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Chapter 14: Q13Q (page 753)

Question: How are gains and losses from extinguishment of a debt classified in the income statement? What disclosures are required of such transactions?

Short Answer

Expert verified

Answer

Gains and losses from extinguishment of debt shall be accumulated and, if material, categorized as an extraordinary item, net of associated income tax effect. For extinguishment of debt transactions, disclosure is needed to show the effect of income tax in the phase of extinguishment.

Step by step solution

01

Meaning of Extinguishment of Debt

Debt extinguishment takes place when the borrower pays the full amount of debt, and the creditor liberates the borrower. Extinguishment is the revocation of constitutional rights, interest or contract.

02

Gains and losses from extinguishment of debt and disclosure for such transactions

Gains or losses from extinguishment of debt should be collected and listed in income.

Disclosure is essential for the following items for the purpose of extinguishment of debt transactions. They are:

  • An illustration of the transactions involving the sources of any funds used to extinguish debt if it is possible to recognize the sources.
  • The value per share of the accumulated gain or loss net of associated tax effect.

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Most popular questions from this chapter

Strickland Company owes \(200,000 plus \)18,000 of accrued interest to Moran State Bank. The debt is a 10-year, 10% note. During 2017, Strickland鈥檚 business deteriorated due to a faltering regional economy. On December 31, 2017, Moran State Bank agrees to accept an old machine and cancel the entire debt. The machine has a cost of \(390,000, accumulated depreciation of \)221,000, and a fair value of \(180,000.

Instructions

  1. Prepare journal entries for Strickland Company and Moran State Bank to record this debt settlement.
  2. How should Strickland report the gain or loss on the disposition of machine and on restructuring of debt in its 2017 income statement?
  3. Assume that, instead of transferring the machine, Strickland decides to grant 15,000 shares of its common stock (\)10 par) which has a fair value of $180,000 in full settlement of the loan obligation. If Moran State Bank treats Strickland鈥檚 stock as a trading investment, prepare the entries to record the transaction for both parties.

What is done to record properly a transaction involving the issuance of a non-interest -bearing long-term note in exchange for property?

Good-Deal Inc. developed a new sales gimmick to help sell its inventory of new automobiles. Because many new car buyers need financing, Good-Deal offered a low down payment and low car payments for the first year after purchase. It believes that this promotion will bring in some new buyers.

On January 1, 2017, a customer purchased a new \(33,000 automobile, making a down payment of \)1,000. The customer signed a note indicating that the annual rate of interest would be 8% and that quarterly payments would be made over 3 years. For the first year, Good-Deal required a $400 quarterly payment to be made on April 1, July 1, October 1, and January 1, 2018. After this one-year period, the customer was required to make regular quarterly payments that would pay off the loan as of January 1, 2020.

Instructions

(a) Prepare a note amortization schedule for the first year.

(b) Indicate the amount the customer owes on the contract at the end of the first year.

(c) Compute the amount of the new quarterly payments.

(d) Prepare a note amortization schedule for these new payments for the next 2 years.

(e) What do you think of the new sales promotion used by Good-Deal?

Teton Corporation issued \(600,000 of 7% bonds on November 1, 2017, for \)644,636. The bonds were dated November 1, 2017, and mature in 10 years, with interest payable each May 1 and November 1. Teton uses the effective-interest method with an effective rate of 6%. Prepare Teton鈥檚 December 31, 2017, adjusting entry.

The following amortization and interest schedule reflects the issuance of 10-year bonds by Capulet Corporation on January 1, 2011, and the subsequent interest payments and charges. The company鈥檚 year-end is December 31, and financial statements are prepared once yearly.

Amortization Schedule

Year

Cash

Interest

Amount unamortized

Carrying value

1/1/2011

\(5,651

\)94,349

2011

\(11,000

\)11,322

5,329

94,671

2012

11,000

11,361

4,968

95,032

2013

11,000

11,404

4,564

95,436

2014

11,000

11,452

4,112

95,888

2015

11,000

11,507

3,605

95,395

2016

11,000

11,567

3,038

96,962

2017

11,000

11,635

2,403

97,597

2018

11,000

11,712

1,691

98,309

2019

11,000

11,797

894

99,106

2020

11,000

11,894

100,000

Instructions

(a) Indicate whether the bonds were issued at a premium or a discount and how you can determine this fact from the schedule.

(b) Indicate whether the amortization schedule is based on the straight-line method or the effective-interest method, and how you can determine which method is used.

(c) Determine the stated interest rate and the effective-interest rate.

(d) On the basis of the schedule above, prepare the journal entry to record the issuance of the bonds on January 1, 2011.

(e) On the basis of the schedule above, prepare the journal entry or entries to reflect the bond transactions and accruals for 2011. (Interest is paid on January 1.)

(f) On the basis of the schedule above, prepare the journal entry or entries to reflect the bond transactions and accruals for 2018. Capulet Corporation does not use reversing entries.
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