Question

Enterprise Group issued $100,000 of 3-year, 6% bonds outstanding on December 31, 2015 for $106,000. Enterprise uses straight-line amortization. On May 1, 2016, $10,000 of the bonds were retired at 110. As a result of the retirement, Enterprise will report a:

1) $400 loss
2) $467 loss
3) $1,100 loss
4) $1,100 gain

Answer 1

When bonds are issued at a premium, the premium must be amortized over the life of the bonds. Using the straight-line method, the annual amortization expense is $2,000. When $10,000 of the bonds are retired, there is a 1) $400 loss.

Step-by-step explanation:

When bonds are issued at a premium, the premium must be amortized (spread out) over the life of the bonds. In this case, Enterprise issued the bonds for $106,000, which is $6,000 more than their face value. The straight-line method of amortization allocates an equal amount to interest expense each year. Since there are 3 years remaining on the bonds, the annual amortization expense would be $6,000 / 3 = $2,000.

When $10,000 of the bonds are retired before maturity, we need to calculate the gain or loss on retirement. To do this, we compare the carrying value of the bonds (the face value minus the accumulated amortization) to the cash paid to retire the bonds. The carrying value of the $100,000 bonds is $100,000 - $2,000 amortization per year x 2 years = $96,000. The cash paid to retire the bonds is $10,000 x 1.10 = $11,000.

Since the carrying value is less than the cash paid, there is a loss on retirement. The loss is calculated by subtracting the carrying value from the cash paid: $11,000 - $96,000 = -$85,000. However, since it's a loss, we need to take the absolute value: $85,000. Therefore, the correct answer is 1) $400 loss.