Question

Mills Corporation acquired as a long-term investment $240 million of 5% bonds, dated July 1, on July 1, 2021. Company management has the positive intent and ability to hold the bonds until maturity. The market interest rate (yield) was 3% for bonds of similar risk and maturity. Mills paid $280.0 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, 2021, was $270.0 million.

Required:
a. Prepare the journal entry to record Mills' investment in the bonds on July 1, 2021 and interest on December 31, 2021, at the effective (market) rate.
b. At what amount will Mills report its investment in the December 31, 2021, balance sheet?
c. Suppose Moody's bond rating agency upgraded the risk rating of the bonds, and Mills decided to sell the investment on January 2, 2022, for $290 million. Prepare the journal entry to record the sale.

Answer 1

a. Prepare the journal entry to record Mills' investment in the bonds on July 1, 2021 and interest on December 31, 2021, at the effective (market) rate.

July 1, 2021

Dr Investment in bonds 240,000,000

Dr Premium on investment in bonds 40,000,000

Cr Cash 280,000,000

December 31, 2021

Dr Cash 12,000,000

Cr Interest revenue 8,400,000

Cr Premium on investment in bonds 3,600,000

b. At what amount will Mills report its investment in the December 31, 2021, balance sheet?

Investment in bonds $240,000,000

Premium on investment in bonds $36,400,000

c. Suppose Moody's bond rating agency upgraded the risk rating of the bonds, and Mills decided to sell the investment on January 2, 2022, for $290 million. Prepare the journal entry to record the sale.

January 2, 2022

Dr Cash 290,000,000

Cr Investment in bonds 240,000,000

Cr Premium on investment in bonds 36,400,000

Cr Gain on sale of investments 13,600,000

Step-by-step explanation:

effective interest rate on first coupon received = ($240,000,000 x 5%) - ($280,000,000 x 3%) = $12,000,000 - $8,400,000 = $3,600,000

Premium on investment in bonds = $40,000,000 - $3,600,000 = $36,400,000