On January 1, 20X1, Mason Manufacturing borrows $500,000 and uses the money to purchase corporate bonds for investment purposes. Interest rates were quite volatile that year and so were the fair values of Mason’s bond investment (an asset) and loan (a liability):

Required:

1. Mason is required to use fair value accounting for the bond investment. Prepare the journal entry to record the investment purchase on January 1, 20X1, and the fair value adjustments required at the end of each quarter: March 31, June 30, September 30, and December 31.

2. Suppose that Mason uses conventional amortized cost accounting for the loan. The loan principal is due in five years. Ignore interest on the loan to simplify the problem. What will be the loan’s carrying value at the end of each quarter?

3. Suppose that instead Mason elects to use the GAAP fair value option permitted by FASB ASC Topic 825. All changes in the fair values of the loan are due to changes in general interest rates. What dollar impact will this change have on reported profits each quarter?

4. Which accounting approach—amortized cost or fair value—do you believe Mason should use for the loan? Why?

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Fair Value 20X1 Bond Investment Loan January 1 March 31 $500,000 450,000 $500,000 465,000 June 30 480,000 493,000 504,000 495,000 September 30 December 31 5 10,000 485,000