On July 1, 2018, Kit Kat Company purchased $400,000 of Kool Company’s 10%, 10-year bonds for...

On July 1, 2018, Kit Kat Company purchased $400,000 of Kool Company’s 10%, 10-year bonds for $354,118, reflecting a 12% market rate. Interest on the bonds is paid semi-annually on December 31 and June 30.

Requirement 1: On July 1, 2018, what entry did Kit Kat record for the purchase of the bonds? Below the entry, show the effect of the transaction on the 2018 financial statements.

ASSETS = LIABILITIES + SHAREHOLDERS’ EQUITY 2018 NET INCOME

Requirement 2: On December 31, 2018, what entry did Kit Kat record for the receipt of a semiannual interest payment from Kool Co? Below the entry, show the effect of the transaction on the 2018 financial statements. Kit Kat recorded interest using the effective interest method.

ASSETS = LIABILITIES + SHAREHOLDERS’ EQUITY 2018 NET INCOME

Requirement 3: At the end of 2018, the fair value of the Kool Co. bonds is $344,000. Show the amount reported for the investment on the 2018 balance sheet if the investment is classified as a:

Trading security Held-to-maturity security

Requirement 4: If Kit Kat holds the Kool Co. bonds for 10 years (to maturity), what is the total amount of interest revenue Kit Kat will recognize? SHOW COMPUTATIONS TO SUPPORT YOUR ANSWER.

Expert Solution

	First,Lets prepare Bond amortization table that will help us to pass Journal entries
	Coupon rate=10%		Covert to semi-annual period,Coupon rate=10*1/2=5%
	Market rate=12%		Covert to semi-annual period,Market rate=12*1/2=6%

		Amortization Table
	Date	Interest received	Inteterest revenue	Amortization	Balance in bond Discount account	Balance in bonds receivable	Book value of the bonds
		(Par value*Coupon Rate)	Previous Book value * Market rate				Previuos Book value+Current amortisation
		1	2	(3=1-2)	4=5-6	5	6
	July 1,2018				45882.00	400000.00	354118.00
	Dec 31,2018	20000.00	21247.08	1247.08	44634.92	400000.00	355365.08
	June 30,2019	20000.00	21321.90	1321.90	43313.02	400000.00	356686.98
	Dec 31,2019	20000.00	21401.22	1401.22	41911.80	400000.00	358088.20
	June 30,2020	20000.00	21485.29	1485.29	40426.50	400000.00	359573.50
	Dec 31,2020	20000.00	21574.41	1574.41	38852.09	400000.00	361147.91
	June 30,2021	20000.00	21668.87	1668.87	37183.22	400000.00	362816.78
	Dec 31,2021	20000.00	21769.01	1769.01	35414.21	400000.00	364585.79
	June 30,2022	20000.00	21875.15	1875.15	33539.07	400000.00	366460.93
	Dec 31,2022	20000.00	21987.66	1987.66	31551.41	400000.00	368448.59
	June 30,2023	20000.00	22106.92	2106.92	29444.49	400000.00	370555.51
	Dec 31,2023	20000.00	22233.33	2233.33	27211.16	400000.00	372788.84
	June 30,2024	20000.00	22367.33	2367.33	24843.83	400000.00	375156.17
	Dec 31,2024	20000.00	22509.37	2509.37	22334.46	400000.00	377665.54
	June 30,2025	20000.00	22659.93	2659.93	19674.53	400000.00	380325.47
	Dec 31,2025	20000.00	22819.53	2819.53	16855.00	400000.00	383145.00
	June 30,2026	20000.00	22988.70	2988.70	13866.30	400000.00	386133.70
	Dec 31,2026	20000.00	23168.02	3168.02	10698.28	400000.00	389301.72
	June 30,2027	20000.00	23358.10	3358.10	7340.18	400000.00	392659.82
	Dec 31,2027	20000.00	23559.59	3559.59	3780.59	400000.00	396219.41
	June 30,2028	20000.00	23780.58	3780.58	0.00	400000.00	400000.00
	Total		445882.00

1	Date	Account titles and explanation		Debit	Credit
	July 1,2018	10% bonds receivable		400000
		Discount on bonds			45882
		Cash			354118


	Asset=	Liabilities	+	Shareholder's equity			2018 Net income
	-354118	45882					No effect
	(Cash reduced)	(Discount on bond)
	400000
	(Bonds added)

2	Date	Account titles and explanation		Debit	Credit
	Dec 31,2018	Cash		20000
		Discount on bonds		1247.08
		Interest revenue			21247.08

	Asset=	Liabilities	+	Shareholder's equity			2018 Net income
	20000	-1247.08		21247.08			21247.08
	(Cash Increased)	(Discount on bond)		(Retained earnings increase)			(Interest revenue)



3	Trading security:
	Book value as on Dec 31,2018=$ 355365.08
	Fair value=$ 344000
	Decrease in value=355365.08-344000=$ 11365.08
	Date	Account titles and explanation		Debit	Credit
	Dec 31,2018	Unrealized loss on trading securities		11365.08
		10% bonds receivable			11365.08

	Held to maturity:
	Cost is not adjusted to year end fair value in held to maturity securities

4	Total amount of interest will recognize=$ 445882 (From amortization table,sum total of column.2)

ekkarill92 answered 3 years ago

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