Question

Pharoah Company invests $10,400,000 in 5% fixed rate corporate bonds on January 1, 2017. All the bonds are classified as available-for-sale and are purchased at par. At year-end, market interest rates have declined, and the fair value of the bonds is now $11,078,000. Interest is paid on January 1.Required:
1. Prepare journal entries for Pharoah Company to (a) record the transactions related to these bonds in 2017, assuming Pharoah does not elect the fair option; and (b) record the transactions related to these bonds in 2017, assuming that Pharoah Company elects the fair value option to account for these bonds.

Answer 1

Answer:

1 a) 01 Jan Debit Bond Investment $10,400,000 Credit Bank $10,400,000

31 Dec Debit Interest Receivable $520,000 Credit Interest Income  $520,000

b)  01 Jan Debit Bond Investment $10,400,000 Credit Bank $10,400,000

31 Dec Debit Interest Receivable $520,000 Credit Interest Income  $520,000

           Debit Bond Investment $678,000 Credit Fair Value gain $678,000

Explanation:

interest income =$10,400,000 *5% =520,000

Fair value gain = $11,078,000 - $10,400,000 = 678,000

Interest income is received from the investment that starts the year for an example for 2017 year the interest does not change and the fair value came about only at the end of the year so for 2018 interest in the fair value option interest income will be calculated on the fair value of $11,078,000 as it will be the amount that starts the 2018 year.