Question

Tanner-UNF Corporation acquired as a long-term investment $300 million of 6% bonds, dated July 1, on July 1, 2021. Company management has classified the bonds as an available-for-sale investment. The market interest rate (yield) was 8% for bonds of similar risk and maturity. Tanner-UNF paid $250 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, 2021, was $260 million.
Required
1.& 2. Prepare the journal entry to record Tanner-UNF's investment in the bonds on July 1, 2018 and interest on December 31, 2018, at the effective (market) rate.
3. Prepare any additional journal entry necessary for Tanner-UNF to report its investment in the December 31, 2018, balance sheet.
4. Suppose Moody's bond rating agency downgraded the risk rating of the bonds motivating Tanner-UNF to sell the investment on January 2, 2019, for $240 mllion. Prepare the journal entries necessary to record the sale, including updating the fair-value adjustment, recording any reclassification adjustment, and recording the sale.

Answer 1

Answer:

See the attached excel file for all the journal entries.

Explanation:

1.& 2. Prepare the journal entry to record Tanner-UNF's investment in the bonds on July 1, 2018 and interest on December 31, 2018, at the effective (market) rate.

Note: See part 1.& 2. of the attached excel file for the journal entries.

In the part part 1.& 2. of the attached excel file, we have:

Discount on bond investment (Bal. Fig) = Bond face value - Amount paid for the bond = $300 million - $250 million = $50 million

Cash interest received  = Bond face value * Bond rate * (1 / 2) = $300 million *6% * 1/2 = $9 million

Interest revenue = Amount paid for the bond * Market interest rate * (1 / 2) = $250 million * 8% * (1/2) = $10 million

3. Prepare any additional journal entry necessary for Tanner-UNF to report its investment in the December 31, 2018, balance sheet.

Note: See part 3 of the attached excel file for the journal entries.

In the part part 3 of the attached excel file, we have:

Fair value adjustment = Fair value of the bonds - Amount paid for the investment - (Interest revenue - Cash interest received) = $260 million - $250 million - ($10 million - $9 million) = ($260 million - $250 million - $1 million) = $9 million

4. Suppose Moody's bond rating agency downgraded the risk rating of the bonds motivating Tanner-UNF to sell the investment on January 2, 2019, for $240 million. Prepare the journal entries necessary to record the sale, including updating the fair-value adjustment, recording any reclassification adjustment, and recording the sale.

Note: See part 4 of the attached excel file for the journal entries.

In the part part 4 of the attached excel file, we have:

Discount on bond investment = Discount on bond investment as obtained in part 1.& 2 above - (Interest revenue - Cash interest received) = $50 million - ($10 million - $9 million) = $49 million

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