Under SFAS No. 115, investors are required to report investments in debt securities that are not to be held-to-maturity at fair value rather than at amortized cost. Debtors are not covered by the provisions of SFAS No. 115. Debtors report their obligations for the same securities as liabilities, measured at amortized cost.

At December \(31,20 \times 1\), IOU Corp. reported a \(\$ 100,000,8\) percent bond payable due in sixteen years as a long-term liability net of unamortized premium of \(\$ 1,450\). Interest rates have risen since the bond was issued, and the current market price for the bond is \(\$ 98,000\).

Required:

a. Under SFAS No. 115 , the investor reported the IOU bond at \(\$ 98,000\). Because the bond was classified as available-for-sale, the holding loss was reported as a component of comprehensive income. Explain the rationale for this reporting procedure.

b. In your opinion, why, under GAAP, would IOU report the same debt instrument in a different way? Are the circumstances for the debtor different from those for the creditor? Can one party to the instrument have a loss and the other not have a gain? Explain. (In your answer, assume that IOU does not plan to pay the debt off until maturity.)

c. Would your answer to (b) be different if IOU planned to pay off the debt in the near future? Explain.

d. Ignoring transaction costs, such as bond issue costs, if IOU can pay off the debt at \(\$ 98,000\) but chooses not to, is there an economic gain or loss to the company? What should IOU take into consideration in making a decision to pay the debt?

e. Assume that IOU has the opportunity to refund the bonds by issuing similar debt having a fair value of \(\$ 98,000\). What would be the effects of the refunding on the IOU financial statements? Since no cash changed hands, is the economic substance of the refunding transaction really different from simply leaving the same debt outstanding? If not, do you believe that IOU should report the existing debt at \(\$ 98,000\) or should it leave it at amortized cost? Explain.