Question

On January 1, 2021, Rapid Airlines issued $295 million of its 6% bonds for $271 million. The bonds were priced to yield 8%. Interest is payable semiannually on June 30 and December 31. Rapid Airlines records interest at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2021, the fair value of the bonds was $285 million as determined by their market value in the over-the-counter market. Rapid determined that $1,000,000 of the increase in fair value was due to a decline in general interest rates.

Required:

1. to 3. 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

1) June 30, 2021 - Journal entry for interest payment :

Interest expense a/c Dr $8.85 million

To Cash a/c $8.85 million   

(Interest is paid on face value. Therefore, the interest paid on 30 June would be [$295 million * 6%] *6/12.

Since payments are halfyearly we multiply it with 6/12.)

2) Dec 31, 2021 - Journal entry for interest payment :

Interest expense a/c Dr $8.85 million

To Cash a/c $8.85 million   

(Interest is paid on face value. Therefore, the interest paid on 31 Dec would be [$295 million * 6%] *6/12.

Since payments are halfyearly we multiply it with 6/12.)

3) Dec 31, 2021 - Fair value adjustment :

Bonds Payable a/c Dr $10 million

To Adjustment in fairvalue a/c $10 million

($295 million - $285 million)