Redemption of Bonds Payable: Accounting and Journal Entries
Understand the accounting principles for retiring corporate bonds. See how the settlement of bond debt is accurately recorded and reflected in financial reports.
When a company issues bonds, it takes out a loan from investors. The redemption of bonds payable is the repayment of the principal amount to the bondholders, which must be carefully recorded. This transaction concludes the bond’s lifecycle from the issuer’s perspective, extinguishing the liability from its balance sheet and formally ending the borrowing agreement.
Redemption at Maturity vs Early Redemption
A bond’s redemption timing is determined by its indenture, the contract between the issuer and bondholders. The most straightforward scenario is redemption at maturity. In this case, the company repays the bond’s face amount, also known as par value, to investors on the specified maturity date after all periodic interest payments have been made.
A company may also have the option to redeem its bonds before the scheduled maturity date, a process known as early redemption. This is possible if the bonds are designated as callable, which contain a provision giving the issuer the right to repay the debt early. Companies typically exercise this option when market interest rates fall below the bond’s stated interest rate, allowing them to refinance their debt at a lower cost.
To compensate investors for the risk of an early call, the issuer usually pays a call price that is higher than the bond’s face value. This call price is often expressed as a percentage of the par value, such as 102, meaning the company pays $1,020 for every $1,000 of face value. The decision to redeem early is aimed at reducing future interest expense.
Calculating the Bond Carrying Value
To properly account for a bond redemption, a company must determine the bond’s carrying value, or book value. The carrying value represents the bond’s liability amount as recorded on the company’s balance sheet. It is calculated by taking the face value and adjusting for any unamortized premium or discount that arose when the bond was issued.
When a bond’s stated interest rate is higher than the market interest rate at issuance, investors will pay more than its face value, creating a premium. For example, if a $100,000 bond is sold for $103,000, it has a $3,000 premium. This premium is amortized, or gradually reduced, over the life of the bond, causing the carrying value to decrease over time until it equals the face value at maturity.
Conversely, if a bond’s stated interest rate is lower than the market rate, it will sell for less than its face value, creating a discount. A $100,000 bond sold for $98,000 has a $2,000 discount. This discount is also amortized over the bond’s life, but its amortization increases the bond’s carrying value over time. At any point, the carrying value is the face value plus unamortized premium or minus unamortized discount.
How to Calculate Gain or Loss on Redemption
When a bond is redeemed before its maturity date, the transaction often results in a financial gain or loss. This outcome is determined by comparing the bond’s carrying value at the redemption date with the cash paid to redeem it. The bond’s carrying value minus the redemption price equals the gain or loss.
A gain on redemption occurs if the cash paid to retire the bonds is less than the bond’s carrying value. For instance, if a company has bonds on its books with a carrying value of $102,000 and redeems them for $99,000, it would recognize a gain of $3,000. This gain reflects that the company settled its debt for less than its recorded liability.
A loss on redemption happens when the cash paid is greater than the bond’s carrying value. This is a common scenario with callable bonds, where the call price is set at a premium. For example, if a bond has a carrying value of $98,000 but the call price is 101 ($101,000), the company would pay $101,000 to redeem it, resulting in a $3,000 loss. This loss is reported on the company’s income statement.
Journal Entries for Redeeming Bonds
The redemption process is finalized by recording the transaction in the company’s general ledger with a journal entry. This entry must remove the bond liability from the balance sheet, account for the cash paid, and recognize any resulting gain or loss.
For a redemption at maturity, the carrying value equals the face value because any premium or discount has been fully amortized. If a company redeems a $100,000 bond at maturity, the journal entry is a debit to Bonds Payable for $100,000 and a credit to Cash for $100,000.
When a bond is redeemed early at a loss, the entry is more complex. Assume a bond with a $100,000 face value and a remaining unamortized discount of $2,000 is redeemed for $99,000 cash. The carrying value is $98,000 ($100,000 – $2,000). The entry is a debit to Bonds Payable for $100,000, a debit to Loss on Bond Redemption for $1,000, a credit to Discount on Bonds Payable for $2,000, and a credit to Cash for $99,000.
If a bond is redeemed early at a gain, the entry reflects this positive outcome. Consider a bond with a $100,000 face value and an unamortized premium of $3,000, giving it a carrying value of $103,000. If it is redeemed for $102,000 cash, the company has a $1,000 gain. The journal entry would debit Bonds Payable for $100,000, debit Premium on Bonds Payable for $3,000, credit Cash for $102,000, and credit Gain on Bond Redemption for $1,000.