On 1 January 2009, a company that prepares its financial statements according to IFRS issued bonds with the following features:
| Face value | ￡20,000,000 |
| Term | 5 years |
| Coupon rate | 6% paid annually on December 31 |
| Market rate at issue | 4% |
The company did not elect to carry the bonds at fair value. In December 2011 the market rate on similar bonds had increased to 5% and the company decided to buy back (retire) the bonds after the coupon payment on December 31. As a result, the gain on retirement reported on the 2011 statement of income is closest to:
C is correct.
The market value of debt at retirement can be determined by discounting the future cash flows at the current market rate (5%) using a financial calculator:
FV = 20,000,000; i = 5%; PMT = 1,200,000; N = 2; Compute PV = 20,371,882
The book value after the third interest payment (two payments remaining) can be found either using a financial calculator and the market rate at the time of issue (4%) or an amortization table (shown below).
FV = 20,000,000; i = 4%; PMT = 1,200,000; N = 2; Compute PV = 20,754,438.
The bond’s initial value (required for amortization) can be found using a financial calculator:
FV = 20,000,000; i = 4%; PMT = 1,200,000; N = 5; Compute PV = 21,780,729.
