In: Accounting
On January 1, 2021, Ithaca Corp. purchases Cortland Inc. bonds that have a face value of $330,000. The Cortland bonds have a stated interest rate of 5%. 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, 2021 | 11.0 | % |
June 30, 2021 | 12.0 | % |
December 31, 2021 | 14.0 | % |
Required:
1A - Bond fair value :
1. Calculate the price Ithaca would have paid for
the Cortland bonds on January 1, 2021 (ignoring brokerage fees),
and prepare a journal entry to record the purchase.
2. Prepare all appropriate journal entries related
to the bond investment during 2021, 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 2021, 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).
Semiannual coupon
= $ 330,000 x 5 % x 1/2 = $ 8,250
i = 11 % x 1/2 = 5.5 %
n = 10 x 2 = 20
PVA 5.5%, n=20 = [ { 1 - ( 1 / 1.055 ) 20 } / 0.055 ] = 11.9504
PV 5.5% , n=20 = ( 1 / 1.055 ) = 0.3427
Present value of the bonds
= $ 8,250 x 11.9504 + $ 330,000 x 0.3427
= $ 98,590.80 + $ 113,091
= $ 211,681.80
Date | Account Titles | Debit | Credit |
$ | $ | ||
Jan 1, 2021 | Investment in Bonds Receivable | 330,000 | |
Discount on Bonds | 118,320 | ||
Cash | 211,680 |
(2).
Date | Account Titles | Debit | Credit |
$ | $ | ||
June 30, 2021 | Cash | 8,250 | |
Discount on Bonds | 3,392 | ||
Interest Revenue ( 211,680 x 5.5 % ) | 11,642 | ||
June 30, 2021 | No journal entry required | 0 | 0 |
December 31, 2021 | Cash | 8,250 | |
Discount on Bonds | 3,579 | ||
Interest Revenue ( 211,680 + 3,392) x 5.5 % | 11,829 | ||
December 31, 2021 | No journal entry required | 0 | 0 |
(3). Fair value on June 30, 2021
= $ 8,250 x [ { 1 - ( 1 / 1.06 ) 19 } / 0.06 ] + $ 330,000 x ( 1 / 1.06 ) 19
= 92,054.46 + $ 109,069.29
= $ 201,123.75
Fair value of the bonds on Dec 31, 2021
= $ 8,250 x 10.0591 + $ 330,000 x 0.2959
= $ 82,987.58 + $ 97,647
= $ 180,634.58
Date | Account Titles | Debit | Credit |
$ | $ | ||
June 30, 2021 | Cash | 8,250 | |
Discount on Bonds | 3,392 | ||
Interest Revenue | 11,642 | ||
June 30, 2021 | Unrealized holding loss on Bonds Receivable | 13,948 | |
Fair Value Adjustment | 13,948 | ||
December 31, 2021 | Cash | 8,250 | |
Discount on Bonds | 3,579 | ||
Interest Revenue | 11,829 | ||
December 31, 2021 | Unrealized Holding Loss on Bonds Receivable | 24,068 | |
Fair Value Adjustment | 24,068 |