Answer :
Answer:
A) July 1, 2016, 3% bonds are acquired as long term investment.
Dr Investment in 3% bonds 720,000
Cr Cash 600,000
Cr Discount on investment in 3% bonds 120,000
B) December 31, 2016, interest earned from investment in 3% bonds.
Dr Cash 10,800
Dr Discount on investment in 3% bonds 1,200
Cr Interest revenue 12,000
Explanation:
the bonds' face value is $720,000 but since the company paid only $600,000 for them, it means that it bought them at a discount price. Therefore, the discount, $720,000 - $600,000 = $120,000, must be recorded, and later amortized.
To calculate the amount of interest revenue that will be amortized as discount on investment:
(bonds' market price x market interest rate x 1/2) - (bonds' face value x coupon rate x 1/2) = ($600,000 x 4% x 1/2) - ($720,000 x 3% x 1/2) = $12,000 - $10,800 = $1,200
Answer:
(a)
July 1, 2016
Dr. Investment in Bonds $720,000
Cr. Discount on Bonds $120,000
Cr. Cash $600,000
(b)
December 31, 2016
Dr. Cash $10,800
Dr. Discount on Bonds $1200
Cr. Interest Income $12,000
Explanation:
Investment in the bonds with intention to hold the bond until maturity is classified as the fixed investment and reported in the fixed assets section of the balance sheet.
When the bond is purchased below the face value of the bond, it is issued on discount by the issuer. This discount will be recorded and amortized over the bond life to maturity. Amortized discount will be added to the interest received amount to adjust this value in interest income.
Interest Received = Face value x Coupon rate x 6/12 = $720,000 x 3% x 6/12 = $10,800 semiannually
Interest income = Carrying Balance of Bond x market Rate x 6/12 = $600,000 x 4% x 6/12 = $12,000 semiannually
Now we will calculate the difference between the interest received and interest income to determine the value of discount amortized.
Amortized Discount = $12,000 - $10,800 = $1,200