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Chapter 14: Q19E (page 758)

Fallen Company commonly issues long-term notes payable to its various lenders. Fallen has had a pretty good credit rating such that its effective borrowing rate is quite low (less than 8% on an annual basis). Fallen has elected to use the fair value option for the long-term notes issued to Barclay鈥檚 Bank and has the following data related to the carrying and fair value for these notes. Any changes in fair value are due to changes in market rates, not credit risk.

Carrying Value

Fair Value

December 31, 2017

\(54,000

\)54,000

December 31, 2018

44,000

42,500

December 31, 2019

36,000

38,000

Instructions

(a) Prepare the journal entry at December 31 (Fallen鈥檚 year-end) for 2017, 2018, and 2019, to record the fair value option for these notes.

(b) At what amount will the note be reported on Fallen鈥檚 2018 balance sheet?

(c) What is the effect of recording the fair value option on these notes on Fallen鈥檚 2019 income?

(d) Assuming that general market interest rates have been stable over the period, does the fair value data for the notes indicate that Fallen鈥檚 creditworthiness has improved or declined in 2019? Explain.

Short Answer

Expert verified

(a) No entry needs to be passed for 31/12/2017. At the end of 2018 and 2019, unrealized holding gains/losses were $1,500 and $3,500.

(b) The fair value of $42,500.

(c) Unrealized holding loss of $3,500.

(d) Throughout 2019, Fallen's creditworthiness has increased.

Step by step solution

01

Meaning of Fair value

According to a company's financial statement, the fair value represents the estimated value of its assets and liabilities.Fair market value refers to an item's fair sale value for the buyer and seller.

02

(a) Preparing journal entry

Date

Particulars

Debit ($)

Credit ($)

31/12/2017

No entry

31/12/2018

Notes payable ($44,000鈭�$42,500)

1,500

Unrealized Holdings gain

1,500

31/12/2019

Unrealized Holdings Gain/Loss

3,500

Notes Payable($38,000鈭�$36,000+$1,500)

3,500

Notes: No entry on 31/12/2017 since carrying value = Fair value.

03

(b) Amount to be reported on Fallen’s 2018 balance sheet

The note will be reported at fair value as of Dec 31, 2018, on Fallen's balance sheet.

Hence, the note will report at $42,500

04

(c) Effect of recording the fair value option on these notes on Fallen’s 2019 income

Fallen's net income will decrease by $3,500per the 3rd journal entry since the change in fair value will be deducted from the net income.

05

Explaining whether the fair value data for the notes indicate that Fallen’s creditworthiness has improved or declined in 2019

Fallen's creditworthiness has increased throughout 2019 due to bond investors earning a greater yield than investors in investments with comparable risk. Changes in fallen credit risk should be considered when recording any gains or losses in other comprehensive income.

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Most popular questions from this chapter

E14-15 (L01,2) (Entries for Redemption and Issuance of Bonds) Jason Day Company had bonds outstanding with a maturity value of \(300,000. On April 30, 2017, when these bonds had an unamortized discount of \)10,000, they were called in at 104. To pay for these bonds, Day had issued other bonds a month earlier bearing a lower interest rate. The newly issued bonds had a life of 10 years. The new bonds were issued at 103 (face value $300,000).

Instructions

Ignoring interest, compute the gain or loss, and record this refunding transaction. (AICPA adapted)

What is off-balance sheet financing? Why might a company be interested in using off-balance sheet financing?

Presented below are two independent situations.

(a) On January 1, 2017, Robin Wright Inc. purchased land that had an assessed value of \(350,000 at the time of purchase. A \)550,000, zero-interest-bearing note due January 1, 2020, was given in exchange. There was no established exchange price for the land, nor a ready fair value for the note. The interest rate charged on a note of this type is 12%. Determine at what amount the land should be recorded at January 1, 2017, and the interest expense to be reported in 2017 related to this transaction.

(b) On January 1, 2017, Field Furniture Co. borrowed $5,000,000 (face value) from Gary Sinise Co., a major customer, through a zero-interest-bearing note due in 4 years. Because the note was zero-interest-bearing, Field Furniture agreed to sell furniture to this customer at lower than market price. A 10% rate of interest is normally charged on this type of loan. Prepare the journal entry to record this transaction and determine the amount of interest expense to report for 2017.

Determine Proper Amounts in Account Balances) Presented below are two independent situations.

(a) George Gershwin Co. sold \(2,000,000 of 10%, 10-year bonds at 104 on January 1, 2017. The bonds were dated January 1, 2017, and pay interest on July 1 and January 1. If Gershwin uses the straight-line method to amortize bond premium or discount, determine the amount of interest expense to be reported on July 1, 2017, and December 31, 2017.

(b) Ron Kenoly Inc. issued \)600,000 of 9%, 10-year bonds on June 30, 2017, for $562,500. This price provided a yield of 10% on the bonds. Interest is payable semiannually on December 31 and June 30. If Kenoly uses the effective interest method, determine the amount of interest expense to record if financial statements are issued on October 31, 2017.

(Issuance and Redemption of Bonds; Income Statement Presentation) Holiday Company issued its 9%, 25-year mortgage bonds in the principal amount of \(3,000,000 on January 2, 2003, at a discount of \)150,000, which it proceeded to amortize by charges to expense over the life of the issue on a straight-line basis. The indenture securing the issue provided that the bonds could be called for redemption in total but not in part at any time before maturity at 104% of the principal amount, but it did not provide for any sinking fund.

On December 18, 2017, the company issued its 11%, 20-year debenture bonds in the principal amount of $4,000,000 at 102, and the proceeds were used to redeem the 9%, 25-year mortgage bonds on January 2, 2018. The indenture securing the new issue did not provide for any sinking fund or for redemption before maturity.

Instructions

(a) Prepare journal entries to record the issuance of the 11% bonds and the redemption of the 9% bonds.

(b) Indicate the income statement treatment of the gain or loss from redemption and the note disclosure required.
See all solutions

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