Question

(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.

Short answer

1. The business entity will suffer the loss of $180,000on early extinguishment of bonds.
2. The loss on early extinguishment will be reported as an ordinary loss.

Step-by-step solution

Definition of Bonds Payable

Bonds payable refers to securities issued by the company to raise money from the public, and it is a non-current liability of the business.

Journal entries

Date	Accounts and Explanation	Debit ($)	Credit ($)
Journal entry for issuance of 11% bonds
18 Dec 2017	Cash	4,080,000
	Premium on bond payable		80,000
	Bonds payable		4,000,000
Entry for recording the retirement of 9% bonds
18 Dec 2017	Bonds payable	3,000,000
	Loss on Redemption	180,000
	Discount on bond payable		60,000
	Cash$\left(\$3,000,000\times 104\%\right)$		3,120,000

Working note:

Calculation of unamortized discount

$\begin{array}{rcl}\mathit{U}\mathit{n}\mathit{a}\mathit{m}\mathit{o}\mathit{r}\mathit{t}\mathit{i}\mathit{z}\mathit{e}\mathit{d}\mathit{d}\mathit{i}\mathit{s}\mathit{c}\mathit{o}\mathit{u}\mathit{n}\mathit{t}& \mathbf{=}& \frac{\mathbf{T}\mathbf{o}\mathbf{t}\mathbf{a}\mathbf{l}\mathbf{d}\mathbf{i}\mathbf{s}\mathbf{c}\mathbf{o}\mathbf{u}\mathbf{n}\mathbf{t}}{\mathbf{T}\mathbf{o}\mathbf{t}\mathbf{a}\mathbf{l}\mathbf{p}\mathbf{e}\mathbf{r}\mathbf{i}\mathbf{o}\mathbf{d}\mathbf{s}}\mathbf{\times }\mathit{P}\mathit{e}\mathit{r}\mathit{i}\mathit{o}\mathit{d}\mathit{s}\mathit{r}\mathit{e}\mathit{m}\mathit{a}\mathit{i}\mathit{n}\mathit{i}\mathit{n}\mathit{g}\\ & \mathbf{=}& \frac{\mathbf{\$}\mathbf{150}\mathbf{,}\mathbf{000}}{\mathbf{25}}\mathbf{\times }\mathbf{10}\\ & \mathbf{=}& \mathbf{\$}\mathbf{60}\mathbf{,}\mathbf{000}\\ & & \end{array}$

Income statement treatment of gain/loss from redemption

The loss suffered from the redemption of the bond will be reported as an ordinary loss.