Question

On January 1, 2021, Essence Communications issued $720,000 of its 10-year, 8% bonds for $630,272. The bonds were priced to yield 10%. Interest is payable semiannually on June 30 and December 31. Essence Communications records interest at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2021, the market interest rate for bonds of similar risk and maturity was 9%. The bonds are not traded on an active exchange. The decrease in the market interest rate was due to a 1% decrease in general (risk-free) interest rates. (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.)

Required:
1. Using the information provided, estimate the fair value of the bonds at December 31, 2021.
2. to 4. Prepare the journal entries to record interest on June 30, 2021 (the first interest payment), on December 31, 2021 (the second interest payment) and to adjust the bonds to their fair value for presentation in the December 31, 2021, balance sheet.

Answer 1

Part 1

Fair value

$676224

Payments	Amount	PV factor	Present value
Interest	28800	12.15999	350208
Principle	720000	0.45280	326016
Bond price	676224

720000*8%/2 = 28800

PV of ordinary annuity of $1 @ n=18, i=4.5% is 12.15999

PV of $1 @ n=18, i=4.5% is 0.45280

Part 2

No.	Date	Account titles and explanation	Debit	Credit
1	June 30, 2021	Interest expense (630272*10%/2)	31514
		Discount on bonds payable		2714
		Cash		28800
		(to record first interest payment)

Part 3

No.	Date	Account titles and explanation	Debit	Credit
1	December 31, 2021	Interest expense ((630272+2714)*10%/2)	31649
		Discount on bonds payable		2849
		Cash		28800
		(to record second interest payment)

Part 4

No.	Date	Account titles and explanation	Debit	Credit
1	December 31, 2021	Unrealized holding loss	40389
		Fair value adjustment (676224-(630272+2714+2849))		40389
		(to record fair value adjustment)