Fallen Company commonly issues long-term notes payble to its various lenders. Fa

Question

Fallen Company commonly issues long-term notes payble to its various lenders. Fallen has had a pretty good credit rating such that its effective borrowing rate is quite low (less than 8% on an annual basis). Fallen has elected to use the fair value option for the long-term notes issued to Barclay's Bank and has the following data related to the carrying and fair value for these notes.

Carrying Value Fair Value

December 31,2014 54,000 54,000

December 31,2015 44,000 42,500

December 31,2016 36,000 38,000

a. Prepare the journal entry at December 31 ( Fallen's year end) for 2014,2015,2016 to record the fair value option for these notes

b. At what amount will the note be reported on Fallen's 2015 balance sheet?

c.What is the effect of recording the fair value option on these notes on Fallen's 2016 income?

d.Assuming that general market interest rates have been stable ove the period, does the fair value data for the notes indicate that Fallen's creditwortiness has improved or declined ni 2016? Explain.

Explanation / Answer

Part A)

There will be no journal entry for the year where the carrying value of the notes payable is equal to the fair market value of such notes. It is so because, there will be no unrealized holding gain or loss on such notes payable. For year, where there is a difference in the carrying value and fair value, we will have to record the unrealized gain/loss in the books of accounts.

The journal entries are given as follows:

_________

Part B)

The note will be reported at the fair value of notes payable as on 31 December 2015. Therefore, the note will get reported at $42,500 in the Fallen's 2015 balance sheet.

_________

Part C)

Fallen's 2016 net income will get reduced by $3,500 (refer to journal entry 3) as any change in fair value will be reported as an adjustment to the net income for the respective year.

_________

Part D)

Since, the general market interest rates have been stable over the period and similar risk investment in the year 2016, the changes in fair value indicate that Fallen's creditworthiness has improved.

Date Account Titles Debit Credit December 31,2014 No Journal Entry December 31,2015 Notes Payable (44,000 – 42,500) $1,500 Unrealized Holding Gain/Loss – Net Income $1,500 December 31,2016 Unrealized Holding Gain/Loss – Net Income $3,500 Notes Payable (38,000 – 36,000 + 1,500) $3,500

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