Royal Inc. issued 10-year, $100,000, 10% annual interest-bearing bonds with a carrying value of $88,800 as of December 31, 2020. Royal Inc. amortizes the discount using the effective interest method. At the time the bonds were issued on June 30, 2020, Royal Inc. elected to account for the bonds using the fair value option. In prepar-ing financial statements for 2020, Royal Inc. will need to make an adjusting entry to reflect the change in the fair value of the bonds. Required:a. Assume that the fair value of the $100,000 bonds is $80,000 on December 31, 2020. The decrease in fair value is due to general interest rate changes. Record the adjusting entry on December 31, 2020. b. Assume instead that the fair value of the $100,000 bonds is $95,000 on December 31, 2020. The increase in the fair value of the bonds is due entirely to a change in the credit risk of the debt.

Royal Inc.

Journal Entries:

a. Assumed fair value on December 31, 2020 = $80,000

Debit Bonds Payable $8,800

Credit Fair Value Adjustment - Bonds Payable $8,800

To record the fair value adjustment in the carrying value of the bonds.

b. Assumed fair value on December 31, 2020 = $95,000

Debit Fair Value Adjustment - Bonds Payable $6,200

Credit Bonds Payable $6,200

To record the fair value adjustment in the carrying value of the bonds.

Explanation:

a) Data and Calculations:

Face value of bonds issued = $100,000

Carrying value as of December 31, 2020 = $88,800

Coupon interest rate = 10%

Maturity period = 10 years

a. Assumed fair value on December 31, 2020 = $80,000

Bonds Payable $8,800 Fair Value Adjustment - Bonds Payable $8,800

b. Assumed fair value on December 31, 2020 = $95,000

Fair Value Adjustment - Bonds Payable $6,200 Bonds Payable $6,200

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