,120
Add: Accrued interest revenue	60
Cash received	$12,180

Table (5)

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

Particulars	Amount ($)
Cash proceeds from sale of  $12,000 bonds $\left(\text{\$12,000×101\%}\right)$	12,120
Cost of bonds sold	(12,000)
Gain (loss) on sale of bonds	$120

Table (6)

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

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
November	1	Cash		840
		Interest Receivable			70
		Interest Revenue			770
		(To record receipt of interest revenue)

Table (7)

• 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 G.

$\begin{array}{c}\text{Interest received = }\left\{\begin{array}{l}\text{Amount of debt investment × }\\ \text{Rate of interest}\times \\ \text{Time period}\end{array}\right\}\\ \text{= \$42,000×4\%}\times \frac{6}{12}\\ \text{= \$840}\end{array}$

Prepare journal entry for accrued interest.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
December	31	Interest Receivable		1,950
		Interest Revenue			1,950
		(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 for accrued interest.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 1
December	31	Interest Receivable		280
		Interest Revenue			280
		(To record interest accrued)

Table (9)

• 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 SB bonds.

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 2
February	1	Cash		2,340
		Interest Receivable			1,950
		Interest Revenue			390
		(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 SB.

$\begin{array}{c}\text{Interest accrued = }\left\{\begin{array}{l}\left(\begin{array}{l}\text{Amount of debt investment bought–}\\ \text{Amount of debt investment sold}\end{array}\right)\text{ × }\\ \text{Rate of interest}\times \text{Time period }\end{array}\right\}\\ \text{= }\left(\text{\$90,000–\$12,000}\right)\text{×6\%}\times \frac{6}{12}\\ \text{= \$2,340}\end{array}$

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

Date		Account Titles and Explanations	Post. Ref.	Debit ($)	Credit ($)
Year 2
May	1	Cash		840
		Interest Receivable			280
		Interest Revenue			560
		(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 G.

$\begin{array}{c}\text{Interest received = }\left\{\begin{array}{l}\text{Amount of debt investment × }\\ \text{Rate of interest}\times \\ \text{Time period}\end{array}\right\}\\ \text{= \$42,000×4\%}\times \frac{6}{12}\\ \text{= \$840}\end{array}$

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.