Question

Debt Investment Transactions, Available-for-Sale Valuation

Rekya Mart Inc. is a general merchandise retail company that began operations on January 1, Year 1. The following transactions relate to debt investments acquired by Rekya Mart Inc., which has a fiscal year ending on December 31:

Year 1
Apr. 1.	Purchased $36,000 of Smoke Bay 5%, 10-year bonds at their face amount plus accrued interest of $300. The bonds pay interest semiannually on February 1 and August 1.
May 16.	Purchased $116,000 of Geotherma Co. 6%, 12-year bonds at their face amount plus accrued interest of $290. The bonds pay interest semiannually on May 1 and November 1.
Aug. 1.	Received semiannual interest on the Smoke Bay bonds.
Sept. 1.	Sold $14,400 of Smoke Bay bonds at 104 plus accrued interest of $60.
Nov. 1.	Received semiannual interest on the Geotherma Co. bonds.
Dec. 31	Accrued $360 interest on Smoke Bay bonds.
Dec. 31	Accrued $580 interest on Geotherma Co. bonds.
Year 2
Feb. 1.	Received semiannual interest on the Smoke Bay bonds.
May 1.	Received semiannual interest on the Geotherma Co. bonds.

Required:

1. Journalize the entries to record these transactions. For a compound transaction, if an amount box does not require an entry, leave it blank.

Date	Description	Debit	Credit
Year 1
Apr. 1.
May 16.
Aug. 1.
Sept. 1.
Nov. 1.
Dec. 31 Smoke Bay
Dec. 31 Geotherma Co.
Year 2
Feb. 1.
May 1.

2. If the bond portfolio is classified as available for sale, what impact would this have on financial statement disclosure?

If the bonds are classified as available-for-sale securities, then the portfolio of bonds would need to be adjusted to . This would be accomplished by using a valuation allowance account and account.

Answer 1

Part 1

Date	Description	debit	credit
Year 1
Apr. 1	investments - Smoke Bay Bonds	36000
	Interest receivable	300
	Cash		36300
May 16	investments - Geotherma Co. Bonds	116000
	Interest receivable	290
	Cash		116290
Aug. 1	cash (36000*5%*1/2)	900
	Interest receivable		300
	Interest revenue (900-300)		600
Sep. 1	cash (14400*1.04)+60	15036
	Interest revenue		60
	Gain on sale of investment		576
	Investments - Smoke Bay Bonds		14400
Nov. 1	cash (116000*6%*1/2)	3480
	Interest receivable		290
	Interest revenue (3480-290)		3190
Dec. 31	interest receivable	360
	Interest revenue		360
Dec. 31	interest receivable	580
	Interest revenue		580
Year 2
Feb. 1	cash (36000-14400)*5%*1/2	540
	Interest receivable		360
	Interest revenue (540-360)		180
May. 1	cash (116000*6%*1/2)	3480
	Interest receivable		580
	Interest revenue (3480-580)		2900

Part 2

If the bonds are classified as available-for-sale securities, then the portfolio of bonds would need to be adjusted to fair value . This would be accomplished by using a valuation allowance account and an unrealized gain (loss) account.

If the fair value were greater than the cost of the bond portfolio, the two accounts would be positive and thus added to investments and stockholders' equity respectively. If the fair value were less than the cost of the bond portfolio, the two accounts would be negative and thus subtracted from investments and stockholders' equity respectively.