Herman Company received proceeds of $188,500 on 10-year, 8% bonds issued on January 1, 2009. The bonds had a face value of $200,000, 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, 2011. What amount of gain or loss would Herman report on its 2011 income statement?

Question

Quizplus · Accepted Answer

Using the straight-line method, the premium of $11,500 ($200,000 face value - $188,500 proceeds) is amortized over 20 semi-annual periods (10 years x 2 semi-annual periods per year). This means that the premium amortization per period is $575 ($11,500 / 20).

As of January 1, 2011, Herman would have amortized the premium for 2 years (4 semi-annual periods), resulting in accumulated amortization of $2,300 ($575 x 4).

To redeem the bonds, Herman would need to pay the call price of 101% of face value, or $202,000 ($200,000 x 101%). However, Herman would only receive credit for the carrying value of the bonds on its books, which is the face value of $200,000 minus the accumulated amortization of $2,300, or $197,700.

Therefore, Herman would have a loss on redemption of $4,300 ($197,700 carrying value - $202,000 call price). This loss would be reported on the 2011 income statement.

Herman Company Received Proceeds of $188,500 on 10-Year, 8% Bonds