Question

1. On January 1,2018,Banno Corporation issued$1,500,000 Face Value of 10% coupon bonds at a price of 103, due December 31 2027. Interest on the bonds is payable annually each December 31. The premium on the bond is being amortized on a straight-line basis over the ten years (Straight-line is not materially different in effect from the preferred effective interest method). The bonds are callable at a price of 100 1⁄2 and on January 1, 2024, called all $1,500,000 Face amount of the bonds and redeemed them. There are no issue costs. Ignoring income taxes, compute the amount of gain or loss to be recognized by Banno as a result of retiring the bonds in 2024 and prepare the journal entry to record the redemption.

2. Re-do problem 1, but this time assume that there were $24,000 of issue costs. Also answer, what is the effect of the issue costs on the gain or loss you calculated in problem 1?

3. Re-do problem 1, but assume that there are no issue costs and that this time, only $900,000 Face Value of the bonds were redeemed.

4. Re-do problem 3, but this time assume that there were $24,000 of issue costs. Also answer, what is the effect of the issue costs on the gain or loss you calculated in problem 1?

Answer 1

Answer 1:

On January 1,2018

Face Value = $1,500,000  

Bonds issued at a price of 103 = $1,500,000 *103% = $1,545,000

Bond Premium = $1,545,000 - $1,500,000 = $45,000

Premium on the bond is being amortized on a straight-line basis over the ten years.

Annual amortization = $45,000 / 10 =$4,500

The bonds are called at a price of 100 1⁄2 on January 1, 2024

Cumulative amount amortized till December 31, 2023 = 6 years * $4,500 = $27,000

As such carrying value of bond as on January 1, 2024 = $1,545,000 - $27,000 = $1,518,000

Redeemed value = $1,500,000 * 100.5% = $1,507,500

Amount of gain or (loss) to be recognized as a result of retiring the bonds in 2024 = $1,518,000 - $1,507,500 = $10,500

Journal Entry to record redemption:

Answer 2:

Bond issue costs = $24,000

Bond issue costs are amortized over life of bond:

Bond issue costs amortized till December 31, 2023 = ($24,000 /10) * 6 = $14,400

Unamortized bond issue costs as on Jan.1, 2024 = $24,000 - $14,400 = $9,600

As such carrying value of bond as on January 1, 2024 = $1,545,000 - $27,000 - $9,600 = $1,508,400

Amount of gain or (loss) to be recognized as a result of retiring the bonds in 2024 = ($1,508,400 - $1,507,500 = $900

Journal entry is:

Effect of issue costs on gain is reduction in gain by an amount of $9,600

Answer 3:

Only $900,000 Face Value of the bonds were redeemed:

Carrying value of bond of $1,500,000 face value as on January 1, 2024 = $$1,518,000

As such carrying value of $900,000 face value which were redeemed = $1,518,000 * $900,000 / $1,500,000

= $910,800

Redeemed value = $900,000 * 100.5% = $904,500

Amount of gain or (loss) to be recognized = $910,800 - $904,500 =$6,300

Journal entry is:

Answer 4:

Issue costs = $24,000

Carrying value of bond of face value $1,500,000 as on January 1, 2024 = $1,545,000 - $27,000 - $9,600 = $1,508,400

As such carrying value of bond of face value $900,000 redeemed on January 1, 2024 = $1,508,400 * $900,000 / $1,500,000 = $905,040

Amount of gain or (loss) to be recognized = $905,040 - $904,500 =$540

Journal entry is:

Effect of issues cost compared to Problem 3, reduction in gain = $5,760

Compared to problem 1, reduction in gain:

Effect of issue costs = $5,760

Effect of only 60% of bonds being redeemed = $4,200

Total reduction is gain = $5,760 + $4,200 =$9,960