On January 1, 2022, BeamingBooks Bureau sold $1,250,000 of 7% bonds to OptimisticOutcomes Inc. The bonds mature on December 31, 2025 (4 years). For bonds of similar risk and maturity, the market yield was 8%. Interest is paid semiannually on June 30 and December 31.
OptimisticOutcomes Enterprise purchased the bonds as an investment and plans to hold the bonds for approximately 2 years.
The fair value of the bonds at 12/31/22 was $1,305,000.
OptimisticOutcomes’s fiscal year end is December 31 and 2022 was its first year of business.
1. Prepare the fair value adjusting entry for OptimisticOutcomes Enterprise as of 12/31/22. Show your work.
2. Show or describe exactly and specifically what will appear on the Balance Sheet of OptimisticOutcomes Enterprise as of 12/31/22, related to these bonds.
3. Show or describe exactly and specifically what will appear on the Income Statement of OptimisticOutcomes Enterprise for the year ending 12/31/22.
4. Prepare the journal entries OptimisticOutcomes Enterprise should make on the following dates related to this investment. Assume that the fair value of these bonds is $950,000 at 12/31/23. Show your work.
6/30/23:
12/31/23:
5. Assume Swift sells these bonds on 4/1/24 for $1,575,000. Prepare all journal entries required on 4/1/24. Show your work.
Accrue interest as of 4/1/24:
Adjust to fair value as of 4/1/24:
Reclassification entry as of 4/1/24:
Record the sale of the investment on 4/1/24:
1. Fair Value Adjusting Entry (December 31, 2022):
Investment in BeamingBooks Bonds 1,305,000
Unrealized Gain on Investment in BeamingBooks Bonds 55,000
Fair Value Adjustment 1,360,000
To record the change in fair value of the BeamingBooks bonds to $1,305,000.
2. Balance Sheet (December 31, 2022):
- Current Assets:
- Investment in BeamingBooks Bonds: $1,305,000
- Long-Term Investments (if holding period exceeds 1 year):
- Unrealized Gain on Investment in BeamingBooks Bonds: $55,000
3. Income Statement (Year Ending December 31, 2022):
- Other Income or Expense:
- Interest Income (calculated based on 6 months at 7%): $43,750 (not reflected if held to maturity)
4. Journal Entries (December 31, 2023):
June 30, 2023:
Cash 43,750
Investment in BeamingBooks Bonds 43,750
To record receipt of semiannual interest payment.
December 31, 2023:
Fair Value Adjustment 160,000
Unrealized Gain on Investment in BeamingBooks Bonds 160,000
To adjust the unrealized gain to reflect the new fair value of $950,000.
Investment in BeamingBooks Bonds 355,000
Fair Value Adjustment 355,000
To adjust the investment account to reflect the new fair value of $950,000.
5. Sale of Bonds (April 1, 2024):
(a) Accrue Interest (April 1, 2024):
Interest Expense 14,583
Interest Payable 14,583
To accrue interest for 3 months at 7%.
(b) Adjust to Fair Value (April 1, 2024):
Unrealized Gain on Investment in BeamingBooks Bonds 345,000
Fair Value Adjustment 345,000
To adjust the unrealized gain to reflect the new fair value of $1,575,000.
Investment in BeamingBooks Bonds 620,000
Fair Value Adjustment 620,000
To adjust the investment account to reflect the new fair value of $1,575,000.
(c) Reclassification Entry (April 1, 2024):
Available-for-Sale Securities 620,000
Investment in BeamingBooks Bonds 620,000
To reclassify the investment as available-for-sale.
(d) Sale of Investment (April 1, 2024):
Cash 1,575,000
Available-for-Sale Securities 620,000
Gain on Sale of Investment 955,000
To record the sale of the investment.
Key Considerations:
- If OptimisticOutcomes intends to hold the bonds to maturity, interest income would be recorded periodically (semiannually), and no fair value adjustments would be needed.
- The specific accounting treatment for fair value adjustments may depend on the accounting framework used (US GAAP vs. IFRS).
- Tax implications are not considered in this response.