[Anonymous]

NINJA Question –

Hello – for simulation 16, my answer is below. Im confused. i got a 25% and it said the only entries should have been Dr. Investment in securities, Cr. Cash, and then Dr. cash Cr. Interest Revenue and Cr. Investment. I’m very confused as I thought Bond Premium was disclosed on the balance sheet, and you would amortize accordingly. can anyone help?

Camp Co. wishes to purchase a 5-year, 12% bond with a face value of $100,000 and interest payable semiannually on January 2 and July 1. The market rate on similar bonds is 10%. Camp Co. purchases the bond at a premium for $107,720. Camp Co. has a calendar-year reporting period.

Complete the journal entries below as they relate to the bond purchase. First choose the accounts that would be affected and then fill in the numbers under debit or credit as appropriate. List debited accounts first and credited accounts second. List entries in descending order by amount. Accounts may be used once, more than once, or not at all. Although all shaded cells may not necessarily be used, an entry must be made in each cell.

To record the purchase of the bond on January 2, 20X1:

Dr. Investment in Debt Securities 100,000
Cr. Bond Premium 7,720
Cr. Cash 107,720

To record the first interest payment on July 1, 20X1:

Dr. Cash 6,000
Cr. Interest Revenue 5,386
Cr. Bond Premium Amortization 614

[Adam]

Read the questions carefully. The Corporation is buying the Bond not issuing the bond.

The investment will be carried at FMV and you'll pick up the revenue on the I/S.

[Anonymous]

I’m not sure how I haven’t put 2 and 2 together on this…so discounts/premiums are never reflecte if you purchase a bond? Only if you’re the issuer?

You mentioned “revenue”, but just to be clear, you mean income, right?

[Adam]

Correct, you purchase and carry at FMV and then the discount or premium simply increases/Decreases the amount of interest income you get.

Revenue and income are the same thing..

“In accounting, revenue is the income that a business has from its normal business activities, usually from the sale of goods and services to customers. Revenue is also referred to as sales or turnover. Some companies receive revenue from interest, royalties, or other fees.”

[Adam]

I take that back, they are carried at FMV when held for trading..HTM and AFS are at amortized cost you are correct.

So the buyer is paying a premium so more then par value and should be getting a higher rate of interest on each Qtrly payment then the stated rate of what is on the Bond..which is reflected in the interest payments. This is why the effective interest method is used to amortize bonds as it uses the Effective interest rate as opposed to stated.

I probably just confused you even more lol..

[Anonymous]

Ok,

Whole lotta misleading and incomplete info in this thread:

First off, this is the initial journal entry (debit the premium when you record it):
Dr. Bond. Inv. 100,000
Prem. Bond Inv. 7,720
Cr. Cash 107,720

Record Int. Revenue:
Dr. Cash 6,000
Cr. Int. Rev. 5386
Prem. Bond Inv. 614

Amortizing a discount acts to increases interest revenue/expense and amortizing a premium decreases them. This is important to understand because some CPA questions will ask you to determine the net effect of using the straight line method of amortizing interest versus the effective interest method.

However, in practice the investor rarely records a separate discount/premium account, but just records the investment at carrying amount and increases it or decreases it as it matures (i.e. amortizes the premium/discount). This is probably why your response was incorrect.

This is not how I learned it in Int. Acct. 2 (or how it was explained in my class text), but it is how Gleim explains it in the study outline for FAR. Hence, I think this is a gray area, and actual AICPA questions will probably dance around this issue a bit, and will just require that you know the amount of discount/premium at the end of each period and the net carrying amount. It's kinda like the gross vs. net method for leases.

Now the FASB also recently tightened up which securities get recorded as HTM, TS, or AFS. So now basically only bonds and some convertible PS (and some random others) get recorded that way. Most generic stock investments are now required to be reported as equity investments and reported at fair value automatically. Therefore you can't elect the HTM, TS, or AFS option for most investments anymore, it is basically just for debt investments now.

So anyway HTM are recorded at amortized cost and and reported on the B/S at amortized cost. TS and AFS are recorded at amortized cost but remeasured each period and reported in the B/S at fair value using a valuation account. UHG/l on TS go on the I/S and UHG/L on AFS go into OCI.

So for TS, the gain adjustment is
Dr. FVA-TS
Cr. UHG-I/S

For AFS, the gain adjustment is:
Dr. FVA-AFS
Cr. UGH-OCI

However, you also have to adjust the carrying amount separately by amortizing the premium or discount, and then that amount is netted with the fair value allowance adjustment account and presented on the B/S. When you sell the investment you then back out the FVA and UHG and record a actual gain in the I/S.

An easy way to think of premium and discount is to equate a discount with the bond being “on sale” at an outlet. The reason for this is that the market rate of interest is higher than the stated rate on the bond, so you can make more money investing in the market than in the bond, so therefore the bond should be cheaper (like last year's suits). Then just reverse this concept for a premium on a bond.

[Anonymous]

It's also important to note that TS are generally by default current assets, and HTM and AFS are usually non-current. However, I believe they can be classified differently if the company elects to do so.

Also, on the statement of cash flows TS are usually listed as cash flows from operating activities, while HTM and AFS get listed as investing. However, this can also be changed in the company elects to do so.

Finally just to confuse things further, if the company elects the FV option for any investments, then they are just reported at FV each period and from what I understand there is not a valuation account, and you just debit/credit the investment for any gain or loss directly which goes on the I/S.

This is where things get weird because the FASB now requires that you report most equity investments at FV, but you can also elect the FV option for them which doesn't seem to really change anything.

However, don't confuse these equity investments with equity investments with significant influence that use the equity method. This is a whole different issue, however you can elect the FV option for equity investments with significant influence.

[Anonymous]

I appreciate everybody's advice, but now I am just more confused. just to clarify, I am not looking for clarity on what the effective interest rate is, or how to calculate amortization. I understand the difference between HTM and TS. My question is, was I incorrect to split out the premium from the investment on the entries?. if so, why? first i was told that since its purchased, its just recognized at FMV. then i was told that's not necessarily true, but in practice it's not necessary. just because its not necessary, doesn't mean its incorrect.

[Anonymous]

@cm185203,

Go back and read my first response. I spelled it out pretty clearly I think…The point is that it is a gray area. I learned your way in my Int. Acct. 2 class, but Gleim teaches it a different way.

[Anonymous]

@benj2017 – i've read your post a couple of times, and understand/agree with everything you've said. what I still do not know is how I should answer should I get this question on the exam. would gross or net both be marked correct? in my opinion, the “correct” entry is to report gross.

[Anonymous]

@cm185203,

I don't think you'll see a question like that on the exam simply because it is not always done the same way. I think common practice is to record the investment at carrying amount without a separate discount on the investor side while the issuer records a separate discount. However, the 8th edition of the Spiceland Intermediate Accounting text records investments in bonds with a separate discount/premium. On the other hand, Gleim has issuers just recording it at initial carrying amount.

I just took FAR Thursday, and most of the Gleim and NINJA exam prep questions I saw asked for the amount of discount and amortization each year, the carrying amount, the purchase price, etc. I didn't see any MCQs with J/E's. You probably won't see a Bond SIM as it is not an topic for analysis in the FAR blueprint.

A safe bet is to assume that if you're the investor you record the investment at carrying amount, and if you are the issuer you record it at maturity amount with a separate discount. The reason I posted all the other info is that some of what @Adam posted wasn't quite complete, and the FASB has been making some changes in the last couple years.

[Anonymous]

Debt securities are part of the new gaap changes. My book is no longer valid, so I read it and kept answering my mcq wrong until I realized there were updates I could print out.
Are you using a 2017 book?

[Author]

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