Question

On January 1, 2018, Ithaca Corp. purchases Cortland Inc. bonds that have a face value of $150,000. The Cortland bonds have a stated interest rate of 6%. 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, 2018	7.0	%
June 30, 2018	8.0	%
December 31, 2018	9.0	%

Required:
1. Calculate the price Ithaca would have paid for the Cortland bonds on January 1, 2018 (ignoring brokerage fees).
2. Prepare all appropriate journal entries related to the bond investment during 2018, 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 2018, 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

Requirement 1

Bond Fair Value at 1/1/2018:                       
Interest     [($150,000 x 6%) / 2] x 14.21240 *   =      $ 63,956
Principal     $150,000    x    0.50257 ** =                                75,386
   Present value of the receivable                             $139,342

*    present value of an ordinary annuity of $1: n=20, i=3.5% (=7% ÷ 2) (from Table 4)

** present value of $1: n=20, i=3.5% (=7% ÷ 2) (from Table 2)

January 1, 2018

Investment in bonds (face amount).....................              150,000
   Discount on bond investment (difference)......                           10,658
   Cash (price of bonds).......................................                           139,342

Requirement 2

January 1, 2018

Investment in bonds (face amount).....................              150,000
   Discount on bond investment (difference)......                           10,658
   Cash (price of bonds).......................................                           139,342

June 30, 2018

Cash [(150,000 x 6%) / 2].....................................                  4,500

Discount on bond investment (difference).........                     377
   Interest revenue [($150,000 – 10,658) x 7%] / 2 ...                                    4,877

December 31, 2018

Cash (6% / 2 x $150,000).....................................                  4,500

Discount on bond investment (difference).........                     390
   Interest revenue [{$150,000 – ($10,658 – 377)} x 7%] / 2                       4,890

Note: For held-to-maturity investments, there are no adjustments to fair value.

Requirement 3

January 1, 2018

Investment in bonds (face amount).....................              150,000
   Discount on bond investment (difference)......                           10,658
   Cash (price of bonds).......................................                           139,342

June 30, 2018

Cash ($150,000 x 6%) / 2 ....................................                  4,500

Discount on bond investment (difference).........                     377
   Interest revenue [($150,000 – 10,658) x 7%] / 2 ..                                    4,877

Bond Fair Value at June 30, 2018:          
Interest     [($150,000 x 6%) / 2] x 13.13394 *   = $ 59,103
Principal $150,000    x    0.47464 ** =                                71,196
   Present value of the receivable                         $130,299

* present value of an ordinary annuity of $1: n=19, i=4% (=8% ÷ 2) (from Table 4)

** present value of $1: n=19, i=4% (=8% ÷ 2) (from Table 2)

January 1 initial cost                                             $139,342

     Increase from discount amortization                            377

June 30 amortized initial cost                                  $139,719

Comparing the amortized initial cost with the fair value of the bonds on that date provides the amount needed to adjust the investment to its fair value.

                                                                                                 

June 30 amortized initial cost                    $139,719

June 30 fair value                                         130,299

       Fair value adjustment needed              $    9,420

    Net unrealized holding gains and losses—I/S ..........................   ..... 9,420
           Fair value adjustment................................................................... 9,420

December 31, 2018

Cash ($150,000 x 6%) / 2....................................                  4,500

Discount on bond investment (difference).........                     390
   Interest revenue [{$150,000 – ($10,658 – 377)} x 7%] / 2                       4,890

Bond Fair Value at December 31, 2018:  
Interest     [($150,000 x 6%) / 2] x 12.15999 *   = $ 54,720
Principal $150,000    x    0.45280 ** =                             67,920
   Present value of the receivable                         $122,640

*    present value of an ordinary annuity of $1: n=18, i=4.5% (=9% ÷ 2) (from Table 4)

** present value of $1: n=18, i=4.5% (=9% ÷ 2) (from Table 2)

June 30 amortized initial cost                            $139,719

    Increase from discount amortization                         390

Dec. 31 amortized initial cost                              $140,109

      

Comparing the amortized initial cost with the fair value of the bonds on that date provides the amount needed to adjust the investment to its fair value.

                                                                              

Dec. 31 amortized initial cost                                                   $140,109

       Dec. 31 fair value                                                                  122,640

Fair value adjustment balance needed: debit/(credit)                      $ 17,469

            Less: Current fair value adjustment debit/(credit)                        (9,420)

Change in fair value adjustment needed                                       $   8,049

    Net unrealized holding gains and losses—I/S ..........................   ..... 8,049
           Fair value adjustment................................................................... 8,049