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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

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鈥檚 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.)

What is the fair value option? Briefly describe the controversy of applying the fair value option to financial liabilities.

On January 1, 2017, Nichols Company issued for \(1,085,800 its 20-year, 11% bonds that have a maturity value of \)1,000,000 and pay interest semiannually on January 1 and July 1. The following are three presentations of the long-term liability section of the balance sheet that might be used for these bonds at the issue date.

1

Bonds payable (maturing January 1, 2037)

\(1,000,000

Unamortized premium on bonds payable

85,800

Total bond liability

\)1,085,800

2

Bonds payable鈥攑rincipal (face value \(1,000,000 maturing January 1, 2037)

\) 142,050a

Bonds payable鈥攊nterest (semiannual payment \(55,000)

943,750b

Total bond liability

\)1,085,800

3

Bonds payable鈥攑rincipal (maturing January 1, 2037)

\(1,000,000

Bonds payable鈥攊nterest (\)55,000 per period for 40 periods)

2,200,000

Total bond liability

\(3,200,000

aThe present value of \)1,000,000 due at the end of 40 (6-month) periods at the yield rate of 5% per period

bThe present value of \(55,000 per period for 40 (6-month) periods at the yield rate of 5% per period.

Instructions

(a) Discuss the conceptual merit(s) of each of the date-of-issue balance sheet presentations shown above for these bonds.

(b) Explain why investors would pay \)1,085,800 for bonds that have a maturity value of only $1,000,000.

(c)Assuming that a discount rate is needed to compute the carrying value of the obligations arising from a bond issue at any date during the life of the bonds, discuss the conceptual merit(s) of using for this purpose: (1) The coupon or nominal rate. (2) The effective or yield rate at date of issue.

(d)If the obligations arising from these bonds are to be carried at their present value computed by means of the current market rate of interest, how would the bond valuation at dates subsequent to the date of the issue be affected by an increase or a decrease in the market rate of interest?

(Equity Securities Entries) On December 21, 2017, Bucky Katt Company provided you with the following information

regarding its equity investments.

December 31, 2017

Investments Cost Fair Value Unrealized Gain (Loss)

Clemson Corp. stock \(20,000 \)19,000 \((1,000)

Colorado Co. stock 10,000 9,000 (1,000)

Buffaloes Co. stock 20,000 20,600 600

Total of portfolio \)50,000 \(48,600 (1,400)

Previous fair value adjustment balance 鈥�0鈥�

Fair value adjustment鈥擟r. \)(1,400)

During 2018, Colorado Co. stock was sold for \(9,400. The fair value of the stock on December 31, 2018, was Clemson Corp.

stock鈥擻)19,100; Buffaloes Co. stock鈥�$20,500. None of the equity investments result in significant influence.

Instructions

(a) Prepare the adjusting journal entry needed on December 31, 2017.

(b) Prepare the journal entry to record the sale of the Colorado Co. stock during 2018.

(c) Prepare the adjusting journal entry needed on December 31, 2018.

What disclosures are required relative to long-term debt and sinking fund requirements?
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