Question

5. Crawford Inc. has bonds outstanding during a year in which the general (risk-free) rate of interest has risen. Crawford elected the fair value option for the bonds upon issuance. What will the company report for the bonds in its income statement for the year?

   1. Interest expense and an unrealized gain.

   2. Interest expense and a realized gain.

   3. No interest expense and an unrealized gain.

   4. Interest expense and no gain or loss.

   5. Interest expense only in the income statement and an unrealized holding gain in other comprehensive

      income.

Plz explain!!! why the answer is A.!!

PLZ!!!! don't just say the answer...

Answer 1

Since the bonds are outstanding, Interest on them will obviously be payable. Hence Interest expense have to be recognized.

Secondly, looking into the valuation part, the general relationship theorem of bond value with that of risk free interest rate is that,

• Bond values will go up when risk free interest rates go down, and
• Bond values will go down when risk free interest rates go up.

Thus in the given scenario the risk free interest rates have bone up, hence the fair value of our bonds have come down. Bonds payable are our liabilities and hence any reduction in fair value of liabilities payable is a gain to us. Since the bonds are not yet paid, this gain remains unrealized.

Thus we have Interest Expense and Unrealized gain .