Question

Bonobo’s Balloons Inc. purchased the $60,000 par value bonds of Gnomes R Us on January 1, 2020. The coupon rate is 8% and the bonds mature in 5 years. The market rate of interest is 12%. The bonds pay interest semi-annually every June 30 and December 31. The bonds were purchased for $51,167.90 and were classified as available-for-sale. Bonobo’s Balloons uses the effective-interest rate method to amortize bond discounts and premiums. At December 31, 2020, the market value of the bonds was $65,000. Bonobo’s Balloons sold the bonds on January 1, 2021, for $65,000.

Instructions

1. Compute the carrying value of the investment at December 31, 2020.
2. Compute the amount of interest revenue earned on this investment at June 30, 2020.
3. Compute the amount of unrealized gain or loss recognized on December 31, 2020. In which financial statement should this amount be reported?
4. Compute the amount of gain or loss recognized on the sale of the investment at January 1, 2021. In which financial statement should this amount be reported?
5. If this investment was instead classified as held-to-maturity, how would this have affected the amount of unrealized gain or loss on December 31, 2020, and how would this have affected its reporting?

Computations:

Carrying value at December 31, 2020:

Interest revenue at June 30, 2020:

Unrealized gain/loss at December 31, 2020:

Gain or loss at January 1, 2021:

Requirement 5:

Answer 1

Held for sale securities will berecorded at the Fair value by discounting the future cash flows at effective interest rate.

Effective interest rate is the rate at which the PV of the future cash inflows will equal with the current purcase cost of the bond.

Total period = 5year * 2 = 10

Interest received per period = $60000*8% *1/2 = $2400

$51,167.90 = [$2400 * AF(Effective interest rate , 10 period)] +[$60000* PVF (Effecitve interest rate, 10th period)]

=>Effective Interest Rate = 6% per semi annum or 12% Per annum.

At the year end the bond will be valued at Fair value and the resulting gain or loss will be transferred to Unrealised gain/Loss(OCI).

Date	Opening balance of Bond	Interest@Effective interest rate	Receipt(Interest)	End Balance of Bond	Fair value of bond to be shown in Balancesheet	Gain/(Loss)(OCI)
30 th June 2020	51,167.90	3070.074	2400	51,837.97
31st Dec 2020	51,837.97	3110.27844	2400	52,548.25	65000	12,451.75
30 th June 2021	52,548.25	3152.895146	2400	53,301.15
31st Dec 2021	53,301.15	3198.068855	2400	54,099.22
30 th June 2022	54,099.22	3245.952986	2400	54,945.17
31st Dec 2022	54,945.17	3296.710166	2400	55,841.88
30 th June 2023	55,841.88	3350.512776	2400	56,792.39
31st Dec 2023	56,792.39	3407.543542	2400	57,799.94
30 th June 2024	57,799.94	3467.996155	2400	58,867.93
31st Dec 2024	58,867.93	3532.075924	2400	60,000.01

Computations:

Carrying value at December 31, 2020: $52,548.25

Interest revenue at June 30, 2020:$3070.074

Unrealized gain/loss at December 31, 2020:$12,451.75 Gain

Gain or loss at January 1, 2021: $0

Calculation

Value of Bond at Balance sheet on January1,2021 = $65000

Less-Selling value = ($65000)

--------------------------------------------------------------------------------------

Gain or Loss = $0

Note-Balance gain on OCI $12,451.75 will be transferred to general reserve.

Journal enry on January 01, 2021-

Cash	$65000
Bond		$65000
OCI reserve	$12,451.75
General Reserve		$12,451.75