16- Early retirement of bonds

Retiring bonds early: main issue?

When debt is retired before it matures, interest rates may have changed since the debt was issued. The result is that the firm must pay an amount reflecting the new market rate of interest to retire the debt. This amount may be more or less than the book value of the debt, which still reflects the market rate of interest at date of issue. The accounting issue here is the computation and classification of the gain or loss on retirement of debt.

Gain on early retirement?

when the market value of the cash, other asset, or debt instrument used to retire the original debt is less than the book value of the original debt less unamortized debt issue costs. (Unamortized debt issue costs reduce the gain.) Gain = debt book value − unamortized debt issue costs − cash paid

Accounting for early retirement of bonds: 3 steps?

1. Record interest and amortization of discount or premium, and amortization of debt issue costs, to the date of extinguishment. Accrued interest from the most recent interest payment date will be included in the proceeds. 2. Remove the related debt accounts at their remaining amounts (face value, unamortized discount or premium, and any unamortized debt issue costs). 3. Record the gain or loss. Unless the gain or loss is both unusual and infrequent, it is classified as an ordinary gain or loss.

Loss on early retirement?

A loss occurs when the market value of the cash, other asset, or debt instrument used to retire the original debt is more than the book value of the original debt less unamortized debt issue costs. (Unamortized debt issue costs increase the loss.) Loss = cash paid − debt book value + unamortized debt issue costs

Net book value /net carrying amount in determining gain/loss?

Book value-unamortized bond issue costs (gain) Book value+unamortized bond issue costs (loss)

How to determine carrying value of a bond when given remaining payments?

Can only be calculated if effective interest method is used: CV=PV remaining payments at original yield rate

Calculation of unamortized bond costs and remaining unamortized discount/premium for final early retirement entry?

Find out how many months remain to be amortized on the bond and use that to calculated remaining balances. This should happen after first making the entry to amortize these items up to the date of retirement.

Effect on gains/losses when interest rates have increased since debt was issued? Decreased

If the interest rate increases, market price of the debt security decreases (interest rates and debt prices are inversely related). The price the firm will have to pay to retire the debt thus declines below book value, resulting in a gain. Conversely, when interest rates have declined, the market price of the debt security increases causing a loss on early retirement.

Cash paid for early retirement?

Price of the bond at the retirement date