(100 points) TankCo buys debt securities for $600 at the beginning of year 1. Effective annual interest rate on the debt at the time of purchase = 10%. Interest accrued = Amortized cost * Interest...

(100 points) TankCo buys debt securities for $600 at the beginning of year 1.
Effective annual interest rate on the debt at the time of purchase = 10%.
Interest accrued = Amortized cost * Interest rate
Cash received at the end of Year 1= 40.
If cash received is more than the interest accrued, then the excess is treated as return of principal and reduces amortized cost, i.e., the bond amortizes. If cash received is less than the interest accrued, then the deficit is added to the amortized cost, i.e., the bond accretes.
Market value at the end of Year 1 after cash has been received = $630.
Cash received at the end of Year 2 = 42.
Market value at the end of Year 2 after cash has been received = $610.
The security is sold for $600 in cash on January 2, Year 3.
Ignore interest for Year 3.
Ignore taxes.

	Year 1	Year 2	Year 3
Net income if classified as trading security
Net income if classified as available-for-sale security

Quiz 6 Answers: Equities and Investments Quiz 6 Answers: Equities and Investments 1 © Rachana and Dan Gode (dangode.com). All rights reserved. May 23, 2006. E-learning from Almaris.com Financial Assets 1. TankCo: AFSS Year Income statement impact during the year 1 $60 2 $62 3 -$40 Interest revenue for year 1= $600 x 0.1 = $60. Beginning book value + interest revenue – cash received = Ending book value Book value at the end of year 1 without the fair value adjustment = $600 + $60 – $40 = $620 Interest revenue for year 2 = $620 x 0.1 = $62 Book value at the end of year 2 without the fair value adjustment = $620 + $62 – $42= $640 Realized gain in year 3 = $600 - $640 = -$40 In case you are interested, the journal entries are as follows: Purchase securities at the beginning of year 1 A +dr -cr L -dr +cr Cash 600 Available for sale securities (AFSS) 600 OE on I/S Interest revenue for year 1 A +dr -cr L -dr +cr Available for sale securities (AFSS) 60 OE on I/S Interest revenue 60 Receive cash during year 1 A +dr -cr L -dr +cr Cash 40 Available for sale securities (AFSS) 40 OE on I/S Mark-to-market at the end of year 1 A +dr -cr L -dr +cr Fair value adjustment (AFSS) 10 E on B/S Unrealized holding gain or loss 10 Interest revenue for year 2 A +dr -cr L -dr +cr Available for sale securities (AFSS) 62 OE on I/S Interest revenue 62 Quiz 6 Answers: Equities and Investments 2 © Rachana and Dan Gode (dangode.com). All rights reserved. May 23, 2006. E-learning from Almaris.com Receive cash during year 2 A +dr -cr L -dr +cr Cash 42 Available for sale securities (AFSS) 42 OE on I/S Mark-to-market at the end of year 2: At the end of year 1, the book value without adjustment is $640 but the market value is only $610. Thus, we need a negative balance of $30 in the fair value adjustment and unrealized gain accounts. Since they had a balance of $10 at the end of year 1, we need to lower them by $40 to bring the balance at the desired level. A +dr -cr L -dr +cr Fair value adjustment (AFSS) 40 E on B/S Unrealized holding gain or loss 40 Securities are sold in year 3: Raise the fair value adjustment from its balance of -$30 to $0 by debiting it. A +dr -cr L -dr +cr Fair value adjustment (AFSS) 30 E on B/S Unrealized holding gain or loss 30 Sell the security for $600 in cash A +dr -cr L -dr +cr Cash 600 AFSS 640 OE on I/S Realized gain or loss 40