Question

Fair value option; bond investment; effective interest [LO12-1, 12-2, 12-3, 12-4, 12-8] Fuzzy Monkey Technologies, Inc., purchased as a long-term investment $80 million of 8% bonds, dated January 1, on January 1, 2018. Management intends to have the investment available for sale when circumstances warrant. When the company purchased the bonds, management elected to account for them under the fair value option. For bonds of similar risk and maturity the market yield was 10%. The price paid for the bonds was $66 million. Interest is received semiannually on June 30 and December 31. Due to changing market conditions, the fair value of the bonds at December 31, 2021, was $70 million.
Required:

1. to 3. Prepare the relevant journal entries on the respective dates (record the interest at the effective rate). 4-a. At what amount will Fuzzy Monkey report its investment in the December 31, 2021, balance sheet? 4-b. Prepare the journal entry necessary to achieve this reporting objective. 5. How would Fuzzy Monkey’s 2018 statement of cash flows be affected by this investment assuming Fuzzy anticipates holding these investments for a sufficiently long period?

1. Record Fuzzy Monkey’s investment on bonds on January 1, 2021.

2. Record the interest revenue on June 30, 2021.

3. Record the interest revenue on December 31, 2021.

Req 4A

Invesment_________ million

Req 4B

Record any necessary entry to report the investment at the correct value on the balance sheet.

Req 5

Operating cash flow $ million
Investing cash flow $ million

Answer 1

Answer:

debt securities investment 80,000,000 debit

            discount on debt securities    14,000,000 credit

              cash                                       66,000,000 credit

--to record the purchase of the bonds--

cash                                 3,200,000 debit

discount on debt securities 100,000 debit

                   interest revenue        3,300,000 credit

--to record first interest collection--

cash                                 3,200,000 debit

discount on debt securities 105,000 debit

                   interest revenue        3,305,000 credit

--to record secod interest collection--

Cash flow:

-66,000,000 purchase

+ 6,400,000 interest

net -59,400,000

Balance sheet

debt securities investment   80,000,000

discount on debt securities  (13,795,000)

net amount for the investment 66,205‬,000

Explanation:

As we pay the bonds lower than face value we recognize a discount.

Then, interest reveneu will be carrying value times market rate:

66,000,000  x 10% / 2 = 3,300,000 interest revenue

cash proceeds: 80,000,000 x 8% / 2 = 3,200,000

the difference will amortize the discount.

Then we do it again for the second one:

66,100,000 x 10% / 2 = 3,305,000

difference amortize the discount

We did not adjust for the fair value as we are using another method.