Question

A corporation called an outstanding bond obligation four years before maturity. At that time there was an unamortized discount of $300,000. To extinguish this debt, the company had to pay a call premium of $100,000. Ignoring income tax considerations, how should these amounts be treated for accounting purposes? A) Amortize $400,000 over four years B) Charge $400,000 to a loss in the year of extinguishment C) Charge $100,000 to a loss in the year of extinguishment and amortize $300,000 over four years D) Either amortize $400,000 over four years or charge $400,000 to a loss immediately, whichever management selects

Answer 1

Answer:

B) Charge $400,000 to a loss in the year of extinguishment.

Explanation:

The $300,000 of amortized discount means that the corporation issued the bonds at a discount and was amortizing the discount over the bond's lifespan.  A discount is already a loss, and we must add the $100,000 that the corporation had to pay in excess (premium) to repurchase the bonds. So the total loss resulting from this bond issuance and repurchase was $300,000 + $100,000 = $400,000. Accrual accounting recognizes losses as soon as they happen, so this loss must be recognized as soon as the bonds are repurchased.