Garfield Company purchased $80,000 of 9%, 5-year bonds of Chester Corporation fo

ID: 2462398 • Letter: G

Question

Garfield Company purchased $80,000 of 9%, 5-year bonds of Chester Corporation for $74,086, which provide an 11% return. It intends to hold these bonds to maturity. The fair market value of the securities at year-end is $75,500.

Assuming that the bonds are considered held-to-maturity investments, prepare the journal entries for:

a) The purchase of the investment

b) The receipt of annual interest and discount amortization (assume effective interest method is used)

c) The fair market value adjustment at year-end (if necessary)

Explanation / Answer

Sl. No.

Account Titles and Explanation

Debit

Credit

Investment in 5 – year Bonds of Chester Corporation A/c Dr.

$80,000

To Cash A/c

$74,086

To Discount on Bonds A/c

$ 5,914

(Purchased bonds at discount)

Interest Receivable A/c Dr.

$7,200

Discount on Bonds A/c Dr.

$ 949.46

To Interest Income A/c

$8,149.46

(Record annual interest and Discount amortization)

No Entry

When the bonds are held-to-maturity, there will be no adjustment needed for the fair market value.

Workings:

b) Interest Income receivable = $80,000 * 9% = $7,200

Carrying amount of Interest = $74,086

Effective Interest rate = 11%

Interest income = $74,086 * 11% = $8,149.46

Difference is the discount amortization = $8,149.46 - $7,200 = $949.46

The carrying amount of investment will increase after discount on bonds is amortized. Next year Interest income will be calculated on the new carrying amount and accordingly discount will be amortized.