A company that retires its bond at maturity will issue to bondholders the last interest payments, if any, and the face value of the bond. At that time the book value of the bond will equal the face value.

Journal entry

Retiring Bonds Prior to Maturity
Sometimes bonds can be retired before they mature. They can be retired, or if they are convertible bonds, they can be converted to another form of securities such as common stock.

If a company retires a bond prior to maturity, the stated book value (or carry value for a discount or premium bond) will most likely be the same as market value for which the company repurchased the bond. This difference creates an extraordinary gain or loss for the repurchasing company. This gain or loss is classified as extraordinary because it is non-recurring in nature. Extraordinary gains and losses are reported on the income statement below the operating line net of taxes.

Remember: carrying value is computed as:

Formula 9.5
Bonds Payable at par Bonds Payable at par
- Unamortized Discount Unamortized Premium
Carrying Value Carrying Value

To compute the gain or loss, compare the carrying value of the bonds with the amount we pay to redeem the bonds.

Formula 9.6
Carrying Value - cash paid to retire bonds = gain or loss on bond retirement

Look Out!
If the carrying value is greater than the cash paid, there is a gain on the bond retirement.
If the carrying value is less than the cash paid, there is a loss on the bond retirement.

Journal entry:
A company retires a bond with a $1m face value early for $1.2m and creates a loss of $200,000.

Converting Bonds Into Common Stock
Some bonds can be converted or exchanged into common stock. Under SFAS 14 the convertible feature of a bond is completely ignored when the bond is issued, and it is considered only when it is converted into equity. The effect of a conversion of a bond into common stock is a decrease in liabilities for the carrying value of the bond and an increase in stockholders' equity for an amount equal to the bond carrying value. Gains or losses on bond conversion are not recognized. Any difference between the carrying value of the bond converted and the par value of the new shares issued is recorded in the account called "contributed capital in excess of par value". The market value of the common stock is ignored.

Example: Bondholders converted $20,000 worth of convertible bonds into the issuer's $5-par common stock. Each $1,000 bond is can be converted into 10 shares of common stock. The carrying value of the bonds at the time of conversion is $21,500.

  1. First we need to compute the carrying value of the bonds converted
    Carrying value = bonds payable + bond premium = $20,000 + $1,500 = $21,500
  2. Then we calculate the number of bonds converted
    Number of bonds converted = $20,000/$1000 = 20 bonds
  3. Then we calculate the number common shares to be issued?
    Number of common shares = 20 bonds * 10 shares = 200 common shares
  4. Then we calculate the contributed capital in excess of par value
    Contributed capital in excess of par value = carrying value of the bond - par value of the new shares = 21,500 - (200*$5) = $20,500

Journal entry:

Accounting For Long-Term Liabilities

Related Articles
  1. Investing

    Understanding Face Value

    Face value is the dollar value stated on a security.
  2. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  3. Investing

    Are Bonds Selling At A Premium A Good Investment?

    A bond with a par value – or face value -- of $1,000 is selling at a premium when its price exceeds par.
  4. Investing

    Understanding Bond Quotes

    A bond quote is a bond’s trading price.
  5. Investing

    Find The Right Bond At The Right Time

    Find out which bonds you should be investing in and when you should be buying them.
  6. Investing

    5 Basic Things To Know About Bonds

    Learn these basic terms to breakdown this seemingly complex investment area.
  7. Investing

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
Frequently Asked Questions
  1. What is the difference between yield and return?

    While both terms are often used to describe the performance of an investment, yield and return are not one and the same ...
  2. What are the Differences Among a Real Estate Agent, a broker and a Realtor?

    Learn how agents, realtors, and brokers are often considered the same, but in reality, these real estate positions have different ...
  3. What is the difference between amortization and depreciation?

    Because very few assets last forever, one of the main principles of accrual accounting requires that an asset's cost be proportionally ...
  4. Which is better, a fixed or variable rate loan?

    A variable interest rate loan is a loan in which the interest rate charged on the outstanding balance varies as market interest ...
Trading Center