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Chapter 14: Q.14-21FRS (page 772)

Question: What are the general rules for measuring and recognizing gain or loss by a debt extinguishment with modification?

Short Answer

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Answer

The general rules for estimating and identifying gain or loss by a debt extinguishment with alteration comprise a debt extinguishment should not be identified earlier to its existence or at a later period.

Step by step solution

01

Meaning of Debt Extinguishment

Debt extinguishment refers to the situation when a debt instrument is completed. This takes place when the borrower compensates the lender or bonds are retired by the issuer.

02

General rules for measuring and recognizing gain or loss by a debt extinguishment with modification

A debt is termed as extinguished when the issuer calls the securities earlier than the date of maturity. It takes place when the market interest rate is lower than the rate that is due on the debt. The issuer can lower its interest expense by recalling and reissuing the debt at the existing market price.

A difference between the net book value of the debt and the repurchase cost of the extinguished debt shall be identified presently in the income of the period of extinguishment, as losses and gains are recognized separately. Gains and losses should not be settled in later periods.

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Most popular questions from this chapter

On March 1, 2017, Sealy Company sold its 5-year, $1,000 face value, 9% bonds dated March 1, 2017, at an effective annual interest rate (yield) of 11%. Interest is payable semiannually, and the first interest payment date is September 1, 2017. Sealy uses the effective-interest method of amortization. The bonds can be called by Sealy at 101 at any time on or after March 1, 2018.

Instructions

a. (1) How would the selling price of the bond be determined?

(2) Specify how all items related to the bonds would be presented in a balance sheet prepared immediately after the bond issue was sold.

b. What items related to the bond issue would be included in Sealy’s 2017 income statement, and how would each be determined?

c. Would the amount of bond discount amortization using the effective-interest method of amortization be lower in the second or third year of the life of the bond issue? Why?

d. Assuming that the bonds were called in and redeemed on March 1, 2018, how should Sealy report the redemption of the bonds on the 2018 income statement?

(Issuance and Redemption of Bonds; Income Statement Presentation) Holiday Company issued its 9%, 25-year mortgage bonds in the principal amount of \(3,000,000 on January 2, 2003, at a discount of \)150,000, which it proceeded to amortize by charges to expense over the life of the issue on a straight-line basis. The indenture securing the issue provided that the bonds could be called for redemption in total but not in part at any time before maturity at 104% of the principal amount, but it did not provide for any sinking fund.

On December 18, 2017, the company issued its 11%, 20-year debenture bonds in the principal amount of $4,000,000 at 102, and the proceeds were used to redeem the 9%, 25-year mortgage bonds on January 2, 2018. The indenture securing the new issue did not provide for any sinking fund or for redemption before maturity.

Instructions

(a) Prepare journal entries to record the issuance of the 11% bonds and the redemption of the 9% bonds.

(b) Indicate the income statement treatment of the gain or loss from redemption and the note disclosure required.

Under what conditions of bond issuance do a discount on bonds payable arise? Under what conditions of bond issuance does a premium on bonds payable arise?

On January 1, 2017, Henderson Corporation redeemed \(500,00 of bonds at 99. At the time of redemption, the unamortized premium was \)15,000. Prepare the corporation’s journal entry to record the reacquisition of the bonds.

Question: Under IFRS, bonds issuance costs, including the printing costs and legal fees associated with the issuance, should be:

  1. expensed in the period when the debt is issued.
  2. recorded as a reduction in the carrying value of bonds payable.
  3. accumulated in a deferred charge account and amortized over the life of the bonds.

d.reported as an expense in the period the bonds mature or are redeemed.
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