Question

On January 1, 2003, Cardinal Corporation issued 5% 25-year bonds at par and used the $12,000,000 proceeds to finance the construction of a new plant. On January 1, 2013, the company acquired the bonds on the open market for $11,500,000. Assuming that Cardinal Corporation is neither bankrupt nor insolvent, the acquisition and retirement of the bonds results in which of the following:

Options:
Option 1: A loss on retirement of bonds
Option 2: A gain on retirement of bonds
Option 3: No effect on net income
Option 4: Increase in total assets

Answer 1

The correct option is 2). The acquisition and retirement of bonds by Cardinal Corporation at a price lower than their original issue price results in a gain on the retirement of bonds, affecting the company's financial statements by reducing liabilities and increasing equity through the gain recorded.

Step-by-step explanation:

On January 1, 2003, Cardinal Corporation issued 5% 25-year bonds at par for $12,000,000 which were later acquired on January 1, 2013, for $11,500,000 on the open market. The acquisition and retirement of these bonds would result in a gain on retirement of bonds since the company paid less to buy back the bonds than the original issue price. This gain will be realized because the carrying amount of the bonds was higher than the price paid to retire them, resulting in a difference that will be recorded as a gain. Retirement would lead to a decrease in total liabilities (bonds payable) and a concurrent decrease in total assets (cash), while the gain would increase retained earnings within the equity section of the balance sheet.