Fuzzy Monkey Technologies, Inc., purchased as a short-term investment $100 milli

Question

Fuzzy Monkey Technologies, Inc., purchased as a short-term investment $100 million of 8% bonds, dated January 1, on January 1, 2018. Management intends to include the investment in a short-term, active trading portfolio. For bonds of similar risk and maturity the market yield was 10%. The price paid for the bonds was $82 million. Interest is received semiannually on June 30 and December 31. Due to changing market conditions, the fair value of the bonds at December 31, 2018, was $90 million. Required: 1. to 3. Prepare the relevant journal entries on the respective dates (record the interest at the effective rate). 4-a. At what amount will Fuzzy Monkey report its investment in the December 31, 2018, balance sheet? 4-b. Prepare any entry necessary to achieve this reporting objective 5. How would Fuzzy Monkey's 2018 statement of cash flows be affected by this investment?

Explanation / Answer

1) Journal entries:

Investments should be recorded in books at cost.

Assuming that investments are purchased at ex interest price.

January 1, 2018

Investment in 8% bonds A/c Dr. $ 82000000

To Bank A/c $ 82000000

June 30

Receipt of interest - effective rate is 8%

Interest is calculated on face value

= 100millions×8%×6/12

= $ 4000000

Bank A/c Dr. $ 4000000

To Investments in 8% bonds A/c $ 4000000

Transfer of interest to profit and loss A/c

Interest on investments A/c Dr. $ 4000000

To profit and loss A/c $ 4000000

December 31

Same entries as above for interest.

4-a ) Since it is active trading portfolio at the end of each subsequent year investments should be adjusted to fair value as on that date. So it should report it's investments at $ 90 millions in its balance sheet as on 31st December 2018.

4-b)

Adjusting entry.

Investment in 8% bonds a/c Dr. $ 8000000

To profit and loss A/c $ 8000000

5) Since adjustments of investments to fair value not in cash flow it does not effect cash flow statement.

For purchase

Cash out flow $82000000

For interest

Cash inflow $ 80000000

Overall cash outflow will be $ 74 millions.

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