Chapter D, Problem 2AE

To determine

Record the transactions and adjustments of Company H using journal entries.

Explanation of Solution

Available-for-sale securities:

These are short-term or long-term investments in debt and equity securities with an intention of holding the investment for some strategic purposes like meeting liquidity needs, or manage interest risk.

Record the transactions and adjustments of the Company H using journal entries as follows:

Journal entry for bond purchase:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
January 1, 2016	Bond investment – Trading		$793,400
	Cash			$793,400
	(To record purchase of $800,000 of S company bonds at 99 plus $1,400)

Table (1)

Working Note:

Calculate theBond Investment Value.

$\begin{array}{c}\text{Bond investment value}=\left(\begin{array}{l}\left(\begin{array}{l}\text{Face value}\\ \times \text{Purchase value }\left(\text{in percentage}\right)\end{array}\right)\\ \text{Brokerage commission}\end{array}\right)\\ =\left(\$800,000\times 99\%\right)+\$1,400\\ =\$792,000+\$1,400\\ =\$793,400\end{array}$

• Bond investment – Trading is an asset. There is an increase in asset’s value. Therefore, it is debited.
• Cash isan asset. There is a decrease in asset’s value. Therefore, it is credited.

Journal entry to record the interest earned from investment:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
June 30, 2016	Cash		$35,670
	Bond investment (Available-for-sales)			$330
	Bond interest income			$36,000
	(To record receipt of semiannual interest and discount amortization on $600,000  of available-for-sale bonds)

Table (2)

Working Note:

Calculate the bond investment (Available-for-sales).

Number of period is 20 period $\left(\frac{\text{10 year}}{\text{2 }\left(\text{semi annual}\right)}\right)$.

$\begin{array}{c}\text{Bond investment}=\left(\frac{\text{Total investment value}-\text{Face value}}{\text{Number of period}}\right)\\ =\frac{\left(\text{\$793,400}-\text{\$800,000}\right)}{\text{20 period}}\\ =\left(\$330\right)\end{array}$

Calculate thebond interest income (January to June).

$\begin{array}{c}\text{Bond interest income}=\left(\begin{array}{l}\left(\begin{array}{l}\text{Face value}\\ \times \text{Interest rate}\end{array}\right)\\ \times \text{Number of month completed}\end{array}\right)\\ =\left(\$800,000\times 9\%\right)\times \frac{\text{6month}}{\text{12month}}\\ =\$72,000\times 0.50\\ =\$36,000\end{array}$

• Cashis an asset. There is an increase in asset’s value. Therefore, it is debited
• Bond interest income is a component of stockholders’ equity account. There is an increase in stockholders’ equity. Therefore, it is credited.
• Bond investment (available-for-sales) isan asset (revenue). There is a decrease in assets value. Therefore, it is credited.

Journal entry to record the interest earned from investment:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
December 31, 2016	Cash		$35,670
	Bond investment (Available-for-sales)			$330
	Bond interest income			$36,000
	(To record receipt of semiannual interest and discount amortization on $600,000  of available-for-sale bonds)

Table (3)

Working Note:

Calculate the bond investment (Available-for-sales).

Number of period is 20 period $\left(\frac{\text{10 year}}{\text{2 }\left(\text{semi annual}\right)}\right)$.

$\begin{array}{c}\text{Bond investment}=\left(\frac{\text{Total investment value}-\text{Face value}}{\text{Number of period}}\right)\\ =\frac{\left(\text{\$793,400}-\text{\$800,000}\right)}{\text{20 period}}\\ =\left(\$330\right)\end{array}$

Calculate thebond interest income (June to December).

$\begin{array}{c}\text{Bond interest income}=\left(\begin{array}{l}\left(\begin{array}{l}\text{Face value}\\ \times \text{Interest rate}\end{array}\right)\\ \times \text{Number of month completed}\end{array}\right)\\ =\left(\$800,000\times 9\%\right)\times \frac{\text{6month}}{\text{12month}}\\ =\$72,000\times 0.50\\ =\$36,000\end{array}$

• Cash is an asset. There is an increase in asset’s value. Therefore, it is debited
• Bond interest income is a component of stockholders’ equity account. There is an increase in stockholders’ equity. Therefore, it is credited.
• Bond investment (available-for-sales) isan asset (revenue). There is a decrease in assets value. Therefore, it is credited.

Journal entry for recording current fair value of bonds:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
December 31, 2016	Unrealized gain or loss on investments (equity)		$3,400
	Fair value adjustment to bond investment			$3,400
	(To adjust available-for-sale debt securities to year-end fair value)

Table (4)

Working Notes:

Calculate the unrealized gain on investment.

$\begin{array}{c}\text{Unrealized gain on investment}=\left(\begin{array}{l}\text{Market value of bonds}\\ -\text{Purchase value of bond}\end{array}\right)\\ =\$790,000-\$793,400\\ =\left(\$3,400\right)\end{array}$

• Unrealized gain on investments (equity) isa liability. There is a decrease in liability value. Therefore, it is debited.
• Fair value adjustment to bond investment is liability. There is an increase in liability value. Therefore, it is credited.

Journal entry to record the interest earned from investment:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
June 30, 2017	Cash		$35,670
	Bond investment (Available-for-sales)			$330
	Bond interest income			$36,000
	(To record receipt of semiannual interest and discount amortization on $600,000  of available-for-sale bonds)

Table (5)

Working Note:

Calculate the bond investment (Available-for-sales).

Number of period is 20 period $\left(\frac{\text{10 year}}{\text{2 }\left(\text{semi annual}\right)}\right)$.

$\begin{array}{c}\text{Bond investment}=\left(\frac{\text{Total investment value}-\text{Face value}}{\text{Number of period}}\right)\\ =\frac{\left(\text{\$793,400}-\text{\$800,000}\right)}{\text{20 period}}\\ =\left(\$330\right)\end{array}$

Calculate thebond interest income (January to June).

$\begin{array}{c}\text{Bond interest income}=\left(\begin{array}{l}\left(\begin{array}{l}\text{Face value}\\ \times \text{Interest rate}\end{array}\right)\\ \times \text{Number of month completed}\end{array}\right)\\ =\left(\$800,000\times 9\%\right)\times \frac{\text{6month}}{\text{12month}}\\ =\$72,000\times 0.50\\ =\$36,000\end{array}$

• Cash is an asset. There is an increase in asset’s value. Therefore, it is debited
• Bond interest income is a component of stockholders’ equity account. There is an increase in stockholders’ equity. Therefore, it is credited.
• Bond investment (available-for-sales) isan asset (revenue). There is a decrease in assets value. Therefore, it is credited.

Journal entry to record the sale of investment:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
July 1, 2017	Cash		$792,500
	Bond investment-Available-for-sales			$790,000
	Gain on sale of investments			$2,500
	(To record sale of trading debt securities for $792,500)

Table (6)

Working Note:

Calculate theincome from gain on sale of investment.

$\begin{array}{c}\begin{array}{l}\text{Gain or loss on }\\ \text{sale of investment}\end{array}\}=\left(\begin{array}{l}\text{Sales value of bonds}\\ -\text{Face value of bond}\end{array}\right)\\ =\left(\$792,500-\$790,000\right)\\ =\$2,500\end{array}$

• Cash is assets. There is an increase in assets value. Therefore, it is debited.
• Bond investment – trading is assets. There is a decrease in assets value. Therefore, it is credited.
• Gain on sale of investment is a revenue account whichis a component of stockholders’ equity account. There is an increase in stockholders’ equity. Therefore, it is credited.

Journal entry for fair value adjustment:

Date	Account Title and Explanation	Post Ref.	Debit	Credit
December 31, 2017	Unrealized gain or loss on investments (equity)		$3,400
	Fair value adjustment to bond investment			$3,400
	(To adjust these account balance to zero)

Table (7)

• Unrealized gain on investments (equity) isa liability. There is a decrease in liability value. Therefore, it is debited.
• Fair value adjustment to bond investment is liability. There is an increase in liability value. Therefore, it is credited.