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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:

Sample Solution

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.

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