Question

On February 1, 2016, Crane purchased $450,000, 6% bonds, with interest payable on January 1 and July 1, for $359,442, NOT INCLUDING accrued interest. The bonds mature on March 1, 2023. Amortization is recorded using the straight-line method and the bonds are classified as trading. On December 31, 2020, the bonds were adjusted to their proper carrying value when their fair value was $382,522. The fair market value of the bonds on December 31, 2019 was $358,457.  

Assuming the bonds were sold on October 1, 2021 for $392,062, PLUS accrued interest, determine the gain or loss on the sale of the bonds? Note: Accrue interest and amortize premium/discount on a monthly basis. Round your answer to the nearest whole dollar. If a gain results, enter your answer as a positive number. If a loss results, place a minus sign '-' prior to the amount of the loss.

Answer 1

Crane purchased 6% bonds of face value $450,000 for $359,442, excluding interest accrued. This gives a discount of $90,558 on the bonds. This discount will be amortized per month from 1 February, 2016 to 1 March, 2023 over 85 months, that is $1,065.39 per month.

As interest is payable on 1 January and 1 July, and bonds are purchased on 1 February, 2016, the interest is accrued for January and paid by Crane on purchase. But this interest will be received by Crane along with the interest for remaining 5 months on 1 July. Therefore, this accrued interest has no relevance for calculation of profit on sale. Similarly, when bonds are sold on 1 October, 2021, the value given to us is excluding interest accrued. Hence, the accrued interest has no relevance as the accrued interest received on sale is the actual income on bonds, which is accrued on monthly basis and has no relevance for calculation of profit/loss on sale of bond.

Carrying value of a bond is found out by adjusting the remaining value of discount after amortization with the fair value of the bond at the reporting date.

Remaining value of discount at 31 December, 2020 is = $90,558 – ($1,065.39 x 59 months)

= $90,558 - $62,858.01 = $27,699.99

Carrying value of bond at 31 December, 2020 = Fair value ($382,522) less remaining value of discount ($27,699.99) = $354,822.01

Remaining value of discount at 1 October, 2021 = $90,558 – ($1,065.39 x 68 months) = $90,558 - $72,446.52 = $18,111.48

Assuming that the bonds have not been revalued at fair value between 31 December, 2020 and 1 October, 2021, carrying value of bond at 1 October, 2021 = Fair value ($382,522) less remaining value of discount ($18,111.48) = $364,410.52

The profit on sale of bonds is difference between the carrying value at 1 October, 2021 and the sale price which is $392,062.

=$392,062 - $364,410.52 = $27,651.48 or $27,651 (Profit)