Financial Accounting and Reporting-CPA Practice Exam

In the context of bond liabilities, what is meant by ‘call privileges’?

1. The right to redeem bonds before maturity

2. The option to reduce interest payments

3. The ability to increase premium payments

4. The requirement to repay principal in segments

The correct answer is: The right to redeem bonds before maturity

Call privileges refer to the issuer's right to redeem or buy back bonds before their scheduled maturity date. This feature allows the issuer to take advantage of favorable market conditions, such as declining interest rates, enabling them to issue new debt at a lower cost or to eliminate debt when cash flows are sufficient. Having the ability to call bonds early can be an advantageous feature for issuers because it offers flexibility in managing their outstanding debt. If interest rates fall, for example, the issuer may choose to call the existing bonds and reissue new bonds at a lower interest rate, thus reducing overall borrowing costs. The other options do not accurately describe what call privileges mean in the context of bond liabilities. Reducing interest payments or increasing premium payments pertains more to the terms of the bond's interest and payment structure rather than the right to redeem. The concept of repaying principal in segments generally relates to amortizing loans rather than bond redemption practices.