Question

Federal Semiconductors issued 11% bonds, dated January 1, with a face amount of $880 million on January 1, 2018. The bonds sold for $813,796,294 and mature on December 31, 2037 (20 years). For bonds of similar risk and maturity the market yield was 12%. Interest is paid semiannually on June 30 and December 31. Federal determines interest at the effective rate. Federal elected the option to report these bonds at their fair value. On December 31, 2018, the fair value of the bonds was $800 million as determined by their market value in the over-the-counter market. Assume the fair value of the bonds on December 31, 2019 had risen to $806 million. Required: Complete the below table to record the following journal entries. 1. & 2. Prepare the journal entry to adjust the bonds to their fair value for presentation in the December 31, 2018, balance sheet, and adjust the bonds to their fair value for presentation in the December 31, 2019, balance sheet. Federal determined that one-half of the increase in fair value was due to a decline in general interest rates.

Answer 1

Calculation of Semi Interest:

$ 880,000,000 x 11% x 6/12 = $ 48400000

Fall in Fair Value = $ 813796294 - $ 800000000 = $ 13796294

Journal Entry:

Debit Fair Value Adjustment A/c $ 13796294

Credit Unrealized Holding Gain A/c $ 13796294

Part 2

Adjustment in FV = $ 806000000 - $ 800000000 = $ 6000000

Journal Entry

Debit Unrealied Holding Loss $ 6000000

Credit FV Adjustment $ 6000000

Note: there is a loss here because rise in FV of bonds will lead to more interest payment which shall lead to more payment amounting to loss.