Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 109

Bonds payable—callable Riley Co. has outstanding $40 million face amount of 15% bonds that were issued on January 1, 1998, for $39,000,000. The 20-year bonds mature on December 31, 2017, and are callable at 102 (that is, they can be paid off at any time by paying the bondholders 102% of the face amount).

Required:

a. Under what circumstances would Riley Co. managers consider calling the bonds?

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b. Assume that the bonds are called on December 31, 2010. Use the horizontal model (or write the journal entry) to show the effect of the retirement of the bonds. (Hint: Calculate the amount paid to bondholders; then determine how much of the bond discount would have been amortized prior to calling the bonds; and then calculate the gain or loss on retirement.)

Step 1 of 4

a.

The company is having 15% bonds payable with face value of $30,000,000 issued on January 1, 2001 for $29,250,000. The 20 year bonds mature on December 31, 2020 and are callable at 102.

Circumstances under which the managers would consider calling the bonds:

Calling of bonds means paying off the bonds (repayment of bonds) by the issuer before the scheduled maturity date of the bonds.

1) Managers would consider paying off the bonds if the company has excess amount of cash that will not needed for operations in the instant future. By paying off the bonds, the company would save the interest expense that is payable on bonds in the future.

2) In case of falling in the market interest rates below the rate paying by the company on the bonds, the managers would pay off the bonds and issue new bonds at a lower rate of interest to reduce the interest costs.

The managers would pay off the bonds in the above circumstances to save the interest costs.