On January 1, 2022, BeamingBooks Bureau sold $1,250,000 of 7% bonds to OptimisticOutcomes Inc. The bonds mature on December 31, 2025 (4 years). For bonds of similar risk and maturity, the market yield was 8%. Interest is paid semiannually on June 30 and December 31.
OptimisticOutcomes Enterprise purchased the bonds as an investment and plans to hold the bonds for approximately 2 years.
The fair value of the bonds at 12/31/22 was $1,305,000.
OptimisticOutcomes’s fiscal year end is December 31 and 2022 was its first year of business.
Required:
- Prepare the fair value adjusting entry for OptimisticOutcomes Enterprise as of 12/31/22. Show your work.
- Show or describe exactly and specifically what will appear on the Balance Sheet of OptimisticOutcomes Enterprise as of 12/31/22, related to these bonds.
- Show or describe exactly and specifically what will appear on the Income Statement of OptimisticOutcomes Enterprise for the year ending 12/31/22.
- Prepare the journal entries OptimisticOutcomes Enterprise should make on the following dates related to this investment. Assume that the fair value of these bonds is $950,000 at 12/31/23. Show your work.
Full Answer Section
- Non-Current Assets:
- N/A (Bonds mature in less than 4 years)
3. Income Statement for the year ending 12/31/22:
- Other Income:
- Interest income from BeamingBooks Bonds: $1,250,000 * 7% * 6/12 = $43,750 (6 months' interest)
4. Journal Entries for 12/31/23:
a) Interest Receipt:
Debit: Cash $43,750 Credit: Interest Receivable $43,750
b) Fair Value Adjustment:
Debit: Unrealized Gain on Investment in BeamingBooks Bonds $105,000 Credit: Investment in BeamingBooks Bonds $105,000
Calculation:
New Fair Value at 12/31/23 - Previous Fair Value = $950,000 - $1,305,000 = -$355,000 (negative value indicates a loss)
c) Interest Revenue:
Debit: Interest Receivable $43,750 Credit: Interest Income $43,750
d) Unrealized Loss on Disposal:
Debit: Loss on Disposal of Investment $355,000 Credit: Investment in BeamingBooks Bonds $355,000
Note:
- Assume semiannual interest payments of $43,750 (calculated as Cost Price * Coupon Rate * 6/12) are received on June 30th and December 31st of each year.
- The negative fair value adjustment at 12/31/23 shows a decrease in the bond's value, leading to an unrealized loss recorded on the income statement.
Sample Answer
1. Fair Value Adjusting Entry as of 12/31/22:
To reflect the change in fair value of the bonds, OptimisticOutcomes needs to adjust their accounts.
Debit: Investment in BeamingBooks Bonds $55,000 Credit: Unrealized Gain on Investment in BeamingBooks Bonds $55,000
Calculation:
Fair Value at 12/31/22 - Cost Price = $1,305,000 - $1,250,000 = $55,000
2. Balance Sheet as of 12/31/22:
- Current Assets:
- Investment in BeamingBooks Bonds: $1,305,000 (fair value, not cost)