Ask Me Help Desk - Reported bonds payable

Reported bonds payable

On its December 31, 2006 balance sheet, Lane Corp. reported bonds payable of $6,000,000 and related unamortized bond issue costs of $320,000. The bonds had been issued at par. On January 2, 2007, Lane retired $3,000,000 of the outstanding bonds at par plus a call premium of $70,000. What amount should Lane report in its 2007 income statement as loss on extinguishment of debt (ignore taxes)?
a. $0
b. $70,000
c. $160,000
d. $230,000

Please read the guidelines on posting homework problems:
Ask Me Help Desk - Announcements in Forum : Homework Help

Show that you have made some attempt at doing your own work first - like your guess at the answer and why. And then someone can guide you.

I am just trying to brush up before school starts again on Bonds (my weakest area of accounting). This questions all together confuses me because they want the loss amount on a premium? I think I am confussing the preception here. Lane issued the bond at a premium of 70k - which for Lane is a loss... Okay so then Lane should report 70,000 in loss?

I wish there was a 1-2-3 step to understanding bonds all together!

You might have just mis-typed there, but Lane didn't issue the bonds at a 70K premium (they were issued at par, according to the info). Lane did, though, retire the bonds at par, plus a 70K early-call premium.

Yeah, the word premium can be a bit confusing when trying to relate it to the concept of loss... 'premium' usually denotes something good (a premium cigar, premium Scotch :))

But in bond lingo, a 'call' premium, or an 'early call' premium, is essentially a fee a bond issuer pays in exchange for exercising a privilege of paying off the bonds prior to their scheduled maturity. If it helps, think of an insurance premium, which is certainly an expense!

Note that this is very different from the 'premium' that's used in the context of a bond issuer selling its bonds at a price that's above par... that's an 'issue premium' and refers to something different altogether.

With respect to the unamortized issue costs of 320K, I'm going to go out on a limb and suggest that half of that amount should be immediately written off as an additional loss, as a result of the early redemption of half of the bonds. But there's a couple of accounting vets on here who run rings around me when it comes to GAAP, so if I'm off base on this one, I'll step up and take a rap across the knuckles for it.

Anyway, I hope that helped a bit with the retirement 'premium' issue.

Quote:

(a premium cigar, premium Scotch :))

I always thought you were male but was never sure. Now I am. :p

Quote:

With respect to the unamortized issue costs of 320K, I'm going to go out on a limb and suggest that half of that amount should be immediately written off as an additional loss, as a result of the early redemption of half of the bonds. But there's a couple of accounting vets on here who run rings around me when it comes to GAAP, so if I'm off base on this one, I'll step up and take a rap across the knuckles for it.

You may keep your knuckles intact. I actually wasn't positive about this myself and decided to look it up - don't usually see problems like this. It's perfectly logical that you would need to deal with half of that amount since only half the bonds are being paid off. It also seemed logical to me that those costs would be amortized over the life of the bonds, but that's the part I wasn't sure about. I found all sorts of interesting stuff, like that GAAP and FASB disagree with each other on this, which is interesting. But since it's not asking for entries, we don't need to worry about the inconsistency, cause mathematically it actually all comes out the same.

The costs are going to reduce carrying value of the bonds. Whenever the company pays higher than carrying value when they retire the bonds, they have a loss. (That may seem confusing since it's the opposite of selling an asset for a higher amount. But think about it.) In this case, we have 320,000 reducing the carrying value. Since they're only redeeming half of them, you need to deal with half of the costs. They're retiring at par, but there's that reduction in carrying value due to those costs, so there's still a difference between what they're paying out and the carrying value.

So what number do you think it is?

I think there are two types of losses:
1. Unamortized bond issue costs $160,000 ($320,000 x 50%)
2. Premium of $70,000 paid on redemtion of bonds. That makes a total of $230,000 to be reported as loss.

Wow, I would have never been able to think all that through. I am going back to reread the treatment of extinguishment of long term liabilities. Thank you for helping - reading your thoughts helped me realize I need more help but your thinking sounds great. Once I get where your great people are I too will start helping lose students such as myself. Thank you again!!

If you really enjoy accounting (and it sounds like you do) and you keep pursuing your studies for the long run, not only will you eventually develop an advanced level of expertise, but you'll also have a lot of enjoyment and satisfaction in your career. Best of luck!