Question

On February 1, 20x1, Davis Corporation issued 12%. $1,000,000 par, 10-year bonds for $1,117,000 Davis reacquired all of these bonds at 103% of par, plus accrued interest, on Mat 1, 20x3 and retired them. THe unamortized bond premium on that date was $75,000. Before income taxes, what was Davis's gain or loss on the bond extignishment?

A. Gain of $45,000
B. Loss of $45,000
C. Gain of $162,000
D. Loss of $162,000
E. Gain of $87,000

Answer 1

Davis Corporation had a loss of $15,000 on the retirement of its 12% bonds due to the reacquisition costs being higher than the carrying amount of the bonds, when accounting for the unamortized bond premium and accrued interest.

Step-by-step explanation:

To calculate the gain or loss on the bond extinguishment for Davis Corporation, we need to consider the reacquisition price, the unamortized bond premium, and the accrued interest on the bonds.

The bonds were reacquired at 103% of par, which equals $1,030,000 ($1,000,000 par x 103%). Accrued interest for the period from February 1, 20x3 to May 1, 20x3 is 3 months of interest. Since the bond has a 12% annual interest rate, the accrued interest is $30,000 ($1,000,000 x 12% x 3/12). So, the total reacquisition cost is the sum of the reacquisition price and the accrued interest, which equals $1,060,000 ($1,030,000 + $30,000).

The unamortized bond premium on the date of reacquisition is $75,000. This needs to be deducted from the carrying amount of the bond. The carrying amount of the bond is the par value plus the unamortized premium, which equals $1,075,000 ($1,000,000 par + $75,000 premium).

The loss on bond extinguishment is the total reacquisition cost minus the carrying amount of the bonds. This results in a loss of $15,000 ($1,060,000 - $1,075,000).

Davis Corporation incurred a loss of $15,000 on the bond extinguishment.