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Each of the following situations allows for the extinguishment of the liability on a bond issuer's books except: A. An in-substance defeasance, which allows the bonds to be placed in an irrevocable trust. B. When the bond is paid off at maturity at par. C. When the bond is paid off prior to maturity and a gain or loss is booked. D. The legal release of a debtor by judicial decree.

Choice "A" is correct. An in-substance defeasance does not extinguish the liability itself; it merely "freezes" the payments of principal and interest until a later time. The debtor is still the primary obligor, so the liability remains on the debtor's books.

A company issues $1,500,000 of par bonds at 98 on January 1, Year 1, with a maturity date of December 31, Year 30. Bond issuance costs are $90,000, and the stated interest rate of the bonds is 6 percent. Interest is paid semiannually on January 1 and July 1. Ten years after the issue date, the entire issue was called at 102 and canceled. The company uses the straight-line method of amortization for bond discounts and issuance costs, and the result of this method is not materially different from the effective interest method. The company should classify what amount as the loss on extinguishment of debt at the time the bonds are called? A. $110,000 B. $30,000 C. $90,000 D. $50,000

Choice "A" is correct. The gain/loss on extinguishment is equal to the difference between the reacquisition price and the net carrying amount. Reacquisition price: $1,500,000 × 102% = $1,530,000 Carrying value: Face 1,500,000 Less: Unamortized discount (20,000) Less: Unamortized bond issuance cost (60,000) = Net carrying value 1,420,000 Total loss on extinguishment: $1,530,000 - $1,420,000 = $110,000 Note: The original discount is $30,000 [$1,500,000 - ($1,500,000 × 98%)]. The bond was retired 10 years into a 30-year issue, so two thirds (or $20,000) of the original discount has not been amortized yet. The original bond issuance cost of $90,000 is amortized over the full 30 years. Through 10 years, $30,000 (or one third) has been amortized and $60,000 (or two thirds) remains unamortized.

The following information pertains to the transfer of real estate pursuant to a troubled debt restructuring by Knob Co. to Mene Corp. in full liquidation of Knob's liability to Mene: Carrying amount of liability liquidated 150,000 Carrying amount of real estate transferred 100,000 Fair value of real estate transferred 90,000 What amount should Knob report as a pretax gain (loss) on restructuring of payables under U.S. GAAP? A. $60,000 B. ($10,000) C. $50,000 D. $0

Choice "A" is correct. When assets are transferred in a troubled debt restructuring, the asset (real estate) is adjusted to fair value and an ordinary gain or loss recorded. Then, the gain or loss on restructuring is recorded as the difference between the debt and fair value of asset transferred. Liability 150,000 Fair value of real estate (90,000) = Gain 60,000

During Year 2, Colt Co. experienced financial difficulties and is likely to default on a $1,000,000, 15%, 3-year note dated January 1, Year 1, payable to Cain National Bank. On December 31, Year 2, the bank agreed to settle the note and unpaid Year 2 interest of $150,000 for $820,000 cash payable on January 31, Year 3. What is the amount of gain, before income taxes, from the debt restructuring? A. $330,000 B. $0 C. $180,000 D. $150,000

Choice "A" is correct. $330,000. The amount of the gain, before taxes, is calculated as follows: Principal 1,000,000 + Interest accrued 150,000 = Net carrying amount 1,150,000 Settlement price - cash (820,000) = Gain from debt restructuring, before tax 330,000

On July 31, Year 1, Dome Co. issued $1,000,000 of 10 percent, 15-year bonds at par and (as a typical risk-management strategy to Dome Co.) used a portion of the proceeds to call its 600 outstanding 11 percent, $1,000 face value bonds, due on July 31, Year 11, at 102. On that date, unamortized bond premium relating to the 11 percent bonds was $65,000. In its Year 1 income statement, what amount should Dome report as gain or loss from retirement of bonds? A. $(77,000) loss B. $53,000 gain C. $(65,000) loss D. $0

Choice "B" is correct. A gain of $53,000 is recognized because the $665,000 book value of the debt ($600,000 face value plus $65,000 unamortized premium) is settled for $612,000 ($600,000 at 102). There is no accrued interest because the redemption takes place on an interest date. The proceeds from the new bond issuance are not relevant. Note that the gain is reported as part of continuing operations because the transaction is a typical risk-management strategy of the company.

A bond is issued at a premium and redeemed at a discount to par. Any gain or loss as a result of extinguishment prior to maturity will be booked as a: A. Loss in retained earnings as an accounting adjustment. B. Gain in income from continuing operations. C. Gain in retained earnings as an accounting adjustment. D. Loss in income from continuing operations.

Choice "B" is correct. If a bond is issued above par and redeemed below par, this will result in a gain, which the issuer will book in income from continuing operations. The issuer is effectively paying less than par to remove a liability that is on the books at a price above par.

The following information pertains to the transfer of real estate pursuant to a troubled debt restructuring by Knob Co. to Mene Corp. in full liquidation of Knob's liability to Mene: Carrying amount of liability liquidated 150,000 Carrying amount of real estate transferred 100,000 Fair value of real estate transferred 90,000 What amount should Knob report as gain (loss) on transfer of real estate? A. $60,000 B. ($10,000) C. $50,000 D. $0

Choice "B" is correct. When assets are transferred in a troubled debt restructuring, the asset (real estate) is adjusted to fair value and a gain or loss is recorded. Carrying amount 100,000 Fair value of real estate (90,000) = Loss 10,000

Embrin Inc. issued a 10-year, $1,000,000 bond at a discount price of $945,000. The company incurred bond issuance costs of $25,000, which are amortized straight-line over 10 years. Three years after issuance, the company redeemed the issue at 102. At the time the issue was redeemed, $12,500 of the discount had been amortized. Under U.S. GAAP, which of the following components of the loss booked by the company when the issue is redeemed is correct? A. Amortization of the discount of $12,500 B. Discount of $55,000 C. Premium paid to retire of $20,000 D. Bond issuance costs of $25,000

Choice "C" is correct. The company will book a loss when the bond is redeemed because the carrying value for a discount bond is always below par prior to maturity and the company paid a premium above par to redeem the issue. The components of the $80,000 total loss are as follows: Unamortized discount $42,500 (Original discount of $55,000 - Amortized amount of $12,500) Unamortized bond issuance costs $17,500 (Original costs of $25,000 - 3 years of straight-line amortization at $2,500 per year) Premium paid to redeem $20,000 (102% of $1,000,000 par = $1,020,000)

Which of the following statements is correct regarding callable bonds? A. Bondholders will typically require a lower rate of return for callable bonds. B. The call price is often set at a discount to par. C. An issuer is more likely to call a bond when interest rates move lower. D. A callable bond provides an option for the bondholder.

Choice "C" is correct. When interest rates move lower, it becomes more attractive for the borrower to "refinance" the debt at lower rates. Because a callable bond provides an early redemption option to the issuer, it is more likely to "call" a bond as rates move lower (in the hopes of reissuing debt at now lower rates). Choice "A" is incorrect. Because the issuer has the option of calling the bond, a bondholder will typically require a higher rate of return for callable bonds as a means of compensation for the risk that the bond is called early and then having to reinvest the cash proceeds at lower market interest rates. Choice "B" is incorrect. The call price is often set at a premium to par. Choice "D" is incorrect. A callable bond provides an option for the issuer (not the bondholder), whereas a puttable bond provides an option to the bondholder.

Anchor Co. is experiencing financial difficulties. Anchor negotiated a settlement of $100,000 in debt owed to Bowden Inc. in exchange for Anchor's gross receivables of $100,000. The receivables have an allowance for uncollectible accounts of $25,000. The impact of this transaction on Anchor's net income is a $25,000: A. Decrease in bad debt expense. B. Increase in bad debt expense. C. Loss on restructuring of payables. D. Gain on restructuring of payables.

Choice "D" is correct. Anchor has effectively paid off a $100,000 liability with an asset with a fair value of $75,000 ($100,000 gross receivable - $25,000 allowance for uncollectible accounts). The difference between the carrying amount of the payable ($100,000) and the fair value of the asset transferred ($75,000) is equal to a gain of $25,000 on the restructuring. Choice "A" is incorrect. Bad debt expense would potentially be booked on the creditor (Bowden) side of the transaction rather than on the debtor (Anchor) side.

Which of the following statements is correct regarding a discount bond redeemed at a premium to par under U.S. GAAP? A. The bond payable account will be debited at the premium price paid to redeem the issue. B. The greater the discount at issuance, the lower the loss upon extinguishment. C. Had a gain been booked when the bond was redeemed, it would have gone to other comprehensive income. D. Bond issuance costs not fully amortized will increase the size of the loss booked.

Choice "D" is correct. Any unamortized bond issuance costs will be deducted from the carrying value of the bond at the time the bond issue is redeemed. Because the loss is equal to the reacquisition price - the carrying value, the lower the carrying value, the greater the loss.

Which of the following statements is correct regarding a 10-year bond issued at 96 and fully redeemed at 102 three years later? A. The unamortized premium will be subtracted from the carrying value to determine gain/loss. B. A gain will be reported in income from continuing operations. C. The unamortized discount will be added to the carrying value to determine gain/loss. D. A loss will be reported in income from continuing operations.

Choice "D" is correct. Because the bond was originally issued at a discount (96% of par) and it was redeemed at a price above par (102%), the result is a loss, which will be booked in income from continuing operations. The issuer is effectively paying 102 to remove a liability that three years after issuance is valued somewhere between 96 and 100. Choice "A" is incorrect. There is no unamortized premium, as this is a discount bond. However, for a premium bond that is redeemed prior to maturity, the unamortized premium is added to the carrying value to determine the gain/loss. Choice "B" is incorrect. The issuer will report a loss (rather than a gain) because it is paying more to remove a liability than it is worth on the books. Choice "C" is incorrect. The unamortized discount will be subtracted from (rather than added to) the carrying value in order to determine the gain/loss.

Weald Co. took advantage of market conditions to refund debt. This was the fifth refunding operation carried out by Weald within the last four years. The excess of the carrying amount of the old debt over the amount paid to extinguish it should be reported as a (an): A. A reduction of interest expense for the year. B. Deferred credit to be amortized over life of new debt. C. Separate item, net of income taxes. D. Part of continuing operations.

Choice "D" is correct. Many companies and agencies extinguish (or refund) long-term debt prior to maturity as a method of managing financial risk. The gain (retirement price less carrying amount of the old debt) will be included as part of continuing operations. Choice "B" is incorrect. Gains or losses on early retirement of debt must be recognized at the time of the transaction.

On March 1, Year 1, Somar Co. issued 20-year bonds at a discount. By September 1, Year 6, the bonds were quoted at 106 when Somar exercised its right to retire the bonds at 105. The amount is material and considered to be unusual in nature and infrequently occurring with respect to Somar Co. How should Somar report the bond retirement on its Year 6 income statement under U.S. GAAP? A. A loss in other comprehensive income. B. A gain in continuing operations. C. A gain in other comprehensive income. D. A loss in continuing operations.

Choice "D" is correct. The settlement price is greater than the face value of the debt and the face value is greater than the book value. Therefore, the settlement price is greater than the book value and a loss would be recognized on the transaction. The transaction results in a realized loss. Original issue price was less than par (discount) and retirement cost was above par (105).