Memorandum Bond

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					Accounting 381                                           Financial Accounting Research

Example Case Facts
In its current fiscal year, ABC Inc. extinguished two separate bond issues prior to
maturity. The first bond issue extinguished, the Class A bonds, resulted in a gain, while
the second bond issue extinguished, the Class B bonds, resulted in a loss. Since in
previous years, ABC Inc. has had numerous extinguishments of debt resulting in gains,
the company is treating this gain as an ordinary gain. However, since ABC, Inc. has
never before extinguished a bond prior to maturity at a loss, the company treated the loss
on the Class B bonds as an extraordinary item.
Accounting 381                                                Financial Accounting Research

Response in the form of a RESEARCH FILE MEMORANDUM

October 28, 1999


Prepared by: <YOUR NAME>

Client:         ABC, Inc.
Subject:        Early Extinguishment of Debt

Background: ABC, Inc. recently extinguished two of its bond issues prior to maturity. For one
of the bond issues, (the Class A bonds), a gain resulted from this early extinguishment. A loss on
the early extinguishment resulted for the other (Class B) bonds. Since ABC, Inc. had previously
extinguished numerous bonds before maturity at gains, the Company has classified this particular
gain as ordinary. However, it has classified the loss on the Class B bonds as an extraordinary
item, since ABC has never before extinguished at a loss.

Statement of research problem or question: Was the treatment of the early extinguishment of
the two bond issues in accordance with generally accepted accounting principles (GAAP)?

Plausible alternatives: The plausible alternatives range from treating both gains and losses as
extraordinary to treating both gains and losses as ordinary. Between these two extremes would be
a position in which one or the other is treated as ordinary, while the other is treated as

Proposed solution: According to GAAP, both the gain and the loss from the early
extinguishment of both bond issues should be treated as extraordinary. Whether or not there was
a previous extinguishment of these bonds has no effect on how they are to be reported.

Explanation and documentation: The research underlying this solution was conducted using the
Financial Accounting Research System (FARS) and the Lexis/Nexis Database Research System.
Both versions were current through (date of your research), and the searches resulted in FAS 4,
Paragraph 8, which requires all gains and losses from extinguishment, if material in amount,
receive extraordinary item treatment.

Other issues and additional considerations: The gains and losses on extinguishments from the
bonds should be segregated from the results of ordinary operations and shown net of taxes in a
separate section of the income statement as an extraordinary item.

Accounting 381                                                   Financial Accounting Research

Response in the form of a CLIENT LETTER

October 28, 1999

Mr. Stanley Albright
Vice President, ABC Inc.
123 SW Main
Portland, OR 97220

Dear Mr. Albright:

As you requested, I have researched the status of the early extinguishments of your Class A and
Class B bonds.

In analyzing generally accepted accounting principles regarding the early extinguishments of
debt, I have determined that both extinguishments should be treated as “extraordinary.” The
Class A bonds, retired at a gain, should appear as an extraordinary gain, (net of tax), on the
income statement. Likewise, the Class B bonds, retired at a loss, should appear as extraordinary
loss, (net of tax benefit), on the income statement. Both amounts are then totaled to result in
either an addition or subtraction to “income after tax.”

The basis for my conclusion is the result of a search of the authoritative literature that constitutes
generally accepted accounting principles. This literature directly addresses the above issues and
requires that all early retirements of debt, whether at a gain or loss, be reported as
“extraordinary,” even if such extinguishments are common in your business or in your industry.

Thank you for this opportunity to be of service, and please feel free to contact me with any
further questions or clarifications.



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