Question

Herman Company received proceeds of ₤188,500 on 10-year, 8% bonds issued on January 1, 2010. The bonds had a face value of ₤200,000, pay interest semi-annually on June 30 and December 31, and have a call price of 101. Herman uses the straight-line method of amortization. Herman Company decided to redeem the bonds on January 1, 2012. What amount of gain or loss would Herman report on its 2012 income statement?

a) ₤9,200 gain
b) ₤11,200 gain
c) ₤11,200 loss
d) ₤9,200 loss

Answer 1

Herman Company would report a ₤9,200 loss on its 2012 income statement. The carrying amount at the time of redemption is the face value minus the total amortization. The gain or loss is the difference between the call price and the unamortized carrying amount.

Step-by-step explanation:

To calculate the gain or loss Herman Company would report on its 2012 income statement, we need to compare the call price to the unamortized carrying amount of the bonds. The unamortized carrying amount is the face value minus the amortized premium or plus the amortized discount, in this case, the amortized premium. The premium is the excess of the proceeds over the face value, which is ₤188,500 - ₤200,000 = ₤-11,500.

The premium is amortized over the 10-year life of the bonds using the straight-line method. To calculate the annual amortization, divide the premium by the number of years: ₤-11,500 / 10 = ₤-1,150 per year. Since the bonds were redeemed on January 1, 2012, only 2 years have passed, so the amortized premium is 2 * ₤1,150 = ₤2,300. Now, calculate the unamortized carrying amount: ₤200,000 - ₤2,300 = ₤197,700. Compare this to the call price of 101% of the face value: 1.01 * ₤200,000 = ₤202,000. The gain or loss is the difference between the call price and the unamortized carrying amount. In this case, ₤202,000 - ₤197,700 = ₤4,300 loss. Therefore, the correct answer is option d) ₤9,200 loss.