Question

(Fair Value Option) Presented below is selected information related to the financial instruments of

Dawson Company at December 31, 2017. This is Dawson Company’s first year of operations.

Carrying Fair Value

Amount (at December 31)

Investment in debt securities (intent is to hold to maturity) \( 40,000 \) 41,000

Investment in Chen Company stock 800,000 910,000

Bonds payable 220,000 195,000

Instructions

(a) Dawson elects to use the fair value option for these investments. Assuming that Dawson’s net income is $100,000 in2017 before reporting any securities gains or losses determine Dawson’s net income for 2017. Assume that the differencebetween the carrying value and fair value is due to credit deterioration.

(b) Record the journal entry, if any, necessary at December 31, 2017, to record the fair value option for the bonds payable

Short answer

a.Net income is $186,000

b.Unrealized holding gains or loss is debited by $25,000 and fair value adjustment is credited by $25,000.

Step-by-step solution

Calculation of net income

Net Income before gain or loss: $100,000

Gain on debt securities: $1,000

Gain on Chen Company stock: $110,000

Loss on bond payable: $25,000

$\begin{array}{c}\text{Net\hspace{0.17em}\hspace{0.17em}Income=\hspace{0.17em}Income\hspace{0.17em}\hspace{0.17em}before\hspace{0.17em}\hspace{0.17em}gain\hspace{0.17em}\hspace{0.17em}or\hspace{0.17em}\hspace{0.17em}losses\hspace{0.17em}Gain\hspace{0.17em}\hspace{0.17em}on\hspace{0.17em}\hspace{0.17em}debt\hspace{0.17em}\hspace{0.17em}securities+\hspace{0.17em}Gain\hspace{0.17em}\hspace{0.17em}on\hspace{0.17em}\hspace{0.17em}Chen\hspace{0.17em}\hspace{0.17em}securities\hspace{0.17em}-\hspace{0.17em}loss\hspace{0.17em}\hspace{0.17em}on\hspace{0.17em}\hspace{0.17em}bond\hspace{0.17em}\hspace{0.17em}payable}\\ =\$100,000+\$1,000+\$110,000-\$25,000\\ =\$186,000\end{array}$

Hence, the net income is $86,000

Fair value adjustment

Date	Particulars	Debit	Credit
December 31, 2017	Unrealized holding Gain or loss	$25,000
	Fair value adjustment		$25,000
	(Loss on the fair value adjustment)