Question

Debt Investment Transactions, Available-for-Sale Valuation

Rekya Mart Inc. is a general merchandise retail company that began operations on January 1, Year 1. The following transactions relate to debt investments acquired by Rekya Mart Inc., which has a fiscal year ending on December 31:

Year 1
Apr. 1.	Purchased $60,000 of Smoke Bay 7%, 10-year bonds at their face amount plus accrued interest of $700. The bonds pay interest semiannually on February 1 and August 1.
May 16.	Purchased $132,000 of Geotherma Co. 6%, 12-year bonds at their face amount plus accrued interest of $330. The bonds pay interest semiannually on May 1 and November 1.
Aug. 1.	Received semiannual interest on the Smoke Bay bonds.
Sept. 1.	Sold $24,000 of Smoke Bay bonds at 104 plus accrued interest of $140.
Nov. 1.	Received semiannual interest on the Geotherma Co. bonds.
Dec. 31	Accrued $840 interest on Smoke Bay bonds.
Dec. 31	Accrued $660 interest on Geotherma Co. bonds.
Year 2
Feb. 1.	Received semiannual interest on the Smoke Bay bonds.
May 1.	Received semiannual interest on the Geotherma Co. bonds.

Required:

1. Journalize the entries to record these transactions. For a compound transaction, if an amount box does not require an entry, leave it blank.

Date	Description	Debit	Credit
Year 1
Apr. 1.	Investments-Smoke Bay Bonds
	Interest Receivable
	Cash
May 16.	Investments-Geotherma Co. Bonds
	Interest Receivable
	Cash
Aug. 1.	Cash
	Interest Receivable
	Interest Revenue
Sept. 1.	Cash
	Interest Revenue
	Gain on Sale of Investment
	Investments-Smoke Bay Bonds
Nov. 1.	Cash
	Interest Receivable
	Interest Revenue
Dec. 31 Smoke Bay	Interest Receivable
	Interest Revenue
Dec. 31 Geotherma Co.	Interest Receivable
	Interest Revenue
Year 2
Feb. 1.	Cash
	Interest Receivable
	Interest Revenue
May 1.	Cash
	Interest Receivable
	Interest Revenue

2. If the bond portfolio is classified as available for sale, what impact would this have on financial statement disclosure?

If the bonds are classified as available-for-sale securities, then the portfolio of bonds would need to be adjusted to fair value . This would be accomplished by using a valuation allowance account and an unrealized gain (loss)  account.

Answer 1

1. Journal entries

(a) Investment- Smoke bay Bonds Dr. 60,000

Interest receivable Dr. 700

To Cash 60,700

(b) Investment- Geotherma Bay bonds Dr. 132,000

Interest receivable Dr. 330

To cash 132,330

(c) Cash Dr. 2,100

To interest receivable 700

To Interest revenue 1,400 [60,000 x 7% x 4/12]

(d) Cash Dr.25,100 [(24,000 x 1.04) + 140]

To interest revenue 140

To gain on sale of investment 960

To Investment- Smoke Bay bonds 24,000

(e) Cash Dr. 3,300

To interest receivable 330

To interest revenue 2,970 [132,000 x 6% x 4.50/12]

(f) Interest receivable Dr. 840

To interest revenue 840

(g) Interest receivable Dr. 660

To interest revenue 660

Year 2

(h) Cash Dr. 1,050

To interest receivable 840

To Interest revenue 210 [(60,000 - 24,000) x 7% x 1/12]

(i) Cash Dr. 3,300

To interest receivable 660

To Interest revenue 2,640 [132,000 x 6% x 4/12]

2. If the bonds are classified as available-for-sale securities, then the portfolio of bonds would need to be adjusted to fair value. This would be accomplished by using a valuation allowance account and an unrealized gain (loss) account.