Chapter 17: Debt Investments

Question 1

What are the three categories of debt investments?

Answer 1

Held to maturity.
Trading.
Available for sale.

Question 2

How do you value held-to-maturity debt investments?

Answer 2

Amortized Cost

Question 3

How do you recognize unrealized holding gains or losses on held-to-maturity debt investments?

Answer 3

Not recognized

Question 4

How do you recognize interest from held-to-maturity debt investments?

Answer 4

Interest Income

Question 5

How do you recognize the effects of a sale from held-to-maturity debt investments?

Answer 5

Gain and losses from sale

Question 6

How do you value “trading securities” debt investments?

Answer 6

Fair Value

Question 7

How do you recognize unrealized holding gains or losses on “trading securities” debt investments?

Answer 7

Net Income

Question 8

How do you recognize interest from “trading securities” debt investments?

Answer 8

Interest Income

Question 9

How do you recognize the effects of a sale from “trading securities” debt investments?

Answer 9

Gain and losses from sale

Question 10

How do you value “available for sale” debt investments?

Answer 10

Fair Value

Question 11

How do you recognize unrealized holding gains or losses on “available for sale” debt investments?

Answer 11

Recognized as other comprehensive income and a separate line item in stockholders’ equity

Question 12

How do you recognize interest from “available for sale” debt investments?

Answer 12

Interest Income

Question 13

How do you recognize the effects of a sale from “available for sale” debt investments?

Answer 13

Gain and losses from sale

Question 14

—————— Background Information —————

Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222.

The bonds mature January 1, 2026 and yield 8%. Broomsticks has the ability and intent to hold these bonds to maturity and so chooses to report these bonds as held-to-maturity securities.

—————— Question —————

How does Broomsticks record the investment?

Answer 14

Dr. Debt Investments 216,222

Cr. Cash 216,222

Question 15

—————— Background Information —————

Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222.

The bonds mature January 1, 2026 and yield 8%. Broomsticks has the ability and intent to hold these bonds to maturity and so chooses to report these bonds as held-to-maturity securities.

—————— Question —————

How does Broomsticks record the receipt of the first coupon on July 1, 2021?

Answer 15

Dr. Cash 10,000
Cr. Interest Revenue 8,649
Cr. Debt Investments 1,351
Cash = coupon payment received = (10% / 2) * 200,000
Interest revenue = 216,222 * (8% / 2)
Debt investments = plug to amortize investment

Question 16

—————— Background Information —————

Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222.

The bonds mature January 1, 2026 and yield 8%. Broomsticks has the ability and intent to hold these bonds to maturity and so chooses to report these bonds as held-to-maturity securities.

—————— Question —————

Broomsticks closes its books on December 31, 2021, the day before the second coupon is received.

Does Broomsticks need to make any adjusting journal entries when the books are closed? If so, what is the journal entry?

Answer 16

Yes, Broomsticks needs to accrue interest and amortize the premium at year end.

Dr. Interest Receivable 10,000
Cr. Interest Revenue 8,595
Cr. Debt Investments 1,405
Interest revenue = (216,222 – 8649) * (8% / 2)

Question 17

—————— Background Information —————
Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222. The bonds mature January 1, 2026 and yield 8%. Broomsticks chooses to report these bonds as available-for-sale securities.

—————— Question —————
How does Broomsticks record the investment?

Answer 17

Dr. Debt Investments 216,222

Cr. Cash 216,222

Question 18

—————— Background Information —————
Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222. The bonds mature January 1, 2026 and yield 8%. Broomsticks chooses to report these bonds as available-for-sale securities.

—————— Question —————
How does Broomsticks record the receipt of the first coupon on July 1, 2021?

Answer 18

Dr. Cash 10,000
Cr. Interest Revenue 8,649
Cr. Debt Investments 1,351

Cash = coupon payment received = (10% / 2) * 200,000
Interest revenue = 216,222 * (8% / 2)
Debt investments = plug to amortize investment

Question 19

—————— Background Information —————
Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222. The bonds mature January 1, 2026 and yield 8%. Broomsticks chooses to report these bonds as available-for-sale securities.

—————— Question —————
Broomsticks closes its books on December 31, 2021, the day before the second coupon is
received.

Does Broomsticks need to make any adjusting journal entries when the books are closed?

If so, what is the journal entries?

Answer 19

Yes, Broomsticks needs to accrue interest and amortize the premium at year end.

Dr. Interest Receivable 10,000
Cr. Interest Revenue 8,595
Cr. Debt Investments 1,405
Interest revenue = (216,222 – 1,351) * (8% / 2)

Question 20

—————— Background Information —————
Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222. The bonds mature January 1, 2026 and yield 8%. Broomsticks chooses to report these bonds as available-for-sale securities.

—————— Question —————

Another entry that needs to be made when the books are closed is the journal entry to apply the fair value method to the debt investment. The carrying amount of the investment at year-end is $213,466 (216,222 – 1,351 – 1,405). Assume year-end fair value of the bond is
$215,000.

What journal entry is required?

Answer 20

The fair value of the asset is 1,534 larger than the carrying value. Therefore, Broomsticks has an
unrealized gain to report.

Dr. Fair Value Adjustment 1,534
Cr. Unrealized Holding Gain or Loss (SE) 1,534

Question 21

—————— Background Information —————
Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222. The bonds mature January 1, 2026 and yield 8%. Broomsticks chooses to report these bonds as available-for-sale securities.

—————— Question —————

Broomsticks Company has held the bonds of Warts Corporation for several years. The amortized cost of the bonds is $205,550 when Broomsticks sells the bonds for $208,000 mid-year.

The fair value at the end of the prior year, when the last fair-value adjustment was made, was $207,000. What journal entry is made at the time of the sale? What other
journal entries are made?

Answer 21

At time of sale, Broomsticks records the sale as:
Dr. Cash 208,000
Cr. Debt Investments 205,550
Cr. Gain on Sale of Investments 2,450

At year end, Broomsticks will look at its fair value adjustment account relative to all securities adjusted to fair value.

Question 22

—————— Background Information —————
Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222. The bonds mature January 1, 2026 and yield 8%. Broomsticks chooses to report these bonds as trading securities.

—————— Question —————
How does Broomsticks record the investment?

Answer 22

Dr. Debt Investments 216,222

Cr. Cash 216,222

Question 23

—————— Background Information —————
Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222. The bonds mature January 1, 2026 and yield 8%. Broomsticks chooses to report these bonds as trading securities.

—————— Question —————
How does Broomsticks record the receipt of the first coupon on July 1, 2021?

Answer 23

Dr. Cash 10,000
Cr. Interest Revenue 8,649
Cr. Debt Investments 1,351
Cash = coupon payment received = (10% / 2) * 200,000
Interest revenue = 216,222 * (8% / 2)
Debt investments = plug to amortize investment

Question 24

—————— Background Information —————
Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222. The bonds mature January 1, 2026 and yield 8%. Broomsticks chooses to report these bonds as trading securities.

—————— Question —————

Broomsticks closes its books on December 31, 2021, the day before the second coupon is received.

Does Broomsticks need to make any adjusting journal entries when the books are closed? If so, what is the journal entries?

Answer 24

Yes, Broomsticks needs to accrue interest and amortize the premium at year end.

Dr. Interest Receivable 10,000
Cr. Interest Revenue 8,595
Cr. Debt Investments 1,405
Interest revenue = (216,222 – 1,351) * (8% / 2)

Question 25

—————— Background Information —————
Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222. The bonds mature January 1, 2026 and yield 8%. Broomsticks chooses to report these bonds as trading securities.

—————— Question —————
Another entry that needs to be made when the books are closed is the journal entry to apply the fair value method to the debt investment.

The carrying amount of the investment at year-end is $213,466 (216,222 – 1,351 – 1,405). Assume year-end fair value of the bond is $215,000.

What journal entry is required?

Answer 25

The fair value of the asset is 1,534 larger than the carrying value.

Therefore, Broomsticks has an
unrealized gain to report.

Dr. Fair Value Adjustment 1,534
Cr. Unrealized Holding Gain or Loss (I/S) 1,534

Question 26

—————— Background Information —————
Broomsticks Company purchased $200,000 of 10% semi-annual bonds of Warts Corporation on January 1, 2021, paying $216,222. The bonds mature January 1, 2026 and yield 8%. Broomsticks chooses to report these bonds as trading securities.

—————— Question —————
Broomsticks Company has held the bonds of Warts Corporation for several years. The amortized cost of the bonds is $205,550 when Broomsticks sells the bonds for $208,000 midyear.

The fair value at the end of the prior year, when the last fair-value adjustment was made, was $207,000.

What journal entry is made at the time of the sale? What other journal entries are made?

Answer 26

At time of sale, Broomsticks records the sale as:
Dr. Cash 208,000
Cr. Debt Investments 205,550
Cr. Gain on Sale of Investments 2,450

At year end, Broomsticks will look at its fair value adjustment account relative to all securities
adjusted to fair value.