Great Brands completed one of the most famous debt refinancings in history. A debt refinancing occurs when a company issues new bonds payable to retire old bonds. The company debits the old bonds payable and credits the new bonds payable.

Great Brands had $140 million of 5 3/4% bonds payable outstanding, with 21 years to maturity. Great retired these old bonds by issuing $77 million of new 11% bonds payable to the holders of the old bonds and paying the bondholders $8 million in cash. Great issued both groups of bonds at face value. At the time of the debt refinancing, Great Brands had total assets of $497 million and total liabilities of $357 million. Net income for the most recent year was $6.2 million on sales of $1 billion.

Requirements

1. Journalize the debt refinancing transaction.

2. Compute annual interest expense for both the old and the new bond issues.

3. Why did Great Brands refinance the old bonds 5 3/4% payable with the new 11% bonds? Consider interest expense, net income, and the debt ratio.