Question

Mills Corporation acquired as a long-term investment $300 million of 6% bonds, dated July 1, on July 1, 2018. Company management is holding the bonds in its trading portfolio. The market interest rate (yield) was 4% for bonds of similar risk and maturity. Mills paid $350 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, 2018, was $325 million.

Required:
1. & 2. Prepare the journal entry to record Mills’ investment in the bonds on July 1, 2018 and interest on December 31, 2018, at the effective (market) rate.
3. At what amount will Mills report its investment in the December 31, 2018, balance sheet?
4. Suppose Moody’s bond rating agency upgraded the risk rating of the bonds, and Mills decided to sell the investment on January 2, 2019, for $360 million. Prepare the journal entries to record the sale.

Answer 1

1 & 2) Journal entries to record investment in the bonds on July 1, 2018 and interest on December 31, 2018, at the effective (market) rate is shown as follows:-

Journal Entries (Amount in million $)

Date	General Journal	Debit	Credit
July 1, 2018	Investment in Bonds	300
	Premium on bond investment (350-300)	50
	Cash		350
	(To record the investment in bonds)
Dec. 31, 2018	Cash (300 million*6%*6/12)	9
	Premium on bond investment (9-7)		2
	Interest Revenue (350 million*4%*6/12)		7
	(To record the interest revenue)

3) Mills will report its investment in the December 31, 2018, balance sheet at its fair value i.e. $325 million

4) Journal Entries to record the sale (Amount in million $)

Date	General Journal	Debit	Credit
Jan 2, 2019	Cash	360
	Profit on sale of investment (Bal fig) ($360-$300-$48)		12
	Premium on bond investment ($50-$2)		48
	Investment in Bonds		300
	(To record the sale of bonds)
Jan 2, 2019	Fair value adjustment [(350 million-2 million) - 325 million]	23
	Net Unrealized holding gains and losses - I/S		23