Unformatted text preview: nted to retire the
bonds through the bond market, it would have to pay less than the value of the bonds per the company's
financial records. Therefore, the effective liability of the company has decreased, which implies that the
company has experienced an economic gain. The gain would be the excess of the bonds' book value over
the bonds' market value, or $1,293.44.
c. Companies experience economic gains and losses when their wealth changes. In the case of bonds, their
market value indicates the company's effective obligation on the bonds at that particular point in time. If the
market value exceeds the bonds' book value, then the company has experienced a decrease in wealth; if
the market value is less than book value, then the company has experienced an increase in wealth.
Such gains and losses, however, are not usually reflected in a company's financial statements because it
is assumed that when a company issues bonds, the bonds will remain outstanding until they mature. That
is, the company will not retire the bonds before they mature. On the date that the company issued the
bonds, the company locked into the market rate of interest on that day. This means that the effective
interest rate on the date the bonds are issued is the interest rate the company expects to incur over the
life of the bonds. Thus, the economic gains and losses due to fluctuations in the market interest rate will
essentially "wash out" over the life of the bonds because the bonds are expected to remain outstanding
until they mature. Economic gains or losses associated with changes in the market interest rate are only
reflected in a company's financial statements when a company retires some bonds prior to their maturity
If you were analyzing Treadway's financial statements, you might want to adjust the amounts reported for
notes and bonds to reflect the prevailing market interest rate. In this manner, the statements would more
accurately reflect the company's economic liability—and hence associate...
View Full Document
- Fall '08