Question

Mills Corporation acquired as a long-term investment $270 million of 8% bonds, dated July 1, on July 1, 2018. Company management has positive intent and ability to hold the bonds until maturity. The market interest rate (yield) was 6% for bonds of similar risk and maturity. Mills paid $310.0 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, 2018, was $290.0 million.

Required: 1. & 2. Prepare the journal entry to record Mills’ investment in the bonds on July 1, 2018 and interest on December 31, 2018, at the effective (market) rate.

3. At what amount will Mills report its investment in the December 31, 2018, balance sheet?

4. Suppose Moody’s bond rating agency upgraded the risk rating of the bonds, and Mills decided to sell the investment on January 2, 2019, for $320 million. Prepare the journal entry to record the sale.

Answer 1

1 & 2 :

In the books of Mills Corporation :

Date	Account Titles	Debit	Credit
		$	$
July 1, 2018	Investment in Bonds	270,000,000
	Premium on Bonds	40,000,000
	Cash		310,000,000
December 31, 2018	Cash ( 270,000,000 x 8 % x 1/2 )	10,800,000
	Interest Revenue ( 310,000,000 x 6 % x 1/2 )		9,300,000
	Premium on Bonds		1,500,000

3. The investment would be reported on December 31, 2018 balance sheet at $ 270,000,000 + $ ( 40,000,000 - $ 1,500,000 = $ 308,500,000

As the management has the intent and ability to hold the bonds till maturity, the bonds would be carried in the balance sheet at book value. Therefore, the fair market value is not relevant.

4.

Date	Account Titles	Debit	Credit
		$	$
January 2, 2019	Cash	320,000,000
	Premium on Bonds		39,850,000
	Investment in Bonds		270,000,000
	Gain on Sale of Bonds		10,150,000