Question

Mills Corporation acquired as a long-term investment $250 million of 6% bonds, dated July 1, on July 1, 2018. Mills determined that it should account for the bonds as an available-for-sale investment. The market interest rate (yield) was 4% for bonds of similar risk and maturity. Mills paid $300 million for the bonds. The company will receive interest semiannually on June 30 and December 31. As a result of changing market conditions, the fair value of the bonds at December 31, 2018, was $275 million.

Required:
1. & 2. Prepare the journal entry to record Mills’ investment in the bonds on July 1, 2018 and interest on December 31, 2018, at the effective (market) rate.
3. At what amount will Mills report its investment in the December 31, 2018, balance sheet?
4. Suppose Moody’s bond rating agency upgraded the risk rating of the bonds, and Mills decided to sell the investment on January 2, 2019, for $290 million. Prepare the journal entries to record the sale.

Answer 1

Answer and Explanation:

1 & 2. The journal entries are shown below:

1. Investment in Bonds $250,000,000

To Premium on Bond Investment $50,000,000

To Cash $300,000,000

(Being the investment in bonds is recorded)

Since the investment in bonds is $250 million and the same is debited as it increased the assets and the cash is paid so it would be credited as it decreased the assets and the remaining balance is transferred to the premium on bond investment

2. Cash ($250,000,000 × 3%) $7,500,000

To Interest Revenue ($300,000,000 × 2%) $6,000,000

To Premium on bonds $1,500,000

(Being the interest is recorded)

Since the cash is received so it would be debited and the interest revenue and the remaining balance i.e premium is credited

3. The Amount to be reported in balance sheet is as follows

Particulars Amount ($)

Investment in Bonds $250,000,000

Premium on bonds

Original Premium $50,000,000

Less: Amortization (1,500,000) 48,500,000

Book value $298,500,000

4. The journal entry is shown below:

Cash $290,000,000

To Loss on sale $8,500,000 ($298,500,000 - $290,000,000

To Investment in bonds $250,000,000

To Premium on bonds $31,500,000

(Being the sale is recorded)

The cash is debited and the other respective accounts are credited