Question

Using the formula: Par value of bonds less unamortized issuance costs less unamortized discount or plus unamortized premium, answer the three questions below. Be show to show your work, as I give partial credit. A company has a $1,000,000 bond issue outstanding with unamortized premium of $10,000 and unamortized issuance costs of $5,300. What is the book value of its liability? If an affiliate purchases half the bonds in the market at 98, what is the gain or loss? Is the gain or loss actual or constructive?

Answer 1

• The book value of a Bond consists of:

>face Value of bonds payable (credit balance)

>unamortised discount on bonds payable (debit balance)

>unamortised premium on bonds payable (credit balance)

>unamortised issuance cost (debit balance)

• Based on above, the book value of our Bond will be $ 1,000,000 (face Value) + $ 10,000 (unamortised premium) - $ 5,300 (unamortised issuance cost)

= 1000000 + 10000 – 5300

= $ 1,004,700 = Book Value of Bonds Liability.

• Gain or Loss when Affiliate purchases such Bonds

>Total Book Value = $ 1,004,700

>Book Value of 50% of Bonds purchased by the affiliate = 1004700 x 50% = $ 502,350

>Bonds purchased by affiliate at 98 = $ 1,000,000 x 50% x 98% = $ 490,000

---Since Book Value is MORE than the value at which the Bonds are purchased by the affiliate, there is LOSS of $ 12,350 in the sale of 50% Bonds Payable.

• The above loss of $ 12,350 is a CONSTRUCTIVE LOSS, because the Bonds are purchased by the Affiliate company and the bonds are retired constructively in such cases. Such loss is reported as constructive loss when preparing Consolidated Financial Statements.