Question

Nichols Corporation purchased $100,000 of Holly Inc. 6% bonds at par with the intent and ability to hold the bonds until they matured in 2020, so Nichols classifies its investment as held to maturity. Unfortunately, a combination of problems at Holly and in the debt market caused the fair value of the Holly investment to decline to $70,000 during 2016. Nichols calculates that, of the $30,000 decrease in fair value, $10,000 of it relates to credit losses and $20,000 relates to noncredit losses.
Assume that Nichols concludes that the Holly bonds are other-than-temporarily impaired because Nichols calculates that the bonds have incurred credit losses. Before-tax net income for 2016 will be reduced by:

$0.

$10,000.

$20,000.

$30,000.

*** If the fair value of a debt investment that is classified as an available-for-sale investment declines for a reason that is viewed as "other than temporary" because it is viewed as "more likely than not" that the investor will be required to sell the investment prior to recovering the amortized cost of the investment less any credit losses arising in the current year:

The investment is not written down to fair value.

The investment is written down to fair value, and the impairment loss is recognized in net income.

The investment is written down to fair value, and the impairment loss is recognized in accumulated other comprehensive income.

The investment is written down to fair value, and only the noncredit loss is included in net income.

Answer 1

Answer:

$10,000.

The investment is written down to fair value, and the impairment loss is recognized in net income.

Explanation:

Given that

Purchase value of the bond = $100,000

Decline value = $70,000

Decrease in fair value = $30,000

Credit losses = $10,000

Non credit losses = $20,000

Based on the above information, the before tax net income for year 2016 is reduced by $10,000 as Nicholds wants to hold the bond till maturity date. So the non credit part of decrease in fair value would not be adjusted

Therefore only credit losses should be relevant  

As it is mentioned in the question that the debt investment fair value is to be considered as an available-for-sale investment and viewed as an other than temporary therefore the written down of investment to fair value and the loss of impairment should be recorded in the net income