Page 607 - Accounting Principles (A Business Perspective)

15. Long-term financing: Bonds

An issuer may redeem some or all of its outstanding bonds before maturity by calling them. The issuer may also
purchase bonds in the market and retire them. In either case, the accounting is the same. Assume that on 2012
January 1, Carr calls bonds totaling USD 10,000 of the USD 100,000 face value bonds in Exhibit 121 at 103, or USD

10,300. Even though accrued interest would be added to the price, assume that the interest due on this date has
been paid. A look at the last column on the line dated 2011/12/31 in Exhibit 121 reveals that the carrying value of
the bonds is USD 102,723, which consists of Bonds Payable of USD 100,000 and Premium on Bonds Payable of
USD 2,723. Since 10 per cent of the bond issue is being redeemed, Carr must remove 10 per cent from each of these
two accounts. The firm incurs a loss for the excess of the price paid for the bonds, USD 10,300, over their carrying
value, USD 10,272. The required entry is:

2012
Jan. 1 Bond payable (-L) 10,000
Premium on bonds payable ($2,723/10) (-L) 272
Loss on bond redemption 9$10,272 - $10,300) 28
(-SE)
Cash (-A) 10,300
To record bonds redeemed.
According to FASB Statement No. 4, gains and losses from voluntary early retirement of bonds are
extraordinary items, if material. We report such gains and losses in the income statement, net of their tax effects, as
described in Chapter 13. The FASB is currently reconsidering the reporting of these gains and losses as
extraordinary items.
To avoid the burden of redeeming an entire bond issue at one time, companies sometimes issue serial bonds
that mature over several dates. Assume that on 2002 June 30, Jasper Company issued USD 100,000 face value, 12
per cent serial bonds at 100. Interest is payable each year on June 30 and December 31. A total of USD 20,000 of

the bonds mature each year starting on 2010 June 30. Jasper has a calendar-year accounting period. Entries
required for 2010 for interest expense and maturing debt are:
2010
June 30 Bond interest expense ($100,000 x 0.12 x ½) (-SE) 6,000
Cash (-A) 6,000
To record interest payment.

30 Serial bonds payable (-L) 20,000
Cash (-A) 20,000
To record retirement of serial debt.
Dec. 31 Bond interest expense ($80,000 x 0.12 x ½) (-SE) 4,800
Cash (-A) 4,800
To record payment of semiannual interest expense.
Note that Jasper calculates the interest expense for the last six months of 2010 only on the remaining
outstanding debt (USD 100,000 original issue less the USD 20,000 that matured on 2010 June 30). Each year after
the bonds maturing that year are retired, interest expense decreases proportionately. Jasper reports the USD
20,000 amount maturing the next year as a current liability on each year-end balance sheet. The remaining debt is
a long-term liability.

Naturally, bond investors are concerned about the safety of their investments. They fear the company may
default on paying the entire principal at the maturity date. This concern has led to provisions in some bond
indentures that require companies to make periodic payments to a bond redemption fund, often called a
sinking fund. The fund trustee uses these payments to redeem a stated amount of bonds annually and pay the

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