Bonds are sometimes retired before the maturity date. The principal reason for retiring bonds early is to relieve the issuing corporation of the obligation to make future interest payments. If interest rates decline to the point that a corporation can borrow at an interest rate below that being paid on a particular bond issue, the corporation may benefit from retiring those bonds and issuing new bonds at a 10)Interesting rate. Most bond issues contain a call provision, permitting the corporation to redeem the bonds by paying a specified price, usually a few points above par. Even without a call provision, the corporation may retire its bonds before maturity by purchasing them in the open market. If the bonds can be purchased by the issuing’ corporation at less than their carrying value, a gain is realized on the retirement of the debt. If the bonds are reacquired by the issuing corporation at a price in excess of their carrying value, a loss must be recognized.
For example, assume that Briggs Corporation has outstanding a 13%, $10 million bond issue, callable on any interest date at a price of 104. Assume also that the bonds were issued at par and will not mature for nine years. Recently, however, market interest rates have declined to less than 10%, and the market price of Briggs’s bonds has increased to 106.11 Regardless of the market price, Briggs can call these bonds’ at 104. If the company exercises this call provision for 10% of the bonds ($1,000,000 face value) the entry will be: he FASB has ruled that the gains and losses from early retirements of debt be classified in a special section of the income statement and identified as extraordinary items. The presentation of extraordinary items is explained and illustrated.
“Falling interest rates cause bond prices to rise. On the other hand, falling interest rates also provide the issuing company with an incentive to call the bonds and, perhaps, replace them with bonds bearing a lower rate of interest. For this reason, call prices often serve as an approximate “ceiling” on market prices .of Goods, Sold account. When lease payments are received, the lessor should recognize an appropriate portion of the payment as representing interest revenue and the remainder as a reduction in Lease Payments Receivable.When equipment is acquired through a capital lease, the lessee should debit an asset account, Leased Equipment, and credit a liability account, Lease Payment Obligation, for the present value of the future lease payments. Lease payments made by the lessee arc allocated between Interest Expense and a reduction in the liability Lease Payment Obligation.
The portion of the lease payment obligation that will be repaid within the next year is classified as a current liability, and the remainder is classified as long-term. No rent expense is involved in ·a capital lease. The asset account Leased Equipment is depreciated by the lessee over the life of the equipment rather than the life of the lease. Accounting for capital leases is illustrated in Appendix C at the end of this textbook.
Distinguishing Between Capital Leases and Operating Leases The FASB has taken the position that the risks and returns of ownership transfer to the lessee under any of the following circumstances:
• The lease transfers ownership of the property to the lessee at the end of the lease term. : The lease contains a bargain purchase option.
• The lease term is equal to 75% or more of the estimated economic life of the leased property.
• The present value of the minimum lease payments amounts to 90% or more of the fair value of the lease property.
Thus, if a lease contains any of these provisions, it is viewed as a capital lease. Otherwise, it is accounted for as an operating lease. LO 7. Accountant for , post retirement costs. Liabilities for Pensions and Other Post retirement Benefits Pensions Many employers agree to pay their employees a pension; that is, monthly cash payments for life. beginning at retirement. Pensions are not an expense of the years in which cash payments are made to retired workers. Employees earn the right to receive the pension while they arc working for their employer. Therefore, the employer’s cost of future pension payments accrues over the years that each employee is on the payroll. Of course, the. amounts of the retirement benefits that will be paid to today’s workers after they retire arc not known with certainty. Among other things, ‘these amounts depend on how long retired employees live. Therefore, the employer’s obligation for future pension payments arising during undercurrent-year can only be estimated.
Employers do not usually pay retirement pensions directly to retired employees. Most . employers meet their pension obligations by making periodic deposits in a pension fund (or pension plan) throughout the years of each worker’s employment. A pension fund is 1/Ot (lit asset of the employer. Rather. it is an independent entity managed by a trustee (usually u bank or an insurance company). As the employer makes deposits in the pension fund, the trustee invests the money in securities such as stocks and bonds. Over time. the pension fund earns investment income ‘and normally accumulates to a balance far in excess of the predispositions. It is the pension fund not the Erlenmeyer=-that ‘disburses monthly pension benefits to retired workers. If the empiric meets all of its estimated pension obligations by promptly depositing cashing a pension fund, the pension fund is said to be fully funded. The operation of a fully funded pension plan is summarized in the illustration 011 the follow aging.