Page 608 - Accounting Principles (A Business Perspective)

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accrued bond interest. The trustee determines which bonds to call and uses the cash deposited in the fund only to
redeem these bonds and pay their accrued interest.
To illustrate, assume Hand Company has 12 per cent coupon bonds outstanding that pay interest on March 31

and September 30 and were issued at face value. The bond indenture requires that Hand pay a trustee USD 53,000
each September 30. The entry for the payment to the trustee is:
Sept. 30 Sinking fund (+A) 53,000
Cash (-A) 53,000
To record payment to trustee of required deposit.
The trustee calls USD 50,000 of bonds, pays for the bonds and accrued interest, and notifies Hand. The trustee
also bills Hand for its fee and expenses incurred of USD 325. Assuming no interest has been recorded on these

bonds for the period ended September 30, the entries are:
Sept.30 Bonds Payable (-L) 50,000
Bond interest expense (-SE) 3,000
Sinking fund (-A) 53,000
To record bond redemption and interest paid by trustee.

30 Sinking fund expense (-SE) 325
Cash (-A) 325
To record trustee fee and expenses.
If a balance exists in the Sinking Fund account at year-end, Hand includes it in a category labeled Investments
or Other Assets on the balance sheet. Hand would describe the USD 50,000 of bonds that must be retired during
the coming year as "Current maturity of long-term debt" and report it as a current liability on the balance sheet.
The existence of a sinking fund does not necessarily mean that the company has created a retained earnings
appropriation entitled "Appropriation for Bonded Indebtedness". A sinking fund usually is contractual (required by

the bond indenture), and an appropriation of retained earnings is simply an announcement by the board of
directors that dividend payments will be limited over the term of the bonds. The former requires cash to be paid in
to a trustee, and the latter restricts retained earnings available for dividends to stockholders. Also, even if the
indenture does not require a sinking fund, the corporation may decide to (1) pay into a sinking fund and not
appropriate retained earnings, (2) appropriate retained earnings and not pay into a sinking fund, (3) do neither, or
(4) do both.
A company may add to the attractiveness of its bonds by giving the bondholders the option to convert the bonds

to shares of the issuer's common stock. In accounting for the conversions of convertible bonds, a company treats
the carrying value of bonds surrendered as the capital contributed for shares issued.
Suppose a company has USD 10,000 face value of bonds outstanding. Each USD 1,000 bond is convertible into
50 shares of the issuer's USD 10 par value common stock. On May 1, when the carrying value of the bonds was USD
9,800, investors presented all of the bonds for conversion. The entry required is:
May 1 Bond payable (-L) 10,000
Discount bonds payable (+L) 200
Common stock ($10,000/$1,000 = 10 bonds;
10 bonds x 50 share x $10 par) (+SE) 5,000
Paid-in capital in excess of par value – common 4,800
(+SE)
To record bonds converted to common stock.
The entry eliminates the USD 9,800 book value of the bonds from the accounts by debiting Bonds Payable for
USD 10,000 and crediting Discount on Bonds Payable for USD 200. It credits Common Stock for the par value of

Accounting Principles: A Business Perspective 609 A Global Text