Question

8. If Thunder Bay acquired a 20% interest in Fort William on December 31, 2019 for $45,000, and during 2018 Fort William reported net income of $25,000 and paid a total cash dividend of $10,000, applying the equity method would give a debit balance in the Investment in Fort William Corp. account at the end of 2020 of

a) $37,000.

b) $45,000.

c) $48,000.

d) $50,000.

Use the following information to answer questions 9 and 10

On January 1, 2019, on their issue date, Diogenes Inc. purchased 9%, $200,000, 10-year bonds. Interest is paid annually on December 31. Diogenes uses the amortized cost model and the effective-interest method for amortizing premium or discount. The current market rate was 10% for bonds. On December 31, 2019, the bonds have a market value of $185,000.

9. What is the amount paid for the bond on January 1, 2019

a) $178,711

b) $200,000

c)$187,711

d) $185,000

10. How much interest would be recorded in 2019?

a) $12,289

b) $18,000

c) $20,000

d) $18,771

Answer 1

Question no. 8

At the time of purchase, Thunder Bays records a debit in the amount of $45,000 to "Investment in Fort William Corp" (an asset account) and a credit in the same amount to cash.

At the end of the year, Thunder Bay records a debit in the amount of $5,000 (20% of $25,000 net income) to "Investment in Fort William Corp" and a credit in the same amount to Investment Revenue. In addition, Thunder Bay also records a debit in the amount of $2,000 (20% of $10,000 dividends) to cash and a credit in the same amount to "Investment in Fort William Corp." The debit to the investment increases the asset value, while the credit to the investment decreases it.

The new balance in the "Investment in Fort William Corp" account is $48,000. The $5,000 Investment Revenue figure will appear on Thunder Bay's income statement, and the new $48,000 balance in the investment account will appear on Thunder Bay's balance sheet.

Therefore the debit balance in investment in Fort William Corps is $.48000.

Question no. 9

​​​​​​The issue price of a bond is based on the relationship between the interest rate that the bond pays and the market interest rate being paid on the same date. The basic steps required to determine the issue price are:

Determine the interest paid by the bond. Here, bond pays a 9% interest rate once a year on a face amount of $200,000, the interest payment is $18000.

Find the present value of the bond. The bond matures in 10 years, its present value factor is 0.386...., as taken from a table for the present value of 1 due in n periods, and based on the market interest rate of 10%. The present value of the bond is therefore $.77109(200000*0.386....).

Calculate present value of interest payments. The present value of an ordinary annuity of 1 at 10% for ten years is 6.145.... When we multiply this present value factor by the annual interest payment of $18000, we arrive at a present value of $110,602 for the interest payments.

Calculate bond price. The price of the bond should be $. 187711(110602+77109), which is the sum of the present value of the bond repayment that is due at its maturity in 10 years, and the present value of the related stream of future interest payments.

Therefore the amount paid for bond in January 1, 2019 is $.187711.

Question no.10

Interest expense is calculated as the effective-interest rate times the bond’s carrying value for each period. The amount of amortization is the difference between the cash paid for interest and the calculated amount of bond interest expense.

So the interest to be recorded in 2019 is $.18,771(187,711*10%).