Lessons on Accounting Theory by Alexandra Keleti

Alexandra Keleti

November 6, 2021

As Alexandra Keleti wraps up her Fall semester in the Masters of Accounting program at KU, she thought she would help a few budding accountants learn about Accounting Theory. Today’s topic is investments. 

Investments

Investments include debt investments and equity investments. The three types of debt investments are available-for-sale, trading, and held-to-maturity. Whether the investment can reach its full maturity value and if the investor intends to hold it until it reaches maturity determines what classification the investment is under.  

Available-for-sale and trading debt investments are recorded at fair value. However, trading securities recognized unrealized holding gains and losses in net income, while Available-for-sale securities recognize unrealized holding gains and losses as other comprehensive income and as a separate component of stockholder’s equity.  

Held-to-maturity investments are recorded at amortized cost, not fair value. Unrealized Holding Gains or Losses are not recognized.  

Held-to-Maturity Example

Hon company purchased 12% Held-to-Maturity bonds with a maturity value of $300,000.00 for $322,744.44. The bonds provide the bondholders with a 10%  yield. The start date is January 1st, 2020 and the maturity date is January 1st, 2025. Use the effective interest method to allocate unamortized discount/premium.  

What is the Journal Entry for the bond purchase? 

Debt Investment              322,744 

Cash  322,744 

Prepare a bond amortization schedule. 

Date Cash received Interest Revenue Premium Amortized Carrying Value 
1/1/20    322,744 
1/1/21 36,000 32,274.44 3,725.56 319,018.88 
1/1/22 36,000 31,901.89 4,098.11 314,920.77 
1/1/23 36,000 31,492.88 4,507.92 310,412.85 
1/1/24 36,000 31,041.29 4,958.71 305,454.14 
1/1/25 36,000 30,545.86 5,454.14 300,000 

Prepare a Journal Entry to record interest revenue and amortization on December 31st, 2020. 

Interest Receivable  36000 

Debt Investments 3725.56

Interest Revenue  32274.44 

Prepare a Journal Entry for interest revenue and amortization on December 31st, 2021 

Interest Receivable  36000 

Debt Investments  4098.11 

Interest Revenue  31901.89 

Available-for-Sale Example 

Suppose that the Nick Corp. made an investment of $10,000,000 in 5% fixed-rate corporate bonds. These Available-for-Sale bonds were purchased at par. At year end, the market rates decline and the fair value of the bonds is $10,600,000. Interest is paid at the beginning of the year.  

Record transactions related to the bonds in 2020 without electing to use the fair value method.  

January 1st, 2020 

Debt Investment 10,000,000

Cash 10,000,000 

December 31st, 2020 

Interest Receivable  500,000 

Interest Revenue  500,000 

Fair Value Adjustment 600,000 

Unrealized Holding G/L – Equity 600,000 

Record these transactions by electing to use the Fair Value Method.

January 1st, 2020 

Debt Investments 10,000,000 

Cash 10,000,000 

December 31st, 2020 

Interest Receivable  500,000 

Interest Revenue  500,000 

Debt Investment 600,000 

Unrealized Holding G/L – Income 600,000