When a corporation or company issues a bond, it comes with maturity. However, the bond can be retired before maturity or retirement by conversion. The journal entry for bond retirement is the difference between the retirement at the maturity, before maturity, and by conversion.
In this article, we cover the bond retirement journal entry. This includes the retirement journal entry at the maturity, before maturity as well as by conversion. Before jumping into detail, we first understand the key concept of bond retirement.
What is Bond Retirement?
Bond retirement refers to the repayment of the bond to the bondholders. It removes the obligation of the corporation or company who issue the bonds. Therefore, the bonds will be derecognized from the Balance Sheet.
The retirement can take place in 3 ways. These are as follows:
Bond Retirement at Maturity
For the retirement at maturity, the corporation issued the bond will need to repay the bondholders the carrying value of the bond. In this case, the carrying value of the bond is always equal to the par value of the bonds regardless of the bond issued at par, at a premium, or a discount.
Therefore, at the maturity date, the principal or par value of the bond will need to remove from the liability account.
Bond Retirement before Maturity
In some circumstances, the corporation or company wishes to retire all or some of its bonds before the maturity date. This is also called the early retirement of bonds. The main reason for the early retirement is the decreasing of interest significantly in the market. Thus, the issuers wish to replace its high-interest paying bonds with the new low-interest paying bonds.
There are two common ways that the issuers can retire their bonds before the maturity date. These are through the exercise a call option or purchase them through the open market.
- Through exercise a call option: In this way, the issuers will need to issue a callable bond that allows them to exercise their right in order to retire the bonds early. In these callable bonds, the issuers reserve the right to exercise the option before the maturity by paying the par value bonds plus a call premium to the bondholders.
- Purchase on the open market: In this way, the issuers can retire the bonds early by repurchasing them on the open market. When the issuers repurchase bonds on the open market, they need to pay the bonds at the current price or current market value of the bonds.
Theoretically, either early retirement through exercise a call option or repurchasing them on the open market, the issuers are unlikely to pay the bond price exactly at the carrying value of the bonds. The bondholders will need to get paid at the carrying value of the bonds plus the premium. The difference between the carrying value of the bonds and the repurchase price is called gain or loss on bond retirement. This gain or loss is presented in the income statement.
Bond Retirement by Conversion
This retirement can be done through conversion. This occurs when a corporation issues convertible bonds that allow the bondholders to convert the bonds into common stock equity.
When the conversion occurs, the carrying value of the bonds is transferred to the equity account and there is no gain or loss recorded in the income statement. For a detailed calculation of the convertible bond, you can read another article on the convertible bond.
Bond Retirement Journal Entry
In this section, we cover the bond retirement journal entry with examples. We illustrate the journal entry for the retirement at maturity, before maturity as well as by conversion.
Journal Entry for Bond Retirement at Maturity
The retirement journal entry at maturity is very straightforward. As mentioned above, regardless of bonds issued at par, premium, or discount, the carrying value of the bonds at maturity is always equal to the par value.
Below is the simple journal entry for the retirement at maturity:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | XXX | |
| Cash | XXX | |
| (To record bond retirement at maturity) |
In order to illustrate this, let’s assume that ABC Co has outstanding bonds with a par value of $100,000 which is due to repay by the end of December 31, 2020. In this example, we assume that the interest on the bonds has been paid separately.
The journal entry for this retirement is as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | $100,000 | |
| Cash | $100,00 | |
| (To record bond retirement at maturity) |
Journal Entry for Bond Retirement before Maturity
The bond retirement journal entry before maturity is a bit different from the journal entry for retirement at maturity. As mentioned above, there will be gain or loss on retirement if the issuers wish to retire their bonds early. This also depends on whether the bonds were originally issued at a premium or discount.
Below is the journal entry for early retirement issued at premium with gain on retirement:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | XXX | |
| Premium on bonds payable | XXX | |
| Gain on bond retirement | XXX | |
| Cash | XXX | |
| (To record bond retirement before maturity) |
Journal entry for early retirement issued at premium with loss on retirement:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | XXX | |
| Premium on bonds payable | XXX | |
| Loss on bond retirement | XXX | |
| Cash | XXX | |
| (To record bond retirement before maturity) |
Journal entry for early retirement issued at discount with gain on retirement:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | XXX | |
| Discount on bonds payable | XXX | |
| Gain on bond retirement | XXX | |
| Cash | XXX | |
| (To record bond retirement before maturity) |
Journal entry for early retirement issued at discount with the loss on retirement:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | XXX | |
| Discount on bonds payable | XXX | |
| Loss on bond retirement | XXX | |
| Cash | XXX | |
| (To record bond retirement before maturity) |
Example: Gain or Loss on Early Retirement of Bonds Issued at Premium
In order to illustrate how the accounting entry for gain on early retirement is recorded, let’s go through the example below.
Let’s assume that ABC Co wishes to exercise a call option to retire the bonds early for the bonds with the par value of $100,000. On July 31, 2020, the carrying value of bonds issued at the premium is $104,200. The company decided to exercise a call option and wishes to pay $103,000 to the bondholders.
From above example, the gain on the retirement is $1,200 ($104,200 – $103,000). Therefore, the journal entry for bond retirement issued at a premium with the gain on retirement is as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | $100,000 | |
| Premium on bonds payable | $4,200 | |
| Gain on bond retirement | $1,200 | |
| Cash | $103,000 | |
| (To record bond retirement before maturity) |
In contrast, if ABC Co would pay the bondholders $105,500, there will be a loss on retirement. Thus, the journal entry would be as follow instead:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | $100,000 | |
| Premium on bonds payable | $4,200 | |
| Loss on bond retirement | $1,300 | |
| Cash | $105,500 | |
| (To record bond retirement before maturity) |
Example: Gain or Loss on Early Retirement of Bonds Issued at Discount
By now, you already know how to account for the retirement of bonds issued at a premium both gain and loss on retirement. Now, let’s go through the example on how to account for gain or loss on early retirement issued at discount.
Let’s assume that ABC Co wishes to exercise a call option to retire the bonds early for the bonds with the par value of $100,000. On July 31, 2020, the carrying value of bonds issued at the premium is $98,500. The company decided to exercise a call option and wishes to pay $103,000 to the bondholders.
From above example, the loss on the retirement is $4,500 ($98,500 – $103,000). Therefore, the journal entry for bond retirement issued at a premium with the gain on retirement is as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | $100,000 | |
| Discount on bonds payable | $1,500 | |
| Loss on bond retirement | $4,500 | |
| Cash | $103,000 | |
| (To record bond retirement before maturity) |
In contrast, if the company would redeem the bonds at $97,000, there is gain on retirement of $1,500 ($98,500 – $97,000). Therefore, the journal entry for the retirement issued at discount with the gain on retirement is as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | $100,000 | |
| Discount on bonds payable | $1,500 | |
| Gain on bond retirement | $1,500 | |
| Cash | $97,000 | |
| (To record bond retirement before maturity) |
Journal Entry for Bond Retirement by Conversion
The journal entry for bond retirement by conversion is simply recorded by transferring from bonds payable account to common stock equity account. Below is the simple journal entry for the retirement by conversion:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | XXX | |
| Common stock | XXX | |
| Contributed capital in excess of par value | XXX | |
| (To record bond retirement by conversion) |
In the above journal entry, we ignore the cost of conversion. For the cost of conversion, we have covered in another article on convertible bonds.
In order to illustrate this, let’s assume that the $100,000 par value of convertible bonds are converted into 10,000 shares of $3 per share of common stock on July 31, 2020.
From the above, example, the total par value of the common stock is $30,000 ($3 × 10,000 shares). The difference of $70,000 ($100,000 – $30,000) is the contributed capital in excess of par.
By ignoring the conversion cost, the journal entry for the retirement by conversion is as follow:
| Account Name | Debit | Credit |
|---|---|---|
| Bonds payable | $100,000 | |
| Common stock | $30,000 | |
| Contributed capital in excess of par value | $70,000 | |
| (To record bond retirement by conversion) |
Conclusion
Bond retirement enables issuers to derecognize the bonds payable which is the obligation of the issuers. This retirement can take in three ways; retirement at the maturity, early retirement through either exercising the call option or repurchasing on the open market, and retirement by conversion. The journal entries for each type of retirement are different.
