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Chapter 10: Problem 9

Early Retirement of Bonds Eaton Company issued \(\$ 600,000\) of eight percent, 20 -year bonds at 106 on January 1, 2013 . Interest is payable semiannually on July 1 and January 1 . Through January 1. 2019, Eaton amortized \(\$ 5,000\) of the bond premium. On January 1, 2019, Eaton retired the bonds at 103 (after making the interest payment on that date). Prepare the journal entry to record the bond retirement on January 1, \(2019 .\)

Short Answer

Expert verified
Eaton Company should record a loss of \( \$13,000 \) on bond retirement.

Step by step solution

01

Determine the Carrying Value of Bonds

Start by determining the carrying value of the bonds as of January 1, 2019. The bonds were initially issued at 106% of the face value, so:\[\text{Initial Issuance Amount} = \\(600,000 \times 1.06 = \\)636,000\]Subtract the amortized premium (\\(5,000) from the initial issuance amount to find the carrying value:\[\text{Carrying Value} = \\)636,000 - \\(5,000 = \\)631,000\]
02

Compute the Retirement Price of the Bonds

Next, calculate the amount Eaton company paid to retire the bonds, which was 103% of the face value:\[\text{Retirement Price} = \\(600,000 \times 1.03 = \\)618,000\]
03

Calculate the Gain or Loss on Retirement

The gain or loss on the retirement of bonds is the difference between the carrying value and the retirement price. Since the carrying value is higher than the retirement price, Eaton Company incurs a loss:\[\text{Loss} = \\(631,000 - \\)618,000 = \$13,000\]
04

Record the Journal Entry for Bond Retirement

Now that all values are determined, record the journal entry for the bond retirement. - Debit Bonds Payable for the face value of the bonds: \( \\(600,000 \).- Debit the Premium on Bonds Payable for the remaining premium: \( \\)31,000 \) (i.e., \( \\(636,000 - \\)5,000 - \\(600,000 \)).- Credit Cash for the retirement payment amount: \( \\)618,000 \).- Debit Loss on Bond Retirement for the calculated loss: \( \\(13,000 \).The journal entry will look like this:Debit: Bonds Payable - \( \\)600,000 \) Debit: Premium on Bonds Payable - \( \\(31,000 \) Credit: Cash - \( \\)618,000 \) Debit: Loss on Bond Retirement - \( \$13,000 \)

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Journal Entry
A journal entry helps in recording business transactions in the accounting records. When a company retires bonds early, it needs to properly record the financial details in its books. In this scenario, Eaton Company is retiring bonds before they mature. To record the bond retirement on January 1, 2019, we note important elements:
  • Debit Bonds Payable for $600,000, showing removal from liabilities.
  • Debit Premium on Bonds Payable by $31,000, reflecting the removal of the premium still associated with these bonds after partial amortization.
  • Credit Cash for $618,000, since this amount was paid to retire the bonds.
  • Debit Loss on Bond Retirement by $13,000, reflecting the financial loss due to the bonds being retired at a higher carrying value.
This captured the effects of all transactions due to early retirement in Eaton鈥檚 accounting books.
Carrying Value
The carrying value represents the net value of a bond from the issuer's books. It's a crucial figure used when calculating potential gains or losses on bond retirement. For Eaton Company's bonds:
  • Bonds were issued at 106% of their face value, originally amounting to $636,000.
  • Over time, $5,000 of the bond premium was amortized.
  • The carrying value is computed by subtracting the amortized premium from the original amount, resulting in $631,000.
This indicates what remains of the bond's value, after considering both the original amount and how much of the premium has been amortized. Knowing this helps when determining outcomes in scenarios like early bond retirement.
Bond Premium Amortization
Bond premium amortization involves gradually writing down the premium value added during issuance over the bond's life. This accounts for the bond price being higher than its face value at issuance. When Eaton Company issued their bonds:
  • The bonds were sold for 106% of the face value due to the premium at issuance.
  • From 2013 to 2019, Eaton amortized $5,000 of this premium.
Amortization of a bond premium is typically calculated using the effective interest rate method or the straight-line method, depending on the company's accounting policy. This process reduces the carrying amount of the bond on the balance sheet and helps allocate the premium expense over the bond's term.
Loss on Bond Retirement
When bonds are retired before their maturity date, the company may face a gain or a loss, depending on the retirement price compared to the carrying value. In Eaton Company's case:
  • The carrying value of the bonds was $631,000.
  • The bonds were retired at 103% of their face value, leading to a retirement price of $618,000.
  • The difference led to a $13,000 loss on the retirement.
This loss is recorded as an expense, affecting the company's financial statements and cash flows. Losses on bond retirement reflect the cost incurred from choosing early retirement over awaiting maturity.

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