Question

Mills Corporation acquired as an investment $235 million of 8% bonds, dated July 1, on July 1, 2021. Company management is holding the bonds in its trading portfolio. The market interest rate (yield) was 6% for bonds of similar risk and maturity. Mills paid $270 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, 2021, was $260 million. Required:

1. & 2. Prepare the journal entry to record Mills’ investment in the bonds on July 1, 2021 and interest on December 31, 2021, at the effective (market) rate.

3. Prepare the journal entry by Mills to record any fair value adjustment necessary for the year ended December 31, 2021.

4. Suppose Moody’s bond rating agency upgraded the risk rating of the bonds, and Mills decided to sell the investment on January 2, 2022, for $280 million. Prepare the journal entries required on the date of sale.

Answer 1

Solution: Answer for 1 & 2
Date	Account Title & Explanation	Debit ($)	Credit ($)
07/01/2021	Investment in bond	$235,000,000
	Premium on bond investment	$35,000,000
	To cash		$270,000,000
	(To record the investment in bond)
12/31/2021	Cash ($235000000 × 4%)	$9,400,000
	To premium on bond		$1,300,000
	To interest revenue($270000000×3%)		$8,100,000
	(To record interest on bonds)
Answer for 3
Date	Account Title & Explanation	Debit ($)	Credit ($)
12/31/2021	Unrealized holding gain or loss	$8,500,000
	fair value adjustment		8500000
	Working:
	Fair Market Value	$260 million
	Book Value + Premium
	[$235million + ($35 million - $1.3 million]	$268.5 milliom
	Decrease in Book Value ($268.5 million - $260 million)	$8.5 million
Answer for 4
Date	Account Title & Explanation	Debit ($)	Credit ($)
01/02/2022	Cash	$280,000,000
	To gain on sale		$11,300,000
	To premium on bond		$33,700,000
	To investment in bond		$235,000,000

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