Chapter D, Problem 2BP

To determine

Journalize the transactions related to bond investments in the books of Corporation J.

Explanation of Solution

Trading securities: These are short-term investments in debt and equity securities purchased with an intention of trading and earning profits due to changes in market prices.

Available-for-sale securities: These are short-term or long-term investments in debt and equity securities with an intention of not selling the investment in the near future but holding the investment for some longer time period, and not till maturity (for debt securities).

Held-to-maturity securities: The investments in debt securities which are bought by the investor with an intention to hold till maturity, are referred to as held-to maturity securities.

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.

Journalize the transactions related to bond investments in the books of Corporation J.

Transaction on June 30, 2016:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
June	30	Bond Investment–Available-for-Sale			97,200
			Cash			97,200
		(Record purchase of investment in available-for-sale securities)

Table (1)

Description:

• Bond Investment–Available-for-Sale is an asset account. Since bond investments are purchased, 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.

Transaction on December 31, 2016 (semiannual interest and premium amortization):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
December	31	Cash			3,500
		Bond Investment–Available-for-Sale			70
			Bond Interest Income			3,570
		(Record recognition of interest income and discount amortized on available-for-sale securities)

Table (2)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Bond Investment–Available-for-Sale is an asset account. Since discount on bond investments is amortized, asset value increased, and an increase in asset is debited.
• Bond Interest Income is a revenue account. Since revenues increase equity and an increase in equity is credited, so Bond Interest Income account is credited.

Working Notes:

Compute cash received as interest income on bonds.

$\begin{array}{c}\text{Cash received = Face value }\times \text{ Interest rate }\times \text{ Interest time period}\\ \text{=\$100,000×}\frac{7}{\text{100}}\text{×}\frac{\text{6}}{\text{12}}\\ \text{=\$3,500}\end{array}$ (1)

Compute discount amortized by straight-line method.

$\begin{array}{c}\text{Discount amortized = }\frac{\text{Face value of bonds–Cash paid}}{\text{Number of semi-annual payment periods}}\\ \text{=}\frac{\text{\$100,000–\$97,200}}{\text{40 periods}}\\ \text{=\$70}\end{array}$ (2)

Compute interest income on bonds.

$\begin{array}{c}\text{Interest income on bonds = Cash received + Discount amortized}\\ \text{=\$3,500+\$70}\\ \text{=\$3,570}\end{array}$ (3)

Note: Refer to Equations (1) and (2) for both the values.

Transaction on December 31, 2016 (purchase of held-to-maturity bonds):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
December	31	Bond Investment–Held-to-Maturity			304,000
			Cash			304,000
		(Record purchase of investment in held-to-maturity securities)

Table (3)

Description:

• Bond Investment–Held-to-Maturity is an asset account. Since bond investments are purchased, 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.

Transaction on December 31, 2016 (fair value adjustment of available-for-sale securities):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2016
December	31	Unrealized Gain/Loss on Investments			870
			Fair Value Adjustment to Bond Investment			870
		(Record the adjustment of cost of investment to the fair value)

Table (4)

Description:

• Unrealized Gain/Loss on Investments is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since loss has occurred and losses decrease stockholders’ equity value, a decrease in stockholders’ equity value is debited. This loss is reported as component of stockholders’ equity section of balance sheet.
• Fair Value Adjustment to Bond Investment is a valuation account to bond investment account. The account is credited to decrease the carrying value of investment.

Working Notes:

Determine the unrealized gain or loss on investment.

Step 1: Compute the carrying value available-for-sale securities as on December 31, 2016.

$\begin{array}{c}\text{Carrying value of investment = }\left\{\begin{array}{l}\text{Cost of investment + }\\ \text{Discount amortized}\end{array}\right\}\\ \text{=\$97,200+\$70}\\ \text{=\$97,270}\end{array}$ (4)

Note: Refer to Equation (2) for value of discount amortized.

Step 2: Compute unrealized gain or loss on investment in available-for-sale securities.

$\begin{array}{c}\text{Unrealized gain }\left(\text{loss}\right)\text{ = }\left\{\begin{array}{l}\text{Fair market value –}\\ \text{Carrying value of the investment }\end{array}\right\}\\ \text{=\$96,400–\$97,270}\\ \text{=\$}\left(\text{870}\right)\end{array}$

Note: Refer to Equation (4) for value of carrying value of investment.

Transaction on June 30, 2017 (semiannual interest and premium amortization):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
December	31	Cash			3,500
		Bond Investment–Available-for-Sale			70
			Bond Interest Income			3,570
		(Record recognition of interest income and discount amortized on available-for-sale securities)

Table (5)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Bond Investment–Available-for-Sale is an asset account. Since discount on bond investments is amortized, asset value increased, and an increase in asset is debited.
• Bond Interest Income is a revenue account. Since revenues increase equity and an increase in equity is credited, so Bond Interest Income account is credited.

Note: Refer to Equations (1), (2) and (3) for all the values.

Transaction on June 30, 2017 (semiannual interest and discount amortization):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
June	30	Cash			12,000
			Bond Interest Income			11,800
			Bond Investment–Held-to-Maturity			200
		(Record recognition of interest income and premium amortized on held-to-maturity securities)

Table (6)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Bond Interest Income is a revenue account. Since revenues increase equity and an increase in equity is credited, so Bond Interest Income account is credited.
• Bond Investment–Held-to-Maturity is an asset account. Since premium on bond investments is amortized, asset value decreased, and a decrease in asset is credited.

Working Notes:

Compute cash received as interest income on bonds.

$\begin{array}{c}\text{Cash received = Face value }\times \text{ Interest rate }\times \text{ Interest time period}\\ \text{=\$300,000×}\frac{8}{\text{100}}\text{×}\frac{\text{6}}{\text{12}}\\ \text{=\$12,000}\end{array}$ (5)

Compute premium amortized by straight-line method.

$\begin{array}{c}\text{Premium amortized = }\frac{\text{Cash paid – Face value of bonds}}{\text{Number of semi-annual payment periods}}\\ \text{=}\frac{\text{\$304,000–\$300,000}}{\text{20 periods}}\\ \text{=\$200}\end{array}$ (6)

Compute interest income on bonds.

$\begin{array}{c}\text{Interest income on bonds = Cash received – Premium amortized}\\ \text{=\$12,000–\$200}\\ \text{=\$11,800}\end{array}$ (7)

Note: Refer to Equations (5) and (6) for both the values.

Transaction on July 1, 2017:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
July	1	Cash			96,500
		Loss on Sale of Investments			840
			Bond Investment–Available-for-Sale			97,340
		(Record the disposal of investment in available-for-sale securities)

Table (7)

Description:

• 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 a loss account. Since losses and expenses decrease equity, and a decrease in equity is debited, so, Loss on Sale of Investments is debited.
• Bond Investment–Available-for-Sale is an asset account. Since bond investments are sold, asset value decreased, and a decrease in asset is credited.

Working Notes:

Compute gain or loss on sale of available-for-sale securities.

Step 1: Compute the carrying value of investment as on June 30, 2017.

$\begin{array}{c}\begin{array}{l}\text{Carrying value of investment }\\ \text{on June 30, 2017}\end{array}\}\text{ = }\left\{\begin{array}{l}\text{Carrying value of investment on }\\ \text{December 31, 2016 + Discount amortized}\end{array}\right\}\\ \text{=\$97,270+\$70}\\ \text{=\$97,340}\end{array}$ (8)

Note: Refer to Equation (4) for carrying value of investment on December 31, 2016, and Equation (2) for value of discount amortized.

Step 2: Compute gain or loss on sale of available-for-sale securities.

$\begin{array}{c}\text{Gain }\left(\text{loss}\right)\text{ on disposal = }\left\{\begin{array}{l}\text{Cash received –}\\ \text{Carrying value of investment on June 30, 2017 }\end{array}\right\}\\ \text{=\$96,500–\$97,340}\\ \text{=\$}\left(\text{840}\right)\end{array}$

Note: Refer to Equation (8) for value and computation of carrying value.

Transaction on October 31, 2017:

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
October	31	Bond Investment–Trading			79,000
			Cash			79,000
		(Record purchase of investment in trading securities)

Table (8)

Description:

• Bond Investment–Trading is an asset account. Since bond investments are purchased, 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.

Transaction on December 31, 2017 (semiannual interest and discount amortization):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
December	31	Cash			12,000
			Bond Interest Income			11,800
			Bond Investment–Held-to-Maturity			200
		(Record recognition of interest income and premium amortized on held-to-maturity securities)

Table (9)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Bond Interest Income is a revenue account. Since revenues increase equity and an increase in equity is credited, so Bond Interest Income account is credited.
• Bond Investment–Held-to-Maturity is an asset account. Since premium on bond investments is amortized, asset value decreased, and a decrease in asset is credited.

Note: Refer to Equations (5), (6) and (7) for all the values.

Transaction on December 31, 2017 (adjusting entry for accrued interest on trading securities):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
December	31	Bond Interest Receivable			1,009
			Bond Interest Income			1,009
		(Record interest accrued on trading bond investment)

Table (10)

Description:

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

Working Notes:

Determine amount of interest accrued on December 31, 2017.

$\begin{array}{c}\text{Interest receivable = }\left\{\begin{array}{l}\text{Face value of bonds }\times \\ \text{Interest rate }\times \\ \text{Interest time period}\end{array}\right\}\\ =\$80,000\times \frac{7.57}{100}\times \frac{2}{12}\\ =\$1,009\end{array}$

Transaction on December 31, 2017 (fair value adjustment of trading securities):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
December	31	Bond Investment–Trading			900
			Unrealized Gain/Loss on Investments			900
		(Record the adjustment of cost of investment to the fair value)

Table (11)

Description:

• Bond Investment–Trading is an asset account. Since fair value of bond investments is more than the cost of investment, asset value increased, and an increase in asset is debited.
• Unrealized Gain/Loss on Investments is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since gain has occurred and gains increase stockholders’ equity value, an increase in stockholders’ equity value is credited. This gain is reported as component of stockholders’ equity section of balance sheet.

Working Notes:

Calculate the unrealized gain (loss) on trading bond investment.

$\begin{array}{c}\text{Unrealized gain }\left(\text{loss}\right)\text{ = }\left\{\begin{array}{l}\text{Fair market value –}\\ \text{Cost of the investment }\end{array}\right\}\\ \text{=\$79,900–\$79,000}\\ \text{=\$900}\end{array}$

Transaction on December 31, 2017 (adjustment to eliminate the unrealized holding gains and losses on available-for-sale securities):

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
2017
December	31	Fair Value Adjustment to Bond Investment			870
			Unrealized Gain/Loss on Investments			870
		(Record the reversal effect of fair value adjustment)

Table (12)

Description:

• Fair Value Adjustment to Bond Investment is a valuation account to bond investment account. Since the investment is sold, the unrealized gain is cancelled by reversing (debiting) the entry, and adjust the balance to $0.
• Unrealized Gain/Loss on Investments is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since the investment is sold, the unrealized gain is cancelled by reversing (crediting) the entry, and adjust the balance to $0.

Note: Refer to Table (4) and its corresponding working notes for value and computation of unrealized gain.