Question

On January 1, 2017, Buffalo Company purchased  12% bonds, having a maturity value of $ 304,000, for $ 327,047.70. The bonds provide the bondholders with a 10% yield. They are dated January 1, 2017, and mature January 1, 2022, with interest received on January 1 of each year. Buffalo Company uses the effective-interest method to allocate unamortized discount or premium. The bonds are classified as available-for-sale category. The fair value of the bonds at December 31 of each year-end is as follows.

2017		$ 324,800		2020		$ 313,800
2018		$ 312,700		2021		$ 304,000
2019		$ 311,800

(a)		Prepare the journal entry at the date of the bond purchase.
(b)		Prepare the journal entries to record the interest revenue and recognition of fair value for 2017.
(c)		Prepare the journal entry to record the recognition of fair value for 2018.

(Round answers to 2 decimal places, e.g. 2,525.25. Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts.)

Answer 1

The available for sale investments are investments which the company does not intends to hold till maturity and is going to sell the investment
When bonds are issued above the par value than the bond is issued at premium and if they are issued below par value than the bond is issued at discount
a)	Journal entry for purchase of bonds
Date	Particulars	Debit	Credit
1-Jan-17	Debt Investments (available for sale)	$327,047.70
	Cash		$327,047.70
	(To record the purchase of bonds)
	Explanation : The company has purchased the bonds and are therefore investment of the company which will be shown as available for sale
	The investments are assets of the company and therefore debited.
	To purchase the investment, there would be cash outflow which would reduce the balance of cash and therefore cash is credited.
b)	Journal entry for interest revenue
Date	Particulars	Debit	Credit
31-Dec-17	Cash	$36,480.00
	Debt Investments (available for sale)		$3,775.23
	Interest revenue		$32,704.77
	(To record interest revenue from debt investment)
	Explanation : Company will receive coupon payment for its investment as return which is calculated as par value multiplied by coupon rate.
	Company would record cash receipt of $36,480 ($304,000*12%) which will increase the cash balance and therefore is debited.
	Company uses effective interest method to amortize the premium and therefore the interest revenue would be recognized as $32,704.77 (327,047.70*10%)
	Interest revenue would increase the income and therefore is credited.
	The amortization of premium would reduce the balance of debt investment and is calculated as difference between coupon payment and interest revenue.
	The balance of debt investment would reduce by $3,775.23 ($36,480-$32,704.77)
	Since the value of asset is reducing, debt investment is credited.
	Journal entry for recognition of fair value for 2017
Date	Particulars	Debit	Credit
31-Dec-17	Securities fair value adjustment (available for sale)	$1,527.53
	Unrealized holding gain or loss		$1,527.53
	(To record the unrealized gain on bonds)
	Explanation: The fair value of the debt at year end is $324,800 and the ending balance of debt is $323,272.47 ($327,047.70-$3,775.23)
	The unrealized gain therefore would be $1,527.53 ($324,800-$323,272.47)
	These are income and therefore unrealized gain is credited.
	The increase in fair value is not reflected on the debt investment and is shown separately as securities fair value adjustment
c)	Journal entry for recognition of fair value for 2018
Date	Particulars	Debit	Credit
31-Dec-18	Unrealized holding gain or loss	$6,419.72
	Securities fair value adjustment (available for sale)		$6,419.72
	(To record the unrealized loss on bonds)
	Explanation: The fair value of the debt at year end 2018 is $312,700
	Calculation of book value of debt investment
	Book Value as on 01st Jan 2018	$323,272.47
	Add: Interest revenue	$32,327.25	$323,272.47*10%
	Less: Coupon received	-$36,480.00	$304,000*12%
	Book Value as on 31st Dec 2018	$319,119.72
	Calculation of unrealized gain or loss
	Book Value as on 31st Dec 2018	$319,119.72
	Add: Securities fair value adjustment	$1,527.53
	Total value of debt investment	$320,647.25
	Less : Fair Value adjustment	$312,700.00
	Unrealized loss	$7,947.25
	These is loss for company and therefore unrealized loss is debited.
	The decrease in fair value is not reflected on the debt investment and is shown separately as securities fair value adjustment