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Unformatted text preview: t income $27,000 (3,517) $23,483 The loss is not a decrease in the wealth of the company if it intends to keep the bonds outstanding until maturity. However, if Beasley intends to retire this debt, the loss represents a decrease in wealth because Beasley will sacrifice net assets of $3,517 to do so. d. Extraordinary Realized Loss on Retirement of Debt Bonds Payable 3,517 100,000 Discount on Bonds Payable 5,350 Cash 98,167 Once the repurchase has occurred, the loss has been realized because a reduction in net assets has occurred. Before this occurs, however, the loss is unrealized and may be misleading if the company intends to keep the bonds until maturity. E11–21 a. The effective interest rate can be calculated in two ways. The first way is by solving for i in the following equation where n=2 since there are two periods until maturity (12/31/12, the balance sheet date and maturity at 12/31/14). $193,059 = [($200,000 (1 + i )­2] + {$10,000 [(1 – [(1 + i)­2 + i ]} The second way is by trial and error. Simply plug an interest rate into the equation above until the right­hand side of the equation equals the left hand side. Since the bond is issued at a discount, we start with the knowledge that the effective rate is greater than the stated rate of 5%. The annual effective interest rate for the bonds is 6.92%. b. To determine the effective rate an investor would be earning if the bonds were purchased on 12/31/12 at the market value of $186,479, perform the same procedure using the equation. $186,479 = [($100,000 (1 + i )­2] + {$5,000 [(1 – [(1 + i)­2 + i ]} The annual effective interest rate for the bonds is 8.83%. c. The book value of the bonds on Cohort Enterprises’ books at December 31, 2012 is $193,059. The market value of the bonds as of December 31, 2012 is $186,479. The difference represents a gain of $6,580. It is a gain because if Cohort Enterprises were to repurchase these bonds on the market in order to retire them, it would have to pay $6,580 less than the boo...
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