Question

Mills Corporation acquired as an investment $240 million of 7% bonds, dated July 1, on July 1, 2021. Company management is holding the bonds in its trading portfolio. The market interest rate (yield) was 5% for bonds of similar risk and maturity. Mills paid $280 million for the bonds. The company will receive interest semiannually on June 30 and December 31. As a result of changing market conditions, the fair value of the bonds at December 31, 2021, was $260 million. Required: 1. & 2. Prepare the journal entry to record Mills'investment in the bonds on July 1, 2021 and interest on December 31, 2021, at the effective (market) rate. 3. Prepare the journal entry by Mills to record any fair value adjustment necessary for the year ended December 31, 2021. 4. Suppose Moody's bond rating agency upgraded the risk rating of the bonds, and Mills decided to sell the investment on January 2, 2022, for $290 million. Prepare the journal entries required on the date of sale.

Answer 1

Solution:

1&2)

Date	Account title and explanation	Debit	Credit
01 July 2021	Investment in bond	$240,000,000
	Premium on bond investment	$40,000,000
	To cash		$280,000,000
	(To record the investment in bond)
31 Dec 2021	Cash ($240,000,000*3.5%)	$8,400,000
	To premium on bond		$1,400,000
	To interest revenue ($280,000,000*2.5%)		$7,000,000
	(To record interest on bonds)

3)

Date	Account title and explanation	Debit	Credit
31 Dec 2021	Unrealized holding gain or loss	$18,600,000
	Fair value adjustment		$18,600,000

Working:

Fair market value	$260,000,000
Book value and premium ($240,000,000+$40,000,000-$1,400,000)	($278,600,000)
Decrease in book value	$18,600,000

4)

Date	Account title and explanation	Debit	Credit
02 Jan 2022	cash	$290,000,000
	Gain on sale		$11,400,000
	Premium on bond		$38,600,000
	Investment in bond		$240,000,000

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