Lance Brothers Enterprises acquired $720,000 of 3% bonds, dated July 1, on July 1, 2016, as a long-term investment. Management has the positive intent and ability to hold the bonds until maturity. The market interest rate (yield) was 4% for bonds of similar risk and maturity. Lance Brothers paid $600,000 for the investment in bonds and will receive interest semiannually on June 30 and December 31. Prepare the journal entries (a) to record Lance Brothers’ investment in the bonds on July 1, 2016, and (b) to record interest on December 31, 2016, at the effective (market) rate.

A) July 1, 2016, 3% bonds are acquired as long term investment.

Dr Investment in 3% bonds 720,000

    Cr Cash 600,000

    Cr Discount on investment in 3% bonds 120,000

B) December 31, 2016, interest earned from investment in 3% bonds.

Dr Cash 10,800

Dr Discount on investment in 3% bonds 1,200

    Cr Interest revenue 12,000

Explanation:

the bonds' face value is $720,000 but since the company paid only $600,000 for them, it means that it bought them at a discount price. Therefore, the discount, $720,000 - $600,000 = $120,000, must be recorded, and later amortized.

To calculate the amount of interest revenue that will be amortized as discount on investment:

(bonds' market price x market interest rate x 1/2) - (bonds' face value x coupon rate x 1/2) = ($600,000 x 4% x 1/2) - ($720,000 x 3% x 1/2) = $12,000 - $10,800 = $1,200

88 because 4 plus 4 equals 8. 40 plus 40 equals 80. 80 plus 8 equals 88