Question

On January 1, 2021, Rapid Airlines issued $240 million of its 8% bonds for $221 million. The bonds were priced to yield 10%. Interest is payable semiannually on June 30 and December 31. Rapid Airlines records interest at the effective rate and elected the option to report these bonds at their fair value. On December 31, 2021, the fair value of the bonds was $229 million as determined by their market value in the over-the-counter market. Rapid determined that $1,000,000 of the increase in fair value was due to a decline in general interest rates.

Required:
Prepare the journal entries to record interest on June 30, 2021 (the first interest payment), on December 31, 2021 (the second interest payment) and to adjust the bonds to their fair value for presentation in the December 31, 2021, balance sheet.

Answer 1

June 30

Dr Interest expense $11,050,0000

Cr Discount on bond payable $1,450,000

Cr Cash $9,600,000

December 31, 2021

Dr Interest expense $11,122,500

Cr Discount on bond payable $1,522,500

Dr Cash $9,600,000

December 31, 2021

Dr Unrealized Holding loss -NI $1,000,000

Dr Unrealized Holding loss -OCI $9,972,500

Cr Fair value Adjustment $10,972,500

Step-by-step explanation:

Preparation of the journal entries to record interest on June 30, 2021

June 30

Dr Interest expense $11,050,0000

($221 million*10%/2)

Cr Discount on bond payable $1,450,000

($11,050,000-$9,600,000)

Cr Cash $9,600,000

($240 million*8%/2)

(To record first interest payment)

Preparation of the journal entries to record interest on December 31, 2021

December 31, 2021

Dr Interest expense $11,122,500

[($221,000,000+$1,450,000)*10%/2]

Cr Discount on bond payable $1,522,500

($11,122,500-$9,600,000)

Dr Cash $9,600,000

($240 million*8%/2)

(To record second interest payment)

Preparation of the journal entry to adjust the bonds to their fair value for presentation in the December 31, 2021, balance sheet.

December 31, 2021

Dr Unrealized Holding loss -NI $1,000,000

Dr Unrealized Holding loss -OCI $9,972,500

($10,972,500-$1,000,000)

Cr Fair value Adjustment $10,972,500

($229 million-$221 million+$1,450,000+$1,522,500)

(To adjust the bonds to Fair value)