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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

Determine Proper Amounts in Account Balances) Presented below are two independent situations.

(a) George Gershwin Co. sold \(2,000,000 of 10%, 10-year bonds at 104 on January 1, 2017. The bonds were dated January 1, 2017, and pay interest on July 1 and January 1. If Gershwin uses the straight-line method to amortize bond premium or discount, determine the amount of interest expense to be reported on July 1, 2017, and December 31, 2017.

(b) Ron Kenoly Inc. issued \)600,000 of 9%, 10-year bonds on June 30, 2017, for $562,500. This price provided a yield of 10% on the bonds. Interest is payable semiannually on December 31 and June 30. If Kenoly uses the effective interest method, determine the amount of interest expense to record if financial statements are issued on October 31, 2017.

Assume the bonds in BE14-6 were issued for $644,636 and the effective-interest rate is 6%. Prepare the company’s journal entries for (a) the January 1 issuance, (b) the July 1 interest payment, and (c) the December 31 adjusting entry.

The following article appeared in the Wall Street Journal.

Bond Markets

Giant Commonwealth Edison Issue Hits Resale Market With \(70 Million Left Over

New york—Commonwealth Edison Co.’s slow-selling new 91 /4% bonds were tossed onto the resale market at a reduced price with about \)70 million still available from the \(200 million offered Thursday, dealers said.

The Chicago utility’s bonds, rated double-A by Moody’s and double-A-minus by Standard & Poor’s, originally had been priced at 99.803, to yield 9.3% in 5 years. They were marked down yesterday the equivalent of about \)5.50 for each $1,000 face amount, to about 99.25, where their yield jumped to 9.45%.

Instructions

  1. How will the development above affect the accounting for Commonwealth Edison’s bond issue?
  2. Provide several possible explanations for the markdown and the slow sale of Commonwealth Edison’s bonds.

(Issuance and Redemption of Bonds) Venezuela Co. is building a new hockey arena at a cost of \(2,500,000. It received a downpayment of \)500,000 from local businesses to support the project, and now needs to borrow \(2,000,000 to complete the project. It therefore decides to issue \)2,000,000 of 10.5%, 10-year bonds. These bonds were issued on January 1, 2016, and pay interest annually on each January 1. The bonds yield 10%.

Instructions

(a) Prepare the journal entry to record the issuance of the bonds on January 1, 2016.

(b) Prepare a bond amortization schedule up to and including January 1, 2020, using the effective-interest method.

(c) Assume that on July 1, 2019, Venezuela Co. redeems half of the bonds at a cost of $1,065,000 plus accrued interest. Prepare the journal entry to record this redemption.

Assume the same information as in E14-4, except that Celine Dion Company uses the effective-interest method of amortization for bond premium or discount. Assume an effective yield of 9.7705%

Instructions

Prepare the journal entries to record the following. (Round to the nearest dollar.)

(a) The issuance of the bonds.

(b) The payment of interest and related amortization on July 1, 2017.

(c) The accrual of interest and the related amortization on December 31, 2017.
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