Question

Fuzzy Monkey Technologies, Inc., purchased as a long-term investment $240 million of 6% bonds, dated January 1, on January 1, 2018. Management has the positive intent and ability to hold the bonds until maturity. For bonds of similar risk and maturity the market yield was 8%. The price paid for the bonds was $219 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 $230 million.

Required: 1. to 3. Prepare the relevant journal entries on the respective dates (record the interest at the effective rate).

4. At what amount will Fuzzy Monkey report its investment in the December 31, 2018, balance sheet?

5. How would Fuzzy Monkey's 2018 statement of cash flows be affected by this investment?

Answer 1

ANSWER:-

a	Date	Account Title and explanation	Debit	Credit
	January1,2018	Investment in bonds	$240,000,000
		Discount on bond investment		$21,000,000
		Cash		$219,000,000
		(to record investiment in bonds at discount)
	June 30,2018	Cash	7,200,000
		Discount on bond investment	1,560,000
		Interest Revenue		8,760,000
		(to record interest revenue, cash recieved and discount amortization)
	December,31,2018	Cash	7,200,000
		Discount on bond investment	1,622,400
		Interest Revenue		8,822,400
		(to record interest revenue ,cash recieved and discount amortization

Workings:-

Jan. 1, 2018:

Discount = Face value - Price paid = $240,000,000 - $219,000,000 = $21,000,000

June 30, 2018:

Interest revenue (interest at the effective rate) = $219,000,000 * 8%/2 = $8,760,000

Amortization of discount = Interest revenue - Cash received = $8,760,000 - ($240,000,000 * 6%/2) =$1,560,000

Carrying value of bond investment = $219,000,000 + $1,560,000 = $220,560,000

December 31, 2018:

Interest revenue (interest at the effective rate) = $220,560,000* 8%/2 = $8,822,400

Amortization of discount = Interest revenue - Cash received = $8,822,400 - ($240,000,000 * 6%/2) =$1,622,400

Carrying value of bond investment = $220,560,000 + $1,622,400= $1,622,400

Answer 4:

Face value = $240,000,000

Less, contra entry = Discount on bond investment = $21,000,000 - 1,560,000 - 1,622,400 =$17,817,600

Carrying value of bond investment = $240,000,000 - $17,817,600 = $222,182,400

Amount will Fuzzy Monkey report its investment in the December 31, 2018, balance sheet = $222,182,400

Answer 5:

Effect on 2018 statement of cash flows

Operating cash flow:

If direct method is used:

Cash inflow from interest revenue = $7,200,000 + $7,200,000 = $14,400,000

If indirect method is used = Cash inflow from interest revenue = Interest revenue - Amortization of discount = ($8,760,000 + $8,822,400 - $1,560,000 - $1,622,400) = $14,400,000

Investing cash flows:

Cash outflow from purchasing investments = $219,000,000

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