Question

On January 1, 2021, Ithaca Corp. purchases Cortland Inc. bonds that have a face value of $160,000. The Cortland bonds have a stated interest rate of 5%. Interest is paid semiannually on June 30 and December 31, and the bonds mature in 10 years. For bonds of similar risk and maturity, the market yield on particular dates is as follows: (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.):

January 1, 2021	6.0	%
June 30, 2021	7.0	%
December 31, 2021	8.0	%

Required:
1. Calculate the price Ithaca would have paid for the Cortland bonds on January 1, 2021 (ignoring brokerage fees), and prepare a journal entry to record the purchase.
2. Prepare all appropriate journal entries related to the bond investment during 2021, assuming Ithaca accounts for the bonds as a held-to-maturity investment. Ithaca calculates interest revenue at the effective interest rate as of the date it purchased the bonds.
3. Prepare all appropriate journal entries related to the bond investment during 2021, assuming that Ithaca chose the fair value option when the bonds were purchased, and that Ithaca determines fair value of the bonds semiannually. Ithaca calculates interest revenue at the effective interest rate as of the date it purchased the bonds.

Answer 1

Req.1 Calculate the price as follows: Bond Fair Value at January 01, 2021 Principal Interest Present value of the receivable ($160,000 x 0.553675) [($160.000 x 5%)/2] x 14.877475 Amount $88,588 $59,510 $148,098 Present value of $1: n = 20, i = 3% (6%/2) PVF (3%, 20) = 0.553675 PVAF (3%. 20) = 14.877475 Prepare Journal entries as follows: Credit Debit $160,000 Account Titles Jan. 01, 2021 Investment in Bonds Discount on bonds investment Cash $11,092 $148,098 Req.2

Account Titles Debit Credit Date Jan. 01. 2021 $160.000 Investment in Bonds Discount on bonds investment Cash $11.092 $148,098 June 2021 Cash ($160,000 x 5%)/2 Discount on bonds investment Interest revenue [($160,000 - $11092) x 6%]2 $4,000 $467 $4.467 Dec. 31. 2021 Cash ($160,000 x 5%)/2 Discount on bonds investment Interest revenue [(S160,000 - ($11092 - $467)] x 6%]2 $4,000 $481 $4,481 Req.3

Account Titles Debit Credit Date Jan. 01, 2021 $160.000 Investment in Bonds Discount on bonds investment Cash $11,092 $148,098 June 30. 2021 Cash ($160.000 x 5%)/2 Discount on bonds investment Interest revenue [($160,000 - $11092) 6%)/2 $4.000 $467 $4,467 Bond Fair Value at June 30, 2021 Principal Interest Present value of the receivable ($160,000 x 0.5201557) [($160,000 x 5%)/2] x 13.709837 Amount $83,225 $54.839 $138,064 Present value of $1: n= 19, i = 3.5% (7%/2) PVF (3.5%, 19) = 0.5201557 PVAF (3.5%, 19) = 13.709837

Compute June 30 Amortized initial cost as follows: June 30 Amortized initial = January 01 Initial cost + Increase from discount amortization = $148,098 + $467 = $148,565 Now, Compare the amortized initial cost with the fair value of the bonds on that date to evaluate the amount needed to adjust the investment to its fair value. June 30 Amortized initial cost June 30 fair value Fair value adjustment amount $148,565 $138,064 $10,501

Debit Credit Account Titles Net unrealized holding gains & loss-I/S Fair value adjustments $10,501 $10.501 Account Titles Debit Credit Date Dec. 31, 2021 Cash ($160,000 x 5%)/2 Discount on bonds investment Interest revenue [($160,000 - ($11092 - $467)] x 6%]2 $4.000 $481 $4,481 Bond Fair Value at Dec. 31, 2021 Principal Interest Present value of the receivable ($160.000 0.493628) Ir($160.000 x 5%)/2] x 13.709837 Amount $78,980 $50,637 $129,617 Present value of $1: n = 18. i = 4% (8%/2) PVF (4%, 18)=0.493628 PVAF (4%, 18) = 12.659297

Compute December 31 Amortized initial cost as follows: June 30 Amortized initial cost Increase from discount amortization Dec. 31 Amortized initial cost $148,565 $481 $149,046 Now. Compare the amortized initial cost with the fair value of the bonds on that date to evaluate the amount needed to adjust the investment to its fair value. Dec. 31 Amortized initial cost Dec. 31 fair value Fair value adjustment amount Less: Current fair value adjustment Changes in fair value adjustment $149,046 $129,617 $19,429 $10.501 $8,928 Debit Credit Account Titles Net unrealized holding gains & loss-I/S Fair value adjustments $8.928 $8,928

Answer 2

The above answer is mostly correct, but here are a few notes:

2. 

No fair value adjustment needed for June or December.

The correct formula for the Dec. 31 adjustment is:

[($160,000-$11,092+$467)x6%]/2

(note that the plug from the June 30th entry is added, not subtracted)

3. 

The correct account to debit for the fair value adjustment is "Loss on Investment (Unrealized, NI)"