Question

Sand, Inc. has outstanding $5,000,000, 10%, 20-year bonds. The bonds are callable at 104 on any interest date. The bonds were issued at par and mature in 10 years. Recently, interest rates have declined to 5% and the market price of the bonds has increased to 107. If the company exercises the call provision, the company will record:
A) A credit to cash of $5,350,000.
B) A loss of $200,000 on its income statement in the year the bonds are called.
C) A loss of $20,000 in the year the bonds are called and a $20,000 loss for the next 9 years.
D) A gain of $50,000 in the year the bonds are called.

Answer 1

Answer: B) A loss of $200,000 on its income statement in the year the bonds are called.

Explanation:

The bonds were issued at Par. This means they were issued at 100 of par.

The bonds are now trading at 104 of par.

If Sand Inc calls the bonds then they will make a profit (loss) of,

= 5,000,000 * 104/100

= $5,200,000

Therefore their Profit (loss) will be the bond at par minus the Calling price

= 5,000,000 - 5,200,000

= -$200,000

That means they make a loss of $200,000 in the year the bonds are called.

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