Question

Fuzzy Monkey Technologies, Inc., purchased as a long-term investment $220 million of 8% bonds, dated January 1, on January 1, 2021. Management has the positive intent and ability to hold the bonds until maturity. For bonds of similar risk and maturity the market yield was 10%. The price paid for the bonds was $201 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, 2021, was $210 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, 2021 balance sheet? 5. How would Fuzzy Monkey's 2021 statement of cash flows be affected by this investment? (If more than one approach is possible, indicate the one that is most likely.)

Answer 1

To record the purchase of the bonds by Fuzzy Monkey Technologies, the Investments in Bonds account should be debited with $201 million and the Cash account should be credited with $201 million. The interest received on June 30 can be calculated using the face value ($220 million), the interest rate (8%), and the semiannual payment frequency. The market price of the bonds at December 31 can be calculated using the face value ($220 million) and the market interest rate (10%). The resulting value is $210 million.

Step-by-step explanation:

To record the purchase of the bonds, you would debit the Investments in Bonds account for $201 million and credit the Cash account for $201 million. To record the receipt of interest on June 30, you would debit the Cash account and credit the Interest Revenue account. The interest revenue can be calculated by multiplying the face value of the bonds ($220 million) by the interest rate (8%) and dividing it by 2, since interest is received semiannually. To calculate the market price of the bonds at December 31, you would multiply the face value of the bonds ($220 million) by the market interest rate (10%) and divide it by 2, since interest is received semiannually. The resulting value is $210 million.