Question

On January 1, 2021, Ithaca Corp. purchases Cortland Inc. bonds that have a face value of $330,000. The Cortland bonds have a stated interest rate of 5%. Interest is paid semiannually on June 30 and December 31, and the bonds mature in 10 years. For bonds of similar risk and maturity, the market yield on particular dates is as follows: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.): January 1, 2021 11.0 % June 30, 2021 12.0 % December 31, 2021 14.0 %

Required: 1. Calculate the price Ithaca would have paid for the Cortland bonds on January 1, 2021 (ignoring brokerage fees), and prepare a journal entry to record the purchase.

2. Prepare all appropriate journal entries related to the bond investment during 2021, assuming Ithaca accounts for the bonds as a held-to-maturity investment. Ithaca calculates interest revenue at the effective interest rate as of the date it purchased the bonds.

3. Prepare all appropriate journal entries related to the bond investment during 2021, assuming that Ithaca chose the fair value option when the bonds were purchased, and that Ithaca determines fair value of the bonds semiannually. Ithaca calculates interest revenue at the effective interest rate as of the date it purchased the bonds.

Answer 1

Answer :

(1) Calculation of fair value of bond on January 1, 2021 :

Interest Payment Semiannually = ($330,000 x 5%) / 2 = $8,250

Present Value of ordinary annuity of $1 n = 20, i = 5.5% = 11.9504

Present value of Interest Payments = $8,250 x 11.9504 = $98,590.8

Face Value of bonds = $330,000

Present Value Factor of $1 n = 20, i = 5.5% = 0.3427

Present Value of Face Value of bonds = $330,000 x 0.3427 = $113,091

Fair Value of Bonds = Present value of Interest Payments + Present Value of Face Value of bonds

= $98,590.8 + $113,091

= $211,681.8

Fair Value of Bonds = $211,681.8

So, Ithaca would have paid $211,681.8 for the Cortland bonds on January 1, 2021

Journal entry to record the purchase :

Date	Particulars	Debit	Credit
1-Jan-21	Investment in bonds	330,000
	Discount on bond investment		118,318.2
	Cash		211,681.8

(2)

Date	Particulars	Debit	Credit
1-Jan-21	Investment in bonds	330,000
	Discount on bond investment		118,318.2
	Cash		211,681.8
30-Jun-21	Cash [(330,000 x 5%) / 2]	8,250
	Discount on bond investment (difference)	3,392.5
	Interest revenue [(330,000 - 118,318.2) x 11%] / 2		11,642.5
31-Dec-21	Cash [(330,000 x 5%) / 2]	8,250
	Discount on bond investment (difference)	3,579
	Interest revenue [(330,000 - (118,318.2 - 3,392.5)) x 11%] / 2		11,829

(3)

Date	Particulars	Debit	Credit
1-Jan-21	Investment in bonds	330,000
	Discount on bond investment		118,318.2
	Cash		211,681.8
30-Jun-21	Cash [(330,000 x 5%) / 2]	8,250
	Discount on bond investment (difference)	3,392.5
	Interest revenue [(330,000 - 118,318.2) x 11%] / 2		11,642.5

Fair Value of Bond at June 30, 2021 :

Interest Payment Semiannually = ($330,000 x 5%) / 2 = $8,250

Present Value of ordinary annuity of $1 n = 19, i = 6% = 11.1581

Present value of Interest Payments = $8,250 x 11.1581 = $92,054.33

Face Value of bonds = $330,000

Present Value Factor of $1 n = 19, i = 6% = 0.3305

Present Value of Face Value of bonds = $330,000 x 0.3305 = $109,065

Fair Value of Bonds = Present value of Interest Payments + Present Value of Face Value of bonds

= $92,054.33 + $109,065

= $201,119.33

January 1 initial cost	211,681.8
Increase from discount amortization	3,392.50
June 30 amortized initial cost	215,074.3

June 30 amortized initial cost	215,074.3
June 30 fair value	201,119.33
Fair value adjustment needed	13,954.97

Date	Particulars	Debit	Credit
30-Jun-21	Net unrealized holding gains and losses	13,954.97
	Fair value adjustment		13,954.97
31-Dec-21	Cash [(330,000 x 5%) / 2]	8,250
	Discount on bond investment (difference)	3,579
	Interest revenue [(330,000 - (118,318.2 - 3,392.5)) x 11%] / 2		11,829

Fair Value of Bond at December 31, 2021 :

Interest Payment Semiannually = ($330,000 x 5%) / 2 = $8,250

Present Value of ordinary annuity of $1 n = 18, i = 7% = 10.0591

Present value of Interest Payments = $8,250 x 10.0591 = $82,987.58

Face Value of bonds = $330,000

Present Value Factor of $1 n = 18, i = 7% = 0.2959

Present Value of Face Value of bonds = $330,000 x 0.2959 = $97,647

Fair Value of Bonds = Present value of Interest Payments + Present Value of Face Value of bonds

= $82,987.58 + $97,647

= $180,634.58

June 30 amortized initial cost	215,074.3
Increase from discount amortization	3,579
Dec. 31 amortized initial cost	218,653.3

Dec. 31 amortized initial cost	218,653.3
Dec. 31 fair value	180,634.58
Fair value adjustment balance needed	38,018.72
Less: Current fair value adjustment	13,954.97
Change in fair value adjustment needed	24,063.75

Date	Particulars	Debit	Credit
31-Dec-21	Net unrealized holding gains and losses	24,063.75
	Fair value adjustment		24,063.75