Question

Tanner-UNF Corporation acquired as a long-term investment $300 million of 4% bonds, dated July 1, on July 1, 2021. Company management has the positive intent and ability to hold the bonds until maturity, but when the bonds were acquired Tanner-UNF decided to elect the fair value option for accounting for its investment. The market interest rate (yield) was 6% for bonds of similar risk and maturity. Tanner-UNF paid $270 million for the bonds. The company will receive interest semiannually on June 30 and December 31. As a result of changing market conditions, the fair value of the bonds at December 31, 2021, was $280 million.

Required:
1. How would this investment be classified on Tanner-UNF's balance sheet?
2. to 4. Prepare the journal entry to record Tanner-UNF’s investment in the bonds on July 1, 2021, interest on December 31, 2021, at the effective (market) and fair value changes as of December 31, 2021.
5. At what amount will Tanner-UNF report its investment in the December 31, 2021, balance sheet?
6. Suppose Moody's bond rating agency downgraded the risk rating of the bonds motivating Tanner-UNF to sell the investment on January 2, 2022, for $260 million. Prepare the journal entries to record the sale.

Answer 1

Requirement 1

Electing the fair value option for held-to-maturity securities simply requires reclassifying those securities as trading securities.  Therefore, this investment would be classified as a trading security on Tanner-UNF's balance sheet.

Requirement 2                                                                           ($ in millions)

Investment in bonds (face amount)........................... 300
    Discount on bond investment (difference).................. 30
    Cash (price of bonds)......................................................               270

Requirement 3

Cash (2% x $300 million)................................................... 6.0
Discount on bond investment (difference)...................... 2.1
    Interest revenue (3% x $270)......................................                8.1

Requirement 4

The carrying value of the bonds is $300 - ($30 - $2.1) = $267.9.  Therefore, to adjust to fair value of $280, Tanner-UNF would need the following journal entry:

Fair value adjustment................................................................. 12.1

     Net unrealized holding gains and losses-I/S ($280 - 267.9) 12.1

Requirement 5

Tanner-UNF reports its investment in the December 31, 2011, balance sheet at fair value of $280 million.

Requirement 6                                                                        ($ in millions)

Cash (proceeds from sale).............................................. 260.0                             

Loss on sale of investments (to balance)........................ 67.9

Discount on bond investment (account balance).......... 27.9 ( 30-2.1)

    Investment in bonds (account balance).......................... 300.0

Assuming no other trading securities, the 2012 adjusting entry would be:

Net unrealized holding gains and losses-I/S............... 12.1

    Fair value adjustment (account balance) ................................. 12.1