Modern Brands recently completed a large debt refinancing. 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.

Modern Brands had $160 million of 5 1/4% bonds payable outstanding, with 20 years to maturity. Modern retired these old bonds by issuing $80 million of new 13% bonds payable to the holders of the old bonds and paying the bondholders $17 million in cash. Modern issued both groups of bonds at face value. At the time of the debt refinancing, Modern Brands had total assets of $503 million and total liabilities of $359 million. Net income for the most recent year was $6.1 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 Modern Brands refinance the old 5 1/4% bonds payable with the new 13% bonds? Consider interest expense, net income, the leverage ratio and the debt ratio.