In: Accounting
Tanner-UNF Corporation acquired as a long-term investment $320
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 $290 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 $300 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 $280 million. Prepare the
journal entries to record the sale.
Answer :
1) In the question it is provided that 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. When fair value option method is used for accounting of Investments the concerned asset will be Classified as Trading securities.
So this investment will be classified as Trading Securities on Tanner-UNF's balance sheet.
2) to 4) Journal entries to record Tanner-UNF’s investment in the bonds on July 1, 2021, interest on December 31, 2021, and fair value changes as of December 31, 2021.
Date | Journal | Debit | Credit |
July 1,2021 | Investment in bonds | $ 320,000,000 | |
Discount on bond investment | $ 30,000,000 | ||
Cash | $ 290,000,000 | ||
(To record the Investmet in bonds) | |||
December 31,2021 | Cash | $ 6,400,000 | |
Discount on bond investment | $ 2,300,000 | ||
Interest revenue | $ 8,700,000 | ||
( To record the Interest on December 31,2021) | |||
December 31,2021 | Fair value adjustment | $ 7,700,000 | |
Net unrealized holding gains | $ 7,700,000 | ||
( To record fair value changes as of December 31,2021) |
Notes : a) Calculation of Interest revenue earned and Interest received as on December 31,2021
Interest revenue on Investment= $ 290,000,000 x 6/2% = 8,700,000
Cash received for interest = $ $ 320,000,000 x 4/2% = 64,000,000
b) Calculation of Fair value adjustment and Net unrealized holding gains as on December 31,2021
Fair value of bond as on December 31,2021 = $300,000,000
Carrying value of bond as on December 31,2021 = $320,000,000 - 30,000,000 + 2,300,000 = $ 292,300,000
Net unrealized holding gains = $ 300,000,000 - $ 292,300,000 = $ 7,700,000
5) On December 31, 2021, Tanner-UNF report its investment at Fair value which is $ 300 million
6) Journal entries to record the sale of bonds.
Date | Journal | Debit | Credit |
January 2,2022 | Cash | $ 280,000,000 | |
Loss on sale of investments | $ 12,300,000 | ||
Discount on bond investment | $ 27,700,000 | ||
Investment in bonds | $ 320,000,000 | ||
( To record the sale of bonds) | |||
January 2,2022 | Net unrealized holding gains | $ 7,700,000 | |
Fair value adjustment | $ 7,700,000 | ||
( to record fair value adjustment) |