Question

Problem 12-1 Securities held-to-maturity; bond investment; effective interest [LO12-1, 12-2) Fuzzy Monkey Technologies, Inc., purchased as a long-term investment $240 million of 6% bonds, dated January 1, on January 1, 2018. Management has the positive intent and ability to hold the bonds until maturity. For bonds of similar risk and maturity the market yield was 8%. The price paid for the bonds was $219 million. Interest is received semiannually on June 30 and December 31. Due to changing market conditions, the fair value of the bonds at December 31, 2018, was $230 million. Required: 1. to 3. Prepare the relevant journal entries on the respective dates (record the interest at the effective rate). 4. At what amount will Fuzzy Monkey report its investment in the December 31, 2018, balance sheet? 5. How would Fuzzy Monkey's 2018 statement of cash flows be affected by this investment?

Answer 1

Solution:

Requirement 1,2,3 Journal Entries

Date	Accounts and Explanation	Debit	Credit
1/1/2018	Investment in Bonds	$ 240,000,000
	Discount on Bond Investment		$    21,000,000
	Cash		$ 219,000,000
	(Being Bonds Purchased)
30/06/2018	Cash	$       7,200,000
	Discount on Bond Investment	$       1,560,000
	Interest Income/ Revenue		$       8,760,000
	( Being interest received and discount amortized)
31/12/2018	Cash	$       7,200,000
	Discount on Bond Investment	$       1,622,400
	Interest Income/ Revenue		$       8,822,400
	( Being interest received and discount amortized)

Notes:

Amortization table based on effective interest rate:

Date	Cash Received	Interest Revenue	Discount Amortized	Carrying Amount of Bonds
1/1/2018				$                           219,000,000
30/06/18	$              7,200,000	$              8,760,000	$                  1,560,000	$                           220,560,000
31/12/18	$              7,200,000	$              8,822,400	$                  1,622,400	$                           222,182,400

Requirement 4 Reporting of investment in bonds in balance sheet as on 31/12/2018:

Investment in Bonds = $ 230.00 Million

Particulars	Amount $	Calculation
Investment in Bonds	$        240,000,000	Given
Add: Fair Value Adjustment	$             7,817,600	(Fair Value - Carrying Amount) $230,000,000-$222,182,400
Less: Discount on Bond Investment	$        (17,817,600)	$21,000,000 - $ 1,560,000 - $ 1,622,400
Total	$        230,000,000

Requirement 5 Statement of cash flow affected in this transaction:

Section	Amount		Inflow/Outflow
Operating Section	$                         14.4	Million	Inflow
Investing Section	$                       219.0	Million	Outflow

Notes:

1) Operating Activity inflow is nothing but interest received $ 7,200,000 + $ 7,200,000 during the year.

2) Investing Activity outflow is $ 219 million paid to purchase the bonds.