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?

Answer 1

1. Carrying value of the investments at December 31, 2020 = $ 52,548.25

Pl. refer to the bond amortization schedule below.

2. Amount of interest revenue earned at June 30, 2020 = $ 51,167.90 x 12 % x 1/ 2 = $ 3,070.07

3. Amount of unrealized gain or loss recognized on December 31, 2020 = $ 65,000 - $ 52,548.25 = $ 12,451.75. It should be recorded in the balance sheet, in accumulated other comprehensive Income, which is a component of Stockholders Equity.

4. Gain on sale of bonds of $ 12,451.75 should be reported on the Income Statement, as it is a realized gain.

5. If the investment was classified as Held-to-Maturity, unrealized gains or losses would not be recorded or reported at all. They would be reported on the balance sheet at amortized cost, and not at fair value.

Bond Amortization Schedule:

Period	Amount Received	Interest Revenue	Amortization of Bond Discount	Bond Carrying Value
Jan 1, 2020				$ 51,167.90
June 30, 2020	$ 2,400	$ 3,070.07	$ 670.07	51,837.97
Dec 31, 2020	2,400	3,110.28	710.28	52,548.25