# Face amount of bonds due at maturity results in total

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face amount of bonds due at maturity, results in total bond payments of \$57,703 ,053. Had this company not redeemed the bonds, it would have paid four additional interest payments of \$2,000,000 ea plus the face amount of \$50,000,000 at maturity, for total bond payments of \$58 ,000 ,000. On the surface, it appears that the firm is able to save \$296,947 by redeeming the bonds and, therefore, reports a gain. (Also, total interesz expense on the new bond issue is \$3,168,333 [\$11 ,168,333 - \$8,000,000] more than it would have recorded und the old issue; so, although it is recording a present gain, it also incurs future higher interest costs which are u recognized under GAAP.) However, this gain is misleading. Specifically, this gain has two components. First, interest payments increase b; \$792,083 per year (\$2,792,083 - \$2,000,000). Second, the face amount of the bond that must be repaid in four years decreases by \$3,465,280 (\$50,000,000 - \$46,534,720). To evaluate whether a real gain has been realized, we mus; consider the present value of these cash outflows and savings. The present value of the increased interest outflow, four-period annuity of \$792,083 discounted at 6% per period, is \$2,744,655 (\$792,083 X 3.46511). The present value of the reduced maturity amount, \$3,465,280 in four periods, is \$2,744,814 (\$3,465,280 X 0.79209)-note: the amounts differ by \$159, which is due to rounding. The conclusion is that the two amounts are the same. Thisanalysis showsthereisnorealeconomic gainfrom earlyredemption ofdebt. The present value of tbe increased interest payments exactly offsets the present value of the decreased amount due at maturity. Why, then.. does GAAP yield a gain? The answer lies in use of historical costing. Bonds are reported at amortized cost, that is.. the face amount less any applicable discount or plus any premium. These amounts are a function of the bond iSSUE price and its yield rate at issuance, which are both fixed for the life of the bond. Market prices for bonds, however. vary continually with changes in market interest rates. Companies do not adjust bond liabilities for these changes in market value. As a result, when companies redeem bonds, their carrying amount differs from market value anC GAAP reports a gain or loss equal to this difference.
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