Upon retirement of the bonds, any resulting gain on retirement of the bonds should be reported in income statement when
a. Retirement price is less than the carrying value of the bonds
b. Retirement price is greater than the carrying value of the bonds
c. Retirement price is equal to the carrying amount of the bonds
d. None of the above
The correct answer and explanation is :
The correct answer is b. Retirement price is greater than the carrying value of the bonds.
Explanation:
When a company retires bonds before their maturity date, it may either retire the bonds at a price greater than or less than their carrying value (book value). The difference between the retirement price and the carrying value of the bonds results in a gain or loss, which must be reported on the income statement. The accounting treatment depends on whether the retirement price is higher or lower than the carrying value.
1. When the Retirement Price is Greater Than the Carrying Value:
If the company retires the bonds at a price greater than their carrying value, it incurs a loss on retirement, which is reported on the income statement. This is because the company is paying more to retire the bonds than the amount it originally owed (the carrying value). However, this is contrary to the question’s framing, as it asks about a gain resulting from retirement.
2. When the Retirement Price is Less Than the Carrying Value:
On the other hand, if the company buys back or retires the bonds for less than their carrying value, the company will recognize a gain on the retirement. This gain arises because the company is paying less than the carrying value of the bonds to settle the liability. This gain is reported in the income statement as it directly impacts the company’s profitability for that period.
3. When the Retirement Price Equals the Carrying Value:
If the retirement price is equal to the carrying value of the bonds, no gain or loss is recognized. This situation results in a neutral transaction because the company pays exactly what it owes, so there is no difference to report in the income statement.
Conclusion:
Therefore, the correct scenario where a gain would be reported on the income statement is when the retirement price is less than the carrying value of the bonds, as the company is retiring the bonds at a cheaper price than originally recorded, thus realizing a gain.