Question

Mills Corporation acquired as an investment $225 million of 8% bonds, dated July 1, on July 1, 2021. Company management is holding the bonds in its trading portfolio. The market interest rate (yield) was 6% for bonds of similar risk and maturity. Mills paid $250 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 $240 million. Required: 1. & 2. 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. 3. Prepare the journal entry by Mills to record any fair value adjustment necessary for the year ended December 31, 2021. 4. 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 $266 million. Prepare the journal entries required on the date of sale.

Answer 1

Please see solution below.

Explanation:

1.

July 1, 2021

Dr Investment in bonds $225,000,000

Dr Premium on investment in bonds $25,000,000

Cr Cash $250,000,000

December 31, 2021

Dr Cash $18,000,000

Cr Interest revenue $15,000,000

Cr Premium on investments in bonds

$3,000,000

2.

Investment in bonds. $225,000,000

Premium on investment in bonds $22,000,000

3.

January 2, 2022

Dr. Cash $266,000,000

Cr Investment in bonds $225,000,000

Cr Premium on investment in bonds $22,000,000

Cr Gain on sale of investments $19,000,000

Workings:

Effective interest rate on first coupon received = [ $225,000,000 × 8%] - [ $250,000,000 × 6%]

= $18,000,000 - $15,000,000

= $3,000,000

Premium on investment in bonds = $25,000,000 - $3,000,000

= $22,000,000