Question

WellmanWellman

Insurance purchased

$50,000

of

8​%

KLP

bonds on January​ 1,

2018​,

at a price of

92

when the market rate of interest was

10​%.

WellmanWellman

intends to hold the bonds until their maturity date of January​ 1,

2023.

The bonds pay interest semiannually on each January 1 and July 1.

Wellman

recorded the following journal entries on January​ 1,

2018

and July​ 1,

2018​:

Make the adjusting entries that

WellmanWellman

Insurance would need to make on December​ 31,

20182018​,

related to the investment in

KLP

bonds. ​(Record debits​ first, then credits. Exclude explanations from any journal​ entries.)​First, record the entry for the interest receivable at December​ 31,

2018.

Journal Entry
Date		Accounts	Debit	Credit
Dec	31

Now record the entry for the amortization of bond discount at December​ 31,

2018.

Journal Entry
Date		Accounts	Debit	Credit
Dec	31

How would the bonds be reported on

WellmanWellman

​Insurance's balance sheet as of December​ 31,

2018​?

​(Abbreviation used: AFSS​ = available-for-sale​ security)

The balance sheet reports			of $		as a		.
Also, the balance sheet will include the			of $		.

What amount of interest revenue would be reported on

WellmanWellman

​Insurance's income statement for the year ended December​ 31,

2018​,

related to the

KLP

​bonds?

The income statement reports

of $

.

Answer 1

Bond face value = $50000
Coupon Interest = 8%
Market rate =10% and Bond is purchased at 92 (at a discount)
Bond purchase price = 92% * $50,000 = $46,000
Bond discount = $50,000 - $46,000 = $4,000
This means that Lamar will get $50,000 face value from bond on Jan 1,2023 but had to pay only $46,000 for it today, i.e., Jan 1,2018. As per accrual concept, this additional benefit of $4,000 should be recognized /amortized over the life of the bond as additional interest income, such that by the end of the life of bond, bond value in books of accounts will increase from $46,000 to face value $50,000 with each interest recording.
Time period = Jan. 1, 2018 to Jan. 1, 2023 with semi-annual payments, so, 5 years * 2 = 10 time periods
Interest income in each year = Coupon interest * Bond face value
= 8% * $50,000 = $4,000
Semi-annual interest income = $4,000 / 2 = $2,000
So, journal entry to record interest income on Dec. 31, 2018 will be as follows:
Particulars	Debit	Credit
Cash A/c	2000
To Interest revenue A/c		2000
(Being bond interest received)
Further, bond discount of $18,000 is to be amortized over the life of the bond.
Using straight-line method, annual amortization will be $4,000 / 5 = $800
Semi-annual amortization = $800 / 2 = $400
So, journal entry to record amortization on Dec. 31, 2018 will be as follows:
Particulars	Debit	Credit
Held-to-maturity investment in bonds A/c	400
To Interest receivable		400
(Being bond discount amortized for the period)
Further, interest receivable will be credited to interest income at the end of year as follows:
Interest receivable A/c	800
To Interest revenue		800
Now, the value of bonds as on Dec. 31, 2018 will increase by the discount amortized semi-annually as additional interest income, i.e. $46000 + $400 + $400 = $46,800
So, the balance sheet reports available-for-sale security of $46,800 as an asset.
Also, the balance sheet will include the unexpired/remaining bond discount of $4,000 – ($400*2) = $3,200
Since the bond discount for the period is to be recognized as interest revenue for the period, $200 + $200= $400 to be added to interest income for the year in addition to $2,000 + $2,000 = $4,000 coupon interest received on the bonds.
So, the income statement reports interest revenue of $4,400 ($400+$4,000) for the year.