Question

Tanner-UNF Corporation acquired as a long-term investment $240 million of 6% bonds, dated July 1, on July 1, 2018. The market interest rate (yield) was 8% for bonds of similar risk and maturity. Tanner-UNF paid $200 million for the bonds. The company will receive interest semi-annually on June 30 and December 31. Company management is holding the bonds in its trading portfolio. As a result of changing market conditions, the fair value of the bonds at December 31, 2018, was $210 million.

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 $190 million. Prepare the journal entries to record the sale.

Answer 1

Tanner-UNF Corporation's journal entries include the initial investment, recording interest, adjusting to fair value, and the sale of bonds. The investment is debited at purchase cost, interest is recorded at the market rate, bonds are adjusted to fair value, and loss is realized during the sale.

Step-by-step explanation:

To record Tanner-UNF Corporation's acquisition of bonds on July 1, 2018, the journal entry is as follows:

Dr. Investment in Bonds $200 million

Cr. Cash $200 million

For the interest on December 31, 2018, at the effective interest rate of 8%:

Dr. Interest Receivable (240 million × 6% ÷ 1/2) $7.2 million

Cr. Interest Income (200 million × 8% ÷ 1/2) $8 million

To adjust the bonds to fair value on the December 31, 2018, balance sheet:

Dr. Fair Value Adjustment $10 million

Cr. Unrealized Gain on Investment $10 million

If Tanner-UNF sells the bonds on January 2, 2019, for $190 million, the entries to record the sale are:

Dr. Cash $190 million

Cr. Investment in Bonds $200 million

Cr. Fair Value Adjustment $10 million

Note that the loss on sale is the difference between the carrying amount of the bonds at fair value ($210 million) and the sale price ($190 million).

Answer 2

Please see journal entries below

Step-by-step explanation:

On July 1, 2018, Tanner-UNF acquired the bond investment

Debit: Investment in Bonds Account $200 million

Credit: Cash/Bank Account $200 million

On December 31, 2018, entries for interest received and fair value recognition are as follows (fair value recognition is necessary because the bond is held in trading portfolio):

Debit: Investment in Bonds Account $10 million (increase in fair value)

Credit: Profit/Loss Account $10 million (increase in fair value)

Debit: Cash/Bank Account $7.2 million (semi-annual interest on bond calculated as follows, 6%*240*0.5 = $7.2 million)

Credit: Profit/Loss Account $7.2 million (semi-annual interest)

On January 2, 2019, sale of bond investment

Debit: Cash/Bank Account $190 million (sales proceed)

Credit: Investment in Bonds Account $190 million (sales proceed)

Debit: Profit/Loss Account $20 million (loss on bond investment, calculated as $210 fair value less $190 million sales proceed)

Credit: Investment in Bonds Account $20 million (loss on bond investment)