Practical Ltd issued $100,000 in 4-year, 6 per cent annual debentures for Theoretical Ltd on 1 July 2002. The market required rate of return on the debentures at the time of issue was 8 per cent. Theoretical Ltd decides to forgive the debt on 1 July 2004. Any premium or discount is amortised straight-line. What is the entry in the books of Theoretical Ltd to record the forgiveness of the debt?
E) None of the given answers.

Question

Quizplus · Accepted Answer

When Theoretical Ltd forgives the debt, Practical Ltd's liability to pay is extinguished. Theoretical Ltd should record the amount of the debt forgiven as a gain in the income statement. The amount of the gain is calculated as the difference between the carrying value of the debt and the amount paid to acquire it. The carrying value of the debt is the issue price ($100,000) plus the premium amortised to date ($12,000 - $6,000 = $6,000). Therefore, the carrying value is $106,000. The amount paid to acquire the debt is $100,000. Therefore, the gain on forgiveness is $6,000. The entry to record the forgiveness is:
Debit: Debenture receivable $106,000
Credit: Gain on forgiveness of debt $6,000
Credit: Debenture payable $100,000

Practical Ltd Issued $100,000 in 4-Year, 6 Per Cent Annual