Gain or Loss on Extinguishment of Debt
Gain or loss on extinguishment of debt is the difference between fair value and the carrying amount of debt on the date it paid off. Debt extinguishment happens when the debt issuer recalls the securities before the maturity date. This occurs due to various situations such as interest rate change, the issuer has cash surplus, and so on.
If the bond or other debt securities remain outstanding in the market up to the maturity date, there will be no gain or loss as the discount or premiums are already take into account and fully amortize over the life. As a result, the carrying amount will be the same as the fair value on the maturity date.
Due to other reasons, issuer decides to extinguish the debt, the gain or loss must be recognized immediately into income statement.
| Gain or Loss = Net Carry Amount – Repurchase price |
Net Carry amount of debt is the amount payable at the maturity date adjusted with unamortized premium or discount and transaction cost.
The repurchase price is the amount company pays to purchase the security from the market.
Gain
It happens when the Net Carry amounts greater than the repurchase price. It means the company pays less than the amount they expect to pay at the maturity date.
Loss
It happens when the company pays higher than the net carry amount of debt. It will be more profitable if we wait until the maturity date.
Example of debt extinguishment
For example, Company A issue the bond with majority amount of $ 100,000 and 5% interest rate for 10 years. However, it was issued at the premium of $ 105,000 instead, and the issue cost is $ 8,000.
After 5 years, company decides to buy back at $101,000 for the same bond.
What is the gain or loss on extinguishment of the bond?
Net carry amount:
Face value $ 100,000
Remaining Premium 5,000 * 5/10 2,500
Remaining Cost 8,000 * 5/10 (4,000)
Total 98,500
Repurchase price $ 101,000
Loss = 98,500 – 101,000 = $ 2,500
Mean that company loss $ 2,500 from extinguishing the bond.
The journal entries for bond extinguishment should be:
| Account | Debit | Credit |
|---|---|---|
| Bonds Payable | 100,000 | |
| Premium Bonds Payable | 2,500 | |
| Loss on Extinguishment | 2,500 | |
| Cost of Bonds Issue | 4,000 | |
| Cash | 101,000 |