Question

Garfield Company purchased, as a held-to-maturity investment, $80,000 of the 9%, 5-year bonds of Chester Corporation for $74,086, which provides an 11% return. Prepare Garfield’s journal entries for (a) the purchase of the investment, and (b) the receipt of annual interest and discount amortization. Assume effective-interest amortization is used. (Round answers to 0 decimal places, e.g. 1,225. Credit account titles are automatically indented when amount is entered. Do not indent manually. If no entry is required, select "No Entry" for the account titles and enter 0 for the amounts.)

Answer 1

Garfield Company's journal entry for purchasing the Chester Corporation bonds is a debit to Investment in Bonds and a credit to Cash for $74,086. Annual interest receipts and discount amortization involve debiting Cash for the interest received, debiting Discount on Bonds Payable for the amortization amount, and crediting Investment in Bonds for the total interest income calculated using the effective interest rate method.

Step-by-step explanation:

When Garfield Company purchases the bonds as a held-to-maturity investment, they will make an entry to debit investment in bonds and credit cash with the purchase price of $74,086. The journal entry for the purchase is:

• Debit Investment in Bonds $74,086
• Credit Cash $74,086

For receipt of annual interest and discount amortization, the effective interest rate method is used to calculate the interest income and the amount of discount to amortize each year.

The annual interest received is $80,000 * 9% = $7,200. We will use the carrying value of the bond multiplied by the market interest rate to find the interest income. The carrying value initially is the purchase price, and the market interest rate is 11%.

• Interest Income for first year = $74,086 * 11% = $8,149.46 (round to $8,149)
• Discount Amortization = Interest Income - Interest Received = $8,149 - $7,200 = $949
• Adjusted carrying value = Previous carrying value + Discount Amortization = $74,086 + $949

The journal entry for the receipt of interest and discount amortization would be:

• Debit Cash $7,200
• Debit Discount on Bonds Payable $949
• Credit Investment in Bonds $8,149

Each successive year, the carrying value will increase because of the discount amortization until it reaches the face value at maturity.