Debt Retirement Examples
Comprehensive Example of Bond Retirement
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What amount of bond issue costs are removed from the accounts upon early retirement of 30% of a bond issue?
Thirty percent of the unamortized bond issue cost account at the date of retirement.
On June 30, 2000, King Co. had outstanding 9%, $5,000,000 face value bonds maturing on June 30, 2005. Interest was payable semi-annually every June 30 and December 31. On June 30, 2000, after amortization was recorded for the period, the unamortized bond premium and bond issue costs were $30,000 and $50,000, respectively. On that date, King acquired all its outstanding bonds on the open market at 98 and retired them. On redemption of the bonds at June 30, 2000, what amount should King recognize as gain before income taxes?
A journal entry illustrates the calculation: Dr:Bonds payable 5,000,000 Dr:Bond premium 30,000 Cr:Bond issue costs 50,000 Cr:Cash .98($5,000,000) 4,900,000 Cr:Gain 80,000 The unamortized bond issue costs reduce the gain because they are an asset that has no further benefit. The write-off simply reduces the gain. Had there been a net loss, the removal of the bond issue costs would have increased that loss.
On July 31, 2005, Dome Co. issued $1,000,000 of 10%, 15-year bonds at par and used a portion of the proceeds to call its 600 outstanding 11%, $1,000 face-value bonds, due on July 31, 2015, at 102. On that date, the unamortized bond premium relating to the 11% bonds was $65,000. In its 2005 income statement, what amount should Dome report as a gain or loss, before income taxes, from the retirement of the bonds?
Book value of bonds retired $600,000 + $65,000 $ 665,000 Less total market value of bonds retired 600($1,000)(1.02) (612,000) Equals gain on retirement $ 53,000 The unamortized premium is a component of the book value at retirement. A premium increases the net book value of the bonds because more was paid in than the face value when the bonds were originally issued. When a liability is retired for less than its book value, a gain is recorded because the firm reduces its liabilities more than the reduction in its cash or other assets used for retirement.
How is the gain on early retirement of bonds computed?
Book value of bonds retired less cash paid to retire bonds less unamortized bond issue costs.
How is the loss on the early retirement of bonds computed?
Cash paid less book value of bonds retired plus unamortized bond issue costs.
Exam Note
Exam Note -- The CPA exam has previously asked the following type of question in relation to an early retirement of bonds: "In computing the gain or loss on the above bond retirement, the price paid for the bonds is compared to which of the following values?" This question refers to the computation of the gain or loss. The loss in the above example is the difference between the cash paid to retire the debt and the book value of the debt retired less the unamortized bond issue costs on the portion of the debt retired: Cash paid to retire debt $5,820 Book value of debt retired 6,000 - 286 = 5,714 Less unamortized bond issue costs (216) (5,498) Equals loss 322 The answer to the question is $5,498.
More Involved Example of Bond Retirement
Example: $10,000 of bonds were issued 5/1/Year 1 at 91. The bonds mature 12/31/Year 6. The straight-line method is used. Bond issue costs of $680 were incurred on issue. The bonds pay interest each December 31. On 1/1/Year 4, 60% of the issue was retired at 97. The bond term is 5 years and 8 months, or 68 months. The bonds are retired when 3 years or 36 months remain in the bond term. The original discount was $900 (.09 x $10,000). Entry for retirement: Dr:Bonds Payable .60($10,000) 6,000 Dr:Loss 322 Cr:Bond Discount .60($900)(36/68) 286 Cr:Bond Issue Costs .60($680)(36/68) 216 Cr:Cash .97(.60)($10,000) 5,820
Describe the journal entry recorded before the entry to remove relevant bond accounts in an early retirement?
Record interest expense, amortization of discount or premium, and amortization of bond issue costs for the period between the previous interest payment date (or fiscal-year end, if later), and the date of retirement.
On January 1, 2005, Hart, Inc. redeemed its 15-year bonds of $500,000 par value for 102. They were originally issued on January 1, 1993 at 98 with a maturity date of January 1, 2008. The bond issue costs relating to this transaction were $20,000. Hart amortizes discounts, premiums, and bond issue costs using the straight-line method. What amount of loss should Hart recognize on the redemption of these bonds?
The journal entry for retirement: Bonds payable 500,000 Loss 16,000 Bond Discount 2,000 .02($500,000)(3/15) Bond Issue Costs 4,000 $20,000(3/15) Cash 510,000 $500,000(1.02) The bond term is 15 years. Retirement is 3 years before maturity. Therefore, under the straight-line method, 3/15 of both the total bond discount and bond issue costs would remain unamortized at the retirement date. These amounts are removed along with the face value of the bonds (bonds payable account). The original discount was 2% of $500,000. The bond issue costs are removed because they no longer have any future benefit. The bond issue has been retired.
On June 30, 2005, Town Co. had outstanding 8%, $2,000,000 face amount, 15-year bonds that matured on June 30, 2015. Interest is payable on June 30 and December 31. The unamortized balances in the bond discount and deferred bond issue costs accounts on June 30, 2005 were $70,000 and $20,000, respectively. On June 30, 2005, Town acquired all these bonds at 94 and retired them. What net carrying amount should be used in computing gain or loss on this early extinguishment of debt?
The journal entry for retirement: Dr:Bonds payable 2,000,000 Cr:Bond discount 70,000 Cr:Bond issue costs 20,000 Cr:Cash .94($2,000,000) 1,880,000 Cr:Gain 30,000 The gain is the difference between (1) the net bond liability less the unamortized bond issue costs and (2) the amount paid to retire the bonds: Net bond liability: $2,000,000 - $70,000 $1,930,000 Less unamortized bond issue costs (20,000) Net carrying amount to use in computing gain or loss $1,910,000 Less amount paid to retire bonds (1,880,000) Gain $30,000 The correct answer is $1,910,000.
On January 1, 2000, Fox Corp. issued 1,000 of its 10%, $1,000 bonds for $1,040,000. These bonds were to mature on January 1, 2010 but were callable at 101 any time after December 31, 2003. Interest was payable semi-annually on July 1 and January 1. On July 1, 2005, Fox called all of the bonds and retired them. The bond premium was amortized on a straight-line basis. Before income taxes, Fox's gain or loss in 2005 on this early extinguishment of debt was
The portion of the bond term that remains is 4 1/2 years as of July 1, 2005, because the bonds have been outstanding for 5 1/2 years as of that date. Therefore, the book value of the bonds on July 1, 2005 equals the face value of the bonds ($1,000,000) plus the unamortized bond premium of $18,000 = (4.5/10)$40,000, for a total of $1,018,000. The gain on the bond extinguishment is the difference between the book value and the amount paid to extinguish the bonds: $1,018,000 - 1.01($1,000,000) = $8,000. The gain results because it cost Fox less to retire the bonds than the book value of the bonds.
On June 2, 2000, Tory, Inc. issued $500,000 of 10%, 15-year bonds at par. Interest is payable semiannually on June 1 and December 1. Bond issue costs were $6,000. On June 2, 2005, Tory retired half of the bonds at 98. What is the net amount that Tory should use in computing the gain or loss on the retirement of debt?
The question asks for the book value amount to be compared to the price paid for the bonds retired when the gain or loss on retirement is computed. The net book value includes the unamortized bond issue costs. The amount of unamortized issue costs relating to the portion of the bond issue retired increases the loss or decreases the gain because it represents the value of an asset that can provide no further benefit. The remaining portion of the bond term for the portion of the bond issue retired is the period for which the bond issue costs can no longer provide benefit. Number of semiannual periods in bond term: 15(2) = 30 Number of semiannual periods remaining at 6/2/05 = 10(2) = 20 Remaining unamortized bond issue costs: $6,000(20/30) = $4,000 Net amount to compare to price paid for bonds, to determine gain or loss on retirement, on one-half the bond issue: (1/2)($500,000 - $4,000) = $248,000. A journal entry recording the retirement of one-half the issue helps show why $248,000 is the correct answer. Dr:Bonds payable 250,000 Cr:Bond issue costs 2,000 Cr:Cash .98($250,000) 245,000 Cr:Gain 3,000 The gain equals the net value of two accounts removed from the books ($248,000) less the amount paid to retire the bonds.
What is the interest rate used to recognize interest expense before early retirement of a bond issued?
The yield rate on the date of issuance.
What is the interest rate used to determine the price of a bond issue to be retired early in an open-market purchase?
The yield rate on the date of retirement.
