Math  /  Numbers & Operations

QuestionOn July 1, Aloha Company exercises a call option that requires Aloha to pay $408,000\$ 408,000 for its outstanding bonds that have a carrying value of $416,000\$ 416,000 and a par value of $400,000\$ 400,000. The company exercises the call option after the semiannual interest is paid the day before on June 30.
Record the entry to retire the bonds.

Studdy Solution

STEP 1

What is this asking? We need to record the journal entry when a company buys back its own bonds for a bit more than their current value, right after paying the interest owed. Watch out! Don't forget that the interest payment is a separate transaction and has already been recorded!
We only need to account for the difference between what the bonds are worth to the company ($416,000\$416,000) and what the company paid to retire them ($408,000\$408,000).

STEP 2

1. Calculate the gain or loss.
2. Prepare the journal entry.

STEP 3

We're **comparing** the carrying value of the bonds to the cash paid to retire them.
The carrying value is what the bonds are *currently* worth on Aloha's books, which is $416,000\$416,000.
Aloha paid $408,000\$408,000 to retire the bonds.

STEP 4

To find the **gain or loss**, we subtract the cash paid from the carrying value:
$416,000$408,000=$8,000 \$416,000 - \$408,000 = \$8,000

STEP 5

Since the result is **positive**, Aloha has a **gain** of $8,000\$8,000.
This means they essentially saved money by retiring the bonds for less than they were worth on their books!

STEP 6

To retire the bonds, Aloha *debits* **Bonds Payable** for the *par value* of the bonds, which is $400,000\$400,000.
This removes the bonds from Aloha's books.

STEP 7

Since the carrying value of the bonds ($416,000\$416,000) is higher than the par value ($400,000\$400,000), there's a **premium** associated with these bonds.
This premium needs to be removed as well.
So, we *debit* **Premium on Bonds Payable** for the difference, which is $416,000$400,000=$16,000\$416,000 - \$400,000 = \$16,000.

STEP 8

We also need to account for the **gain** we calculated earlier.
A gain increases equity, so we *credit* **Gain on Retirement of Bonds** for $8,000\$8,000.

STEP 9

Finally, Aloha paid cash to retire the bonds, so we *credit* **Cash** for the amount paid, which is $408,000\$408,000.

STEP 10

Here's the **final journal entry**:
Debit **Bonds Payable** $400,000\$400,000 Debit **Premium on Bonds Payable** $16,000\$16,000 Credit **Gain on Retirement of Bonds** $8,000\$8,000 Credit **Cash** $408,000\$408,000

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