At the beginning of 2011, Wheel R. Dealer purchased the net assets of Consolidated Corp. by issuing 10-year, 10% bonds with a face value of $100,000,000, with semiannual interest payments made on June 30 and December 31 and no interest payments made until 2016. Dealer hopes to sell off assets of Consolidated and realize enough cash to buy back the bonds on the open market prior to interest payments becoming due in 2016. At the end of 2013, Dealer sold net assets with a carrying value of $85,000,000 for $70,000,000 and used the proceeds to retire the bond issue.
Instructions:
1. Prepare the journal entry to record the issuance of the bonds on January 2, 2011, assuming a market rate of 8%.
2. Prepare the journal entry to record the sale of the net assets.
3. Compute the market value of the bonds on January 3, 2014, the day of retirement, assuming a market rate of 14%.
4. Prepare the journal entry to record the retirement of the bond issue on January 3, 2014, assuming a carrying value of $96,000,000 and the market value as computed in (3).
5. Explain how Mr. Dealer can buy his bonds back three years after their initial sale for less than he originally sold them for and without ever having made an interest payment.
6. Should Mr. Dealer be able to reduce the liability to market value even if he does not retire the bonds?