Question

Tanner-UNF Corporation acquired as an investment $220 million of 6% bonds, dated July 1, on July 1, 2021. Company management is holding the bonds in its trading portfolio. The market interest rate (yield) was 8% for bonds of similar risk and maturity. Tanner-UNF paid $180 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 $190 million.

Required:
1. & 2. Prepare the journal entry to record Tanner-UNF’s investment in the bonds on July 1, 2021 and interest on December 31, 2021, at the effective (market) rate.
3. Prepare any additional journal entry necessary for Tanner-UNF to report its investment in the December 31, 2021, balance sheet.
4. Suppose Moody’s bond rating agency downgraded the risk rating of the bonds motivating Tanner-UNF to sell the investment on January 2, 2022, for $170 million. Prepare the journal entries required on the date of sale.

Answer 1

1.

Invetment in Bonds Dr. 220

To discount on bonds investment 40

To cash 180

2. Cash Dr. 6.60 [220 x 6% x 6/12]

Discount on bonds Dr. 0.60

To interest revenue 7.20 [180 x 8% x 6/12]

3.

Fair market value		190
Book value	220
Less: Discount [40 - 0.60]	(39.40)	(180.60)
Increase in value		9.40

Fair value adjustment Dr. 9.40

To unrealized holding gain 9.40

4.

Fair value	170
Book value	180.60
Decrease in value	10.60

(a) Unrealized holding loss Dr. 20 [190 - 170]

To Fair value adjustment 20

(b) Cash Dr. 170

Fair value adjustment Dr. 10.60

Discount on bond investment Dr. 39.40

To Investment in bonds 220