Question

Fuzzy Monkey Technologies, Inc., purchased as a long-term investment $130 million of 8% bonds, dated January 1, on January 1, 2021. Management intends to have the investment available for sale when circumstances warrant. For bonds of similar risk and maturity the market yield was 10%. The price paid for the bonds was $115 million. Interest is received semiannually on June 30 and December 31. Due to changing market conditions, the fair value of the bonds at December 31, 2021, was $120 million. Required: Prepare the relevant journal entries on the respective dates (record the interest at the effective rate).

Answer 1

The student is asked to prepare accounting journal entries for bond investment transactions, recording interest at the effective interest rate and making adjustments for changes in fair value.

Step-by-step explanation:

The student's question involves accounting journal entries related to a long-term investment in bonds by a company. The company, Fuzzy Monkey Technologies, Inc., purchased $130 million of 8% bonds at a price of $115 million when the market yield was 10%. Given that the interest is received semi-annually, the effective interest rate would be used to record the interest revenue. The fair value of the bonds changed to $120 million at year-end.

To address this question, one must understand the concepts of amortized cost, effective interest method, and fair value adjustment. The journal entries would reflect the purchase of the bond, the receipt of interest income, the amortization of the discount, and the adjustment to fair value at the year's end.

Example Journal Entries:

January 1, 2021: Dr. Bonds investment $115 million; Cr. Cash $115 million.

June 30, 2021 & December 31, 2021: Dr. Cash and Dr. Discount on bonds investment; Cr. Interest revenue (calculate using effective interest rate).

December 31, 2021: Dr. Fair value adjustment; Cr. Unrealized gain (to record the increase in fair value).