Liabilities - Reporting The Retirement Or Conversion of Bonds

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. Personal Finance

    How To Choose A Financial Advisor

    Many advisors display similar skillsets that can make distinguishing between them difficult. The following guidelines can help you better understand their qualifications and services.
  2. Investing

    Asset Manager Ethics: Investment Process and Actions

    Managers, in developing their investment process, need to determine some “general rules” that make it meaningful. We offer six.
  3. Professionals

    Career Advice: Financial Analyst Vs. Investment Banker

    Read an in-depth comparison about working as a Financial Analyst vs. working as an Investment Banker, two highly prestigious business careers.
  4. Professionals

    Advisors: Which Certifications Are Essential?

    The right advisor credentials can make all the difference, but wading through some 100 certifications can be a challenge. Here's some help.
  5. Investing Basics

    Asset Manager Ethics: Valuation Is A Tricky Business

    Asset managers must accurately represent all of a clients assets in the client portfolio. This can be tricky for unique and hard-to-value assets.
  6. Personal Finance

    Top 10 Most Valuable Sports Teams in 2015

    Cleats, pads and profits: we take a look at the top 10 most valuable sports teams in the world.
  7. Professionals

    Chinese Slowdown Affects Iron Ore Market

    The Chinese economy's ongoing slowdown is having a major impact on iron ore demand.
  8. Personal Finance

    Invest in Costco? First Understand Its Balance Sheet

    A strong balance sheet sets a company apart and boosts investor confidence. How healthy is Costco based on an analysis of its balance sheets from the last two years?
  9. Investing Basics

    Brokers and RIAs: One and the Same?

    Brokers and registered investment advisors have some key differences. Here's what you need to know.
  10. Professionals

    DCF Vs. Comparables: Which One To Use

    DCF and Comparables models are widely used in equity valuation. We explain the pros and cons of each method.
  1. Personal Financial Advisor

    Professionals who help individuals manage their finances by providing ...
  2. CFA Institute

    Formerly known as the Association for Investment Management and ...
  3. Chartered Financial Analyst - CFA

    A professional designation given by the CFA Institute (formerly ...
  4. Security Analyst

    A financial professional who studies various industries and companies, ...
  1. What are the differences between a Chartered Financial Analyst (CFA) and a Certified ...

    The differences between a Chartered Financial Analyst (CFA) and a Certified Financial Planner (CFP) are many, but comes down ... Read Full Answer >>
  2. How do I become a Chartered Financial Analyst (CFA)?

    According to the CFA Institute, a person who holds a CFA charter is not a chartered financial analyst. The CFA Institute ... Read Full Answer >>
  3. What types of positions might a Chartered Financial Analyst (CFA) hold?

    The types of positions that a Chartered Financial Analyst (CFA) is likely to hold include any position that deals with large ... Read Full Answer >>
  4. Who benefits the most from prepaid expenses?

    Prepaid expenses benefit both businesses and individuals. Prepaid expenses are the types of expenses that are bought or paid ... Read Full Answer >>
  5. If I am looking to get an Investment Banking job. What education do employers prefer? ...

    If you are looking specifically for an investment banking position, an MBA may be marginally preferable over the CFA. The ... Read Full Answer >>
  6. Can I still pass the CFA Level I if I do poorly in the ethics section?

    You may still pass the Chartered Financial Analysis (CFA) Level I even if you fare poorly in the ethics section, but don't ... Read Full Answer >>
Hot Definitions
  1. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  2. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  3. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  4. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  5. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
  6. Cost Accounting

    A type of accounting process that aims to capture a company's costs of production by assessing the input costs of each step ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!