Question

Bonds issued by a company remain on their books as a liability, but are considered constructively retired when

A) The company borrows money from unaffiliated entities to repurchase its own bonds at a gain.
B) The company borrows money from an affiliate to repurchase its own bonds at a gain.
C) The company's parent or subsidiary purchases the bonds from outside entities.
D) The company borrows money from an affiliate to repurchase its own bonds at a gain or at a loss.

Answer 1

Bonds are constructively retired when a company's parent or subsidiary purchases them from outside entities, which keeps the obligation within the corporate family and changes the nature of the liability.

Step-by-step explanation:

Bonds issued by a company are considered a liability on the company's books and are expected to be repaid over time. These bonds can be constructively retired in certain circumstances, and understanding this concept is important when analyzing a company's financial health and obligations.

In the context given, bonds are considered constructively retired when the company's parent or subsidiary purchases the bonds from outside entities (Option C). This is because such a transaction would effectively remove the bonds from the market, and the obligation would essentially stay within the corporate group, which alters the nature of the liability.

Borrowing from banks and issuing bonds are both ways for a firm to access financial capital. Each method has its advantages and disadvantages, particularly relating to scheduled interest payments and impacts on company control and ownership.