Example Exercise 1 Accounting for Debt Instruments Debt securities include notes and bonds, issued by corporations and governmental organizations. The accounting for bond investments includes recording: Purchase of bonds Interest revenue Sale of bonds Debt securities include notes and bonds, issued by corporations and governmental organizations. [CLICK] The accounting for bond investments includes recording: [CLICK] the purchase of bonds, [CLICK] interest revenue, [CLICK] and the sale of bonds.

Example Exercise 1 Purchase of Bonds The purchase of bonds is recorded by debiting an investments account for the purchase price of the bonds, including any brokerage commissions. If the bonds are purchased between interest dates, the purchase price includes accrued interest since the last payment. Assume that Homer Company purchases $18,000 of U.S. Treasury bonds at their par value on March 17, 2012, plus accrued interest for 45 days. The entry will be as follows: The purchase of bonds is recorded by debiting an investments account for the purchase price of the bonds, including any brokerage commissions. If the bonds are purchased between interest dates, the purchase price includes accrued interest since the last payment. [CLICK] Assume that Homer Company purchases $18,000 of U.S. Treasury bonds at their par value on March 17th, 2012, plus accrued interest for 45 days. The entry to record the purchase will include [CLICK] a debit to Investments─U.S. Treasury Bonds for $18,000, a debit to Interest Receivable for the accrued interest of $135 and a credit to cash for the purchase price including accrued interest.

Example Exercise 1 Interest Revenue On July 31, Homer Company receives a semiannual interest payment of $540. This amount includes the $135 of accrued interest that the company purchased with the bonds on March 17. U.S. Treasury Bonds $18,000 Interest rate x 6% Holding period (years) x ½ Interest received $ 540 Less accrued interest 135 Interest revenue $ 405 On July 31st, Homer Company receives a semiannual interest payment of $540. [CLICK] This amount includes the $135 of accrued interest that the company purchased with the bonds on March 17th. [CLICK] Homer Company has earned $405 of interest revenue since purchasing the bonds. [CLICK]

Example Exercise 1 Interest Revenue On July 31, Homer Company receives a semiannual interest payment of $540. This amount includes the $135 of accrued interest that the company purchased with the bonds on March 17. The entry includes [CLICK] a debit to Cash for $540, a credit to Interest Receivable for $135, the amount of the accrued interest, and a credit to Interest Revenue for $405.

Proceeds > book value Proceeds < book value Example Exercise 1 Sale of Bonds Proceeds > book value Gain Proceeds < book value Loss The sale of a bond investment normally results in a gain or a loss. If the proceeds from the sale exceed the book value, [CLICK] then a gain is recorded. [CLICK] If the proceeds are less than the book value, [CLICK] a loss is recorded. [CLICK]

Example Exercise 1 Sale of Bonds On January 31, 2013, Homer Company sells the Treasury bonds at 98. The sale results in a loss of $360. U.S. Treasury Bonds $18,000 Rate of sale 98% Proceeds from sale $17,640 Less book value of the bonds 18,000 Loss on sale of bonds $ (360) On January 31st, 2013, Homer Company sells the Treasury bonds at 98, which means we take the par value and multiply it by 98%. The proceeds from the sale, $17,640, [CLICK] minus the book value of the bonds [CLICK] results in a loss of $360. [CLICK]

Reported as “Other Income” on the company’s income statement Example Exercise 1 Interest Revenue On January 31, 2013, Homer Company sells the Treasury bonds at 98. The sale results in a loss of $360. The entry is as follows: The entry includes [CLICK] a debit to Cash for $17,640, the proceeds received, a debit to Loss on Sale of Investment for $360, and a credit to Investments‒U.S. Treasury Bonds for $18,000, the book value of the bond investment. The loss on the sale of bond investments [CLICK] is reported as part of other income (loss) on the company’s income statement. Reported as “Other Income” on the company’s income statement

Example Exercise 1 1 (1) Let’s look at the example exercise for Tyler Company. First, [CLICK] we need to record the journal entry for the purchase of $40,000 in 10% bonds purchased at 100 plus accrued interest of $320. The entry includes [CLICK] a debit to Investments─Tyler Company Bonds for $40,000, a debit to Interest Receivable for $320, the amount of the accrued interest, and a credit to Cash for $40,320, the amount paid for the purchase.

Example Exercise 1 1 (2) For part (2), we need to record the journal entry for the first semiannual interest payment. The entry includes [CLICK] a debit to Cash for $2,000, the amount of the interest payment, a credit to Interest Receivable for $320, the amount of the accrued interest, and a credit to Interest Revenue for $1,680, the amount of the interest earned since the purchase of the bonds.

Example Exercise 1 (3) 1 Investment in Bonds $30,000 Rate of sale 102% Proceeds from sale $30,710 Less book value of the bonds 30,000 Gain on sale of bonds $ 710 For part (3),[CLICK] we need to record the journal entry for the sale of $30,000 of bonds at 102 plus accrued interest of $110. The proceeds from the sale, $30,710 [CLICK] minus the book value of the bonds [CLICK] results in a gain of $710. [CLICK]. The entry includes [CLICK] a debit to Cash for $30,710, the proceeds received, a credit to Interest Revenue for $110, the amount of the accrued interest and a credit to Gain on Sale of Investments for $600, and a credit to Investment─Tyler Company Bonds for the carrying value of the bonds.

Example Exercise 1  For Practice: PE 1A, PE 1B 1 1A, 1B Refer to Practice Exercises PE 1A and PE 1B to practice on bond transactions.  For Practice: PE 1A, PE 1B