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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

Samson Corporation issued a 4-year, \(75,000, zero-interest-bearing note to Brown Company on January 1, 2017, and received cash of \)47,664. The implicit interest rate is 12%. Prepare Samson’s journal entries for (a) the January 1 issuance and (b) the December 31 recognition of interest.

McCormick Corporation issued a 4-year, \(40,000, 5% note to Greenbush Company on January 1, 2017, and received a computer that normally sells for \)31,495. The note requires annual interest payments each December 31. The market rate of interest for a note of similar risk is 12%. Prepare McCormick’s journal entries for (a) the January 1 issuance and (b) the December 31 interest.

Karen Austin Inc. has issued three types of debt on January 1, 2017, the start of the company’s fiscal year.

  1. \(10 million, 10-year, 15% unsecured bonds, interest payable quarterly. Bonds were priced to yield 12%.
  2. \)25 million par of 10-year, zero-coupon bonds at a price to yield 12% per year.
  3. $20 million, 10-year, 10% mortgage bonds, interest payable annually to yield 12%.

Instructions

Prepare a schedule that identifies the following items for each bond: (1) maturity value, (2) number of interest periods over life of bond, (3) stated rate per each interest period, (4) effective-interest rate per each interest period, (5) payment amount per period, and (6) present value of bonds at date of issue.

On April 1, 2017, Seminole Company sold 15,000 of its 11%, 15-year, \(1,000 face value bonds at 97. Interest payment dates are April 1 and October 1, and the company uses the straight-line method of bond discount amortization. On March 1, 2018, Seminole took advantage of favorable prices of its stock to extinguish 6,000 of the bonds by issuing 200,000 shares of its \)10 par value common stock. At this time, the accrued interest was paid in cash. The company’s stock was selling for $31 per share on March 1, 2018.

Instructions

Prepare the journal entries needed on the books of Seminole Company to record the following.

(a) April 1, 2017: issuance of the bonds.

(b) October 1, 2017: payment of semi-annual interest.

(c) December 31, 2017: accrual of interest expense.

(d) March 1, 2018: extinguishment of 6,000 bonds. (No reversing entries made.)

BE14-1 (L01) Whiteside Corporation issues $500,000 of 9% bonds, due in 10 years, with interest payable semi-annually. At the time of issue, the market rate for such bonds is 10%. Compute the issue price of the bonds.
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