Question

Question 2 Bonds may be redeemed (retired) before maturity by the issuing corporation. Explain why a company would decide to retire bonds before maturity and the necessary steps to record the redemption.

Answer 1

A callable bond may be retired before the date of maturity. This may be because of the following,

1. Change in interest rates, as bonds carry a fixed rate of interest and a sudden change in the market interest rates will force the company to retire the existing bonds and issue new one's if required with the revised rates of interest.
2. Investment opportunities, investors have a lot other investment opportunities will force the company to do so.
3. Market conditions, also prevailing market conditions will require companies to retire bonds early even for a loss.

Steps to record redemption,

Accounting for bonds retired at maturity is straight forward: the company pays out cash and removes the bond payable from its balance sheet. However, when a bond is retired before maturity a gain or loss may arise. If the price paid to retire the bonds is greater the carrying amount of bonds the company needs to record a loss on retirement. On the other hand if the price paid is less than the carrying amount of the bonds at retirement the company records a gain on retirement of bonds.

Examples for both the situations is as follows,

Loss

Bonds payable	100,000
Loss on retirement of bonds	2,000
Cash		98,000
Discount of bonds		4,000

Gain

Bonds payable	100,000
Premium on bonds	5,000
Cash		102,000
Gain on retirement of bonds		3,000