Redemption of Bonds Payable

Redemption of bonds payable is the repayment of bonds by the company that issued them, which removes the debt from its balance sheet. Redemption can happen at maturity, when the issuer pays bondholders the face value, or before maturity, when the issuer uses a call provision in the bond indenture to buy the bonds back at a set price. Companies redeem bonds early mainly to refinance at lower interest rates, to cut debt, or to escape restrictive covenants.

For the issuer, the accounting question is the difference between the cash paid and the bonds' carrying amount on the redemption date. At maturity there is no difference. Before maturity there usually is, and that difference is reported as a gain or loss on extinguishment of debt.

By the maturity date, any discount on bonds payable or premium on bonds payable has been fully amortized, so the carrying amount equals the face value. The final interest payment is recorded in the usual way, and the principal repayment is a simple entry: debit bonds payable and credit cash for the face value. No gain or loss arises. Many issuers prepare for this by building up a bond sinking fund during the bonds' life.

A callable bond lets the issuer redeem the bonds on or after a stated date at a bond call price, which is usually above face value. The extra amount, the call premium, compensates investors for losing their interest income early. Before recording the redemption, the issuer brings interest and amortization up to date. The gain or loss is then:

Here $\text{Carrying amount}$ is face value plus any unamortized premium, or minus any unamortized discount and unamortized issue costs, and $\text{Redemption price}$ is the cash paid to bondholders, excluding accrued interest. A positive result is a gain; a negative one is a loss.

A company issued $1,000,000 of ten-year bonds at a discount. Six years later, after amortization, the unamortized discount is $24,000, so the carrying amount is $976,000. The bonds are callable at 103, meaning 103 percent of face value. Interest has been paid and amortization recorded up to the call date. The company calls all the bonds and pays $1,030,000.

The loss is $976,000 minus $1,030,000, or $54,000. The journal entry is:

• Debit bonds payable $1,000,000.
• Debit loss on redemption of bonds $54,000.
• Credit discount on bonds payable $24,000.
• Credit cash $1,030,000.

If only part of the issue is called, say 40 percent, the same share of the face value, the unamortized discount and the call price is used: bonds payable of $400,000, discount of $9,600 and cash of $412,000 give a loss of $21,600.

Under US GAAP, the gain or loss on redemption is reported in income for the period, normally within other income and expense rather than as an extraordinary item, a category that was removed in 2015. IFRS similarly recognizes the difference in profit or loss. On the statement of cash flows, the cash paid to redeem bonds is a financing outflow. Companies often fund a call by issuing new bonds at a lower interest rate; whether this saves money depends on comparing the call premium and new issue costs with the interest saved over the remaining term. Redemption is one of several ways to end bond debt; the wider set of methods, including buying bonds in the open market and conversion into shares, is covered under retirement of bonds.