Question

On January 1, 2017, Pharoah Company purchased 12% bonds, having a maturity value of $320,000, for $344,260.74. The bonds provide the bondholders with a 10% yield. They are dated January 1, 2017, and mature January 1, 2022, with interest received on January 1 of each year. Pharoah Company uses the effective-interest method to allocate unamortized discount or premium. The bonds are classified as available-for-sale category. The fair value of the bonds at December 31 of each year-end is as follows. 2017 $342,000 2020 $330,700 2018 $329,700 2021 $320,000 2019 $328,700 (a) Prepare the journal entry at the date of the bond purchase. (b) Prepare the journal entries to record the interest revenue and recognition of fair value for 2017. (c) Prepare the journal entry to record the recognition of fair value for 2018.

Answer 1

a) Prepare the journal entry at the date of the bond purchase.

Details	Debit	Credit
Available for sale securities	344,260.74
Cash		344,260.74

(b) Prepare the journal entries to record the interest revenue and recognition of fair value for 2017.

Details	Debit	Credit
Cash	38,400
Interest revenue		34,426.07
Available for sale securities		3,973.93

Explanation.

Interest is received on face value and at the rate of predetermined coupon. Hence cash is debited with 38400 (being 320,000 * 0.12). But amount of interest to be recognized shall be carrying value of bond X market rate of interest = 344,260.74 X 0.10 = 34,426.07

The difference between cash interest and interest revenue = amortization of bond premium = 3973.93. Now the carrying value of the bonds = 344,260.74 - 3973.93 = 340,286.81. But the fair value as at 2017 is 342,000. Hence it is a gain which shall be credited to " Unrealized holding gain or loss - equity " and corresponding debit is given to " Securities fair value adjustment - AFS "

Amount = 342,000 - 340,386.81 = 1713.19

	Debit	Credit
Securities fair value adjustment - AFS	1713.19
Unrealized holding gain or loss - Equity		1713.19

(c) Prepare the journal entry to record the recognition of fair value for 2018.

Interest revenue for 2018 = 340,386.81 * 0.10 = 34,038.68

Cash interest = 34,800

Amortization for 2018 = 34,800 - 34,038.68 = 761.32

Hence carrying value = 340,386.81 - 761.32 = 339625.49

But the fair value = 329,700 ............... Hence a Loss of ........... 339625.49 - 329,700 = 9925.49

Unrealized holding gain or loss - Equity ( Debit ) .................9925.49

Securities fair value adjustment - AFS ...........................................9925.49