This case illustrates how to account for available for sale financial assets.
Facts
On August 1, 2006, Entity A purchased a two year bond, which it classified as available for sale. The bond had a stated principal amount of $100,000, which Entity A will receive on August 1, 2008. The stated coupon interest rate was 10% per year, which is paid semiannually on December 31 and July 31.
The bond was purchased at a quoted annual yield of 8% on a bond equivalent yield basis.
Required
(a) What price did Entity A pay for the bond? (Hint: Compute the present value using a semiannual yield and semiannual periods.)
(b) Did Entity A purchase the bond at par, at a discount, or at a premium?
(c) Prepare the journal entry at the date Entity A purchased the bond. (Entity A paid cash to acquire the bond. Assume that no transaction costs were paid.)
(d) Prepare a bond amortization schedule for years 2006 to 2008. For each period, show cash interest receivable, recognized interest revenue, amortization of any bond discount or premium, and the carrying amount of the bond at the end of the period.
(e) Prepare the journal entries to record cash interest receivable and interest revenue on July 31,
(f) If the quoted market yield for the bond changes from 8% to 9% on December 31, 2007, should Entity A recognize an increase, a decrease, or no change in the carrying amount of the bond on that date? If you conclude that the carrying amount should change, compute the change and prepare the corresponding journal entries.