[jessanqi]

anyone can help this question?? I don’t understand why the defaulted interest payments are not counted for the loss??

Thank you!!!

On January 1, 2009, Darby Company purchased, at par, 500 of the $1,000 face value, 8% bonds of Clark Corporation as a long-term investment. The bonds mature on January 1, 2019, and pay interest semiannually on July 1 and January 1. Clark incurred heavy losses from operations for several years and defaulted on the July 1, 2013, and January 1, 2014, interest payments. Because of the permanent decline in market value of Clark’s bonds, Darby wrote down its investment to $400,000 at December 31, 2013. Pursuant to Clark’s plan or reorganization effected on July 1, 2014, Darby received 5,000 shares of $100 par value, 8% preferred stock of Clark in exchange for the $500,000 face value bond investment. The quoted market value of the preferred stock was $70 per share on July 1, 2014. What amount of loss should be included in the determination of Darby’s net income for 2014?

A. $0
B. $50,000
C. $100,000
D. $150,000

Explanation
The correct answer is B. This question deals with recognition of other than temporary impairment per ASC 320-10-35, Investments in Debt/Equity Securities – Overall – Subsequent Measurement. It outlines the factors to consider in determining if a security is other than temporarily impaired, which are:

a) Management has intent/ability to sell the security
b) It is more likely than not that it will be required to sell prior to an anticipated recovery
This question relates to a transaction that is “other than temporary”. For 2013, Darby would have an impairment loss of $100,000 on the bonds ($500,000 cost of the bonds – $400,000 fair market value at December 31, 2013). In 2014, the fair market value of the preferred stock received is $350,000 ($70 × 5,000 shares), which is the value that Darby should record the new investment. The journal entries to record the related held to maturity (HTM) transactions are as follows:

12/31/2013:

Dr. Impairment loss on HTM securities $100,000
Cr. Investment in Bonds
$100,000
to record impairment on Darby’s bonds

12/31/2014:

Dr. Investment in Equity Securities (Preferred Stock) $350,000
Cr. Investment in Bonds
$400,000
Dr. Impairment loss on HTM securities $50,000
to record the receipt of preferred stock in exchange for the bond investment

The question is asking for the 12/31/14 net income impact. The $100,000 loss on the bonds was written off in 2013 and the $400,000 becomes the net amortized cost basis for the bonds. The $350,000 investment in preferred stock is subtracted from the $400,000 to arrive at $50,000 of impairment loss at 12/31/14.

[CoachEmUp]

On the Balance Sheet we are listing our investments (in most cases) at Fair Value. Any interest we pay (interest expense) or interest we receive (interest income/revenue) is recorded in the period it occurs, but the interest isn't going to factor in for the value of the face of the investment.

So we have a $500,000 investment that was written down to $400,000. In the next year we exchange that asset for a $350,000 one, so we recognize a $50,000 loss.

[jessanqi]

that's is an excellent explanation!!
Thank you so much @CoachEmUp!!

[Author]

Replies