Question - Temple Co., Ltd. determines that it should expand its investment portfolio. It determines that the convertible debentures issued by Debt Co., Inc. are providing an above average market return. However, its CFO also determined that it will have insufficient cash during the first quarter of 2015 to facilitate a bond purchase in the amount of $750,000. Fortunately, their bank has agreed to loan the entire amount on an interest only basis with a balloon payment due in 24 months. Both transactions occur on January 2. Interest rates during the period proved to be quite volatile. The fair values for both the bond investment and the interest only debt were as follows:
FAIR VALUE
Bond Investment Loan
January 2 $750,000 $750,000
March 31 850,000 800,000
June 30 700,000 765,000
September 30 725,000 745,000
Required:
1) Temple Co. reports this transaction under the fair value accounting rules. What is the journal entry on January 2 to record the purchase of the bonds and the note to the bank?
2) What journal entry would be required on June 30 to reflect the price adjustments to the investment and the debt from the first quarter of 2015?
3) What would be the carrying value of the debt on September 30 if Temple elected to report using conventional amortized cost accounting principles?
4) If Temple elected to use ASC 825 (Fair Value Option) to reflect the debt, what would be the cumulative impact on their income statement for the quarter ending September 30?
5) Explain the difference between the amortized cost approach and the fair value approach in valuing the debt. Support your position.