Question

On January 1, 2004, 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, 2014, 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:

a. The company must recognize a $500,000 gain.
b. The company can make an election to recognize a $500,000 gain or reduce the company's basis in the plant by $500,000.
c. The company must recognize a $500,000 gain and increase the company's basis in the plant by $500,000.
d. The company can amortize the $500,000 gain, recognizing income over the remaining life of the bonds.
e. None of these.

Answer 1

The acquisition and retirement of the bonds can result in the company either recognizing a gain or reducing the basis of the plant.

Step-by-step explanation:

The acquisition and retirement of the bonds by Cardinal Corporation will result in option b. The company can make an election to recognize a $500,000 gain or reduce the company's basis in the plant by $500,000.

When Cardinal Corporation acquired the bonds on the open market for $11,500,000, it paid less than the par value of the bonds. This results in a gain for the company. However, the company has the option to either recognize the gain or reduce the basis of the plant by the gain amount. This decision is dependent on the company's accounting policies.

Answer 2

On January 1, 2004, Cardinal Corporation issued 5% 25-year bonds, assuming that Cardinal Corporation is neither bankrupt nor insolvent, the acquisition and retirement of the bonds results is B. The company can make an election to recognize a $500,000 gain or reduce the company's basis in the plant by $500,000.

Step-by-step explanation:

When Cardinal Corporation acquired the bonds on the open market for $11,500,000, it resulted in a discount of $500,000 ($12,000,000 - $11,500,000). Since the bonds were issued at par, the fair value adjustment of $500,000 represents a gain for Cardinal Corporation.

According to the accounting rules, the company has the option to recognize the gain immediately or reduce the basis of the plant. By recognizing the gain, the company would increase its net income by $500,000, resulting in a positive impact on its financial statements. However, if the company chooses to reduce the basis of the plant, it would allocate the gain to the cost of the plant, reducing its value by $500,000.

In conclusion, the correct answer is option (b) - The company can make an election to recognize a $500,000 gain or reduce the company's basis in the plant by $500,000.