Fallen Company commonly issues long-term notes payble to its various lenders. Fallen has had a...

Question:

Fallen Company commonly issues long-term notes payble to its various lenders. Fallen has had a pretty good credit rating such that its effective borrowing rate is quite low (less than 8% on an annual basis). Fallen has elected to use the fair value option for the long-term notes issued to Barclay's Bank and has the following data related to the carrying and fair value for these notes.

Carrying Value Fair Value
December 31,2014 54,000 54,000
December 31,2015 44,000 42,500
December 31,2016 36,000 38,000

a. Prepare the journal entry at December 31 (Fallen's year end) for 2014, 2015, and 2016 to record the fair value option for these notes.

b. At what amount will the note be reported on Fallen's 2015 balance sheet?

c. What is the effect of recording the fair value option on these notes on Fallen's 2016 income?

d. Assuming that general market interest rates have been stable ove the period, does the fair value data for the notes indicate that Fallen's credit-worthiness has improved or declined in 2016? Explain.

Long Term Notes:

Notes are debt financial instruments issued by companies to generate debt capital. The company records these notes on the balance sheet on the liability side. Company needs to pay periodic interest to the investors.

Answer and Explanation:

a.

The journal entries are given as follows:

Date Account Titles Debit Credit
December 31, 2014, No Journal Entry
December 31, 2015 Notes Payable (44,000 - 42,500) $1,500
Unrealised Holding Gain/Loss - Net Income $1,500
December 31, 2016, Unrealised Holding Gain/Loss -Net Income $3,500
Notes Payable (38,000 - 36,000 + 1,500) $3,500


b.

The note will be accounted for at the reasonable value of notes payable starting on 31 December 2015. Subsequently, the note will get detailed at $42,500 in the Fallen's 2015 asset report.


c.

Fallen's 2016 net gain will get decreased by $3,500 (allude to diary section 3) as any adjustment in reasonable value will be accounted for as an acclimation to the overall gain for the separate year.


d.

Since the general market interest rates have been steady over the period and comparable hazard investment in the year 2016, the adjustments in reasonable value demonstrate that Fallen's creditworthiness has improved.


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Long-Term Debt: Definition, Cost & Formula

from Financial Accounting: Help and Review

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