Herman Company received proceeds of ₤471,250 on 10-year, 8% bonds issued on January 1, 2015. The bonds had a face value of ₤500,000, 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, 2017. What amount of gain or loss would Herman report on its 2017 income statement?
A)₤23,000 gain
B)₤28,000 gain
C)₤28,000 loss
D)₤23,000 loss

Question

Quizplus · Accepted Answer

Herman issued the bonds at a discount since the coupon rate (8%) is less than the market rate. The discount is amortized over the life of the bonds using the straight-line method.
The total discount on the bonds is ₤28,750 (₤500,000 face value – ₤471,250 proceeds), which is amortized over 10 years or 20 semi-annual periods. The semi-annual amortization is ₤1,437.50 (₤28,750 ÷ 20).
As of January 1, 2017, two years or four semi-annual periods have passed since the bonds were issued. The unamortized discount is therefore ₤25,675 (16 x ₤1,437.50). The carrying amount of the bonds on January 1, 2017, is ₤474,325 (₤500,000 face value – ₤25,675 unamortized discount).
To redeem the bonds on January 1, 2017, Herman would need to pay the call price of 101, or ₤505,000 (₤500,000 face value x 101% call price).
Therefore, Herman would recognize a loss of ₤30,675 (₤505,000 payment – ₤474,325 carrying amount) on its 2017 income statement.

Herman Company Received Proceeds of ₤471,250 on 10-Year, 8% Bonds