Nickel Inc.bought $100,000 of 3-year,6% bonds as an investment on December 31,2015 for $106,000.Nickel uses straight-line amortization.On May 1,2016,$10,000 of the bonds were redeemed at 110.As a result of the retirement,MSG will report:

Question

Quizplus · Accepted Answer

First, let's calculate the annual interest payment on the bonds:

Annual interest payment = $100,000 x 6% = $6,000

Since Nickel uses straight-line amortization, we can divide the premium paid ($106,000 - $100,000 = $6,000) by the term of the bonds (3 years) to determine the annual amortization:

Annual amortization = $6,000 ÷ 3 = $2,000

After the bonds were held for five months (from December 31, 2015 to May 1, 2016), Nickel would have recognized $1,000 of amortization ($2,000 ÷ 12 x 5). The carrying value of the bonds before retirement would have been:

Carrying value before retirement = $106,000 - $1,000 = $105,000

When $10,000 of the bonds were redeemed at 110 on May 1, 2016, Nickel would have received $11,000 ($10,000 x 110%). The gain or loss on redemption is calculated as the difference between the proceeds received and the carrying value of the bonds:

Gain or loss on redemption = $11,000 - $105,000 = -$94,000

Since the gain or loss on redemption is negative, it represents a loss. However, this loss needs to be offset by the unamortized premium that was not yet recognized as interest income. At the time of the redemption, there would have been $4,000 ($6,000 - $1,000) of unamortized premium remaining. This amount would be recognized as interest income immediately before the bonds were retired. Therefore, the net effect of the redemption on Nickel's income statement would be:

Interest income (recognized before retirement) = $4,000
Loss on redemption = -$94,000

Net effect = $4,000 - $94,000 = -$90,000

This represents a loss of $90,000, but it is important to note that this loss is only a temporary bookkeeping entry. The actual financial impact of the redemption would be the $11,000 that Nickel received in cash, which is greater than the $10,600 ($106,000 - $90,000) that Nickel originally paid for the bonds. Therefore, the loss will eventually be reversed over the remaining life of the bonds as the unamortized premium is recognized as interest income each year. Since the loss on redemption is less than the remaining unamortized premium of $4,000, the net effect on Nickel's income statement is a gain of $467 ($4,000 - $90,000).