Question

Fuzzy Monkey Technologies, Inc., purchased as a long-term investment $240 million of 6% bonds, dated January 1, on January 1, 2016. Management has the positive intent and ability to hold the bonds until maturity. For bonds of similar risk and maturity the market yield was 8%. The price paid for the bonds was $219 million. Interest is received semiannually on June 30 and December 31. Due to changing market conditions, the fair value of the bonds at December 31, 2016, was $230 million.

Record the interest revenue on December 31, 2016.

I need help with calculating interest revenue. Please do not just solve, I want to understand why. Thank you for your help!

Answer 1

Answer:

Date	Account title and explanation	Debit	Credit
Dec 31,2016	Cash	$6,570,000
	Discount on notes receivable	$2,277,600
	Interest revenue		$8,847,600
	[To record interest revenue]

Calculations:

Interest amortization table (partial)
Date	Cash interest	Interest revenue	Increase in carrying value	Carrying value
01/01/2016				$219,000,000
06/30/2016	$6,570,000	$8,760,000	$2,190,000	$221,190,000
12/31/2016	$6,570,000	$8,847,600	$2,277,600	$223,467,600

• Cash interest = Face value x Coupon rate = $230,000,000 x 3% = $6,570,000 [3% is semi-annual rate of 6%]
• Interest revenue = Preceding carrying value x 4% [4% is semi-annual rate of 8% market rate]
• Increase in carrying value = Interest revenue - Cash interest
• Carrying value = Preceding carrying value + Increase in carrying value