On June 30, year 1, Frick Co. had outstanding 9%, $5,000,000 face value bonds ma

Question

On June 30, year 1, Frick Co. had outstanding 9%, $5,000,000 face value bonds maturing on June 30, year 6. Interest was payable semiannually every June 30 and December 31. Frick did not elect the fair value option for reporting its financial liabilities. On June 30, year 1, after amortization was recorded for the period, the unamortized bond premium and bond issue costs were $30,000 and $50,000, respectively. On that date, Frick acquired all its outstanding bonds on the open market at 99 and retired them. At June 30, year 1, what amount should Frick recognize as gain before income taxes on redemption of bonds?

Explanation / Answer

Solution:

A bond is said to be retired early when it is retired at any time before its maturity date.

Accounting Treatment for Bonds Retired before Maturity

·        When a bond is retired before maturity a gain or loss may arise.

·        If the price paid to retire the bonds is greater the carrying amount of bonds the company needs to record a loss on retirement.

·        If the price paid is less than the carrying amount of the bonds at retirement the company records a gain on retirement of bonds.

Carrying Value of Bond as on retirement date (if bonds are issued on discount initially) = Par Value of Bonds Payable – Unamortized Discount – Unamortized Debt Issue Cost

Carrying Value of Bond as on retirement date (if bonds are issued on premium initially) = Par Value of Bonds Payable + Unamortized Premium – Unamortized Debt Issue Cost

Here in the question:

Assumed par value of bond = $100

Price paid to retire the bonds = $5,000,000/ $100 x $99 = $4,950,000

Net Carrying Value of Bonds retired before maturity on June 30 = Par Value of Bonds Payable + Unamortized Premium on Bonds – Unamortized Debt Issue Cost

Net Carrying Value of Bonds retired before maturity on June 30 = $5,000,000 + $30,000 - $50,000 = $4,980,000

Since the price paid to retire the bonds is less than the carrying value of bonds ----- the company needs to record a gain on retirement of bonds

Gain on retirement of bonds = Carrying Value of Bonds Payable – Price paid to retire the bonds

= $4,980,000 - $4,950,000 = $30,000

Hence, Frick should recognize $30,000 as gain on retirement of bonds before income taxes on redemption of bonds.

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