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Bond Amortization and Gain or Loss Recognition

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on 23 June 2014

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Transcript of Bond Amortization and Gain or Loss Recognition

Bond Amortization and Gain or Loss Recognition
Natalie Pace
Bond Amortization

Straight-Line Method:
Applies a constant

amount in amortizing the
debt, which changes the effective
interest rate over its life.
Effective-Interest Method:
Applies a constant
interest rate

in amortizing the debt, which makes the dollar amount of the premium or discount
amortized vary
over its life.
The value of the discount or premium amortized is the same with both methods
Amortization Using the Effective-Interest Method
Step-by-Step Example
Discount Amortization
Devon Harris Company sells 10%
bonds having a maturity value of
$2,000,000 for $1,855,816.
The bonds are dated
January 1, 2014, and mature
January 1, 2019. Interest is payable
annually on January 1.
The discount on the bonds payable is $144,184
We need to find the
effective-interest rate.
Using Excel or a financial calculator...
n = 5
i% =
PV = 1,855,816
PMT = -200,000
FV = -2,000,000
Face Value of Bond x Coupon Rate x Fraction of Year - Carrying Value of Bond BOY x Effective Rate x Fraction of Year= Amortization Amount
(2,000,000 x 10% x 12/12) - (1,855,816 x 12% x 12/12) = (22,697.92)
= Bond Discount
Old Carrying Amount + Discount Amortized
1,855,816 + 22,697.92
Early Extinguishment of Debt:
Recognizing Gains and Losses
Gains and losses can theorectically be accounted for in three ways:
Amortize over remaining life of old debt.
Amortize over the life of the new debt issue.
Recognize in the period of extinguishment.
The first two approaches:
Argue that gains or losses associated with extinguishing
debt is directly impacted by either the old debt or the new debt issue, and therefore those gains and losses shouldn't be recognized in full.
Immediate Recognition is Generally Accepted
The treatment of early extinguishments is no different than other types of debt that
are paid off, and should be recognized right away.
In Addition...
It has been argued that amortizing these types of gains and losses can help minimize "misuses of debt extinguishments"
(Carpenter, n.d., p. 60).
ASC 470-50-45
Should be reported as ordinary gains and losses unless they meet the criteria for extraordinary treatment.
ASC 470-50-40-2
Gains and losses should be reported as separate items, either as a disclosure or a separate line item on the income statement.
Carpenter, B. (n.d.). An examination of the reporting
and disclosure of early debt extinguishments. Journal of Applied Business Research, 13, 60.
Full transcript