On January 1, 2021, Surge Ltd. issued bonds with a maturity value of $6 million at 104 when the market rate of interest was 4.5%. The bonds have a contractual interest rate of 5% and mature on January 1, 2031. Interest on the bonds is payable semi-annually on July 1 and January 1 of each year. On January 1, 2021, Treasury Ltd., a private company, purchased Surge Ltd. bonds with a maturity value of $2 million to earn interest. Treasury Ltd. will account for the investment at amortized cost using the effective-interest method to amortize the premium or discount. On December 31, 2021, the bonds were trading at 103. Both companies’ year end is December 31.

Instructions

a. What amount did Treasury Ltd. pay for Surge Ltd.’s bonds?

b. Prepare the journal entry for Treasury Ltd. (investor) on January 1, 2021.

c. Prepare a bond amortization schedule for Treasury Ltd. for the first four interest periods.

d. Prepare the journal entries for Treasury Ltd. to record the receipt of interest on July 1, 2021, the accrual of interest on December 31, 2021, and the receipt of interest on January 1, 2022. Show how the bonds and related income statement accounts would be presented in Treasury Ltd.’s financial statements for the year ended December 31, 2021.

e. Prepare the journal entry for Surge Ltd. (investee) on January 1, 2021.

f. Prepare the journal entries for Surge Ltd. to record the payment of interest on July 1, 2021, the accrual of interest on December 31, 2021, and the payment of interest on January 1, 2022, assuming the company uses the effective-interest method to amortize any premium or discount.

g. Show how the bonds and related income statement accounts would be presented in Surge Ltd.’s financial statements for the year ended December 31, 2021.

Taking It Further

Did the market interest rate on the bonds increase or decrease between January 1, 2021, and December 31, 2021? Will Treasury Ltd. want the market interest rate on the bonds to increase or decrease if it holds the bonds to earn interest? Explain.