Retirement of bonds is the process by which an issuer extinguishes its bond debt so that the bonds are no longer outstanding and are removed from the liability section of the balance sheet. Bonds can be retired at maturity, before maturity by exercising a call option, by buying them back from investors in the market or through a tender offer, by converting them into shares, or gradually through a sinking fund. In accounting terms each method is a form of extinguishment of debt.
The general rule is the same for every method: when bonds are retired, the issuer removes their carrying amount, which is face value adjusted for any unamortized premium, discount and issue costs, and records the difference between that amount and what it gives up as a gain or loss. Redemption at a call price, the most formal route, is covered in more detail under redemption of bonds payable.
Methods of retiring bonds
- At maturity: the issuer pays the face value. Any discount or premium has been fully amortized, so no gain or loss arises.
- By call: a callable bond can be redeemed early at a stated call price, usually above par, typically when interest rates have fallen and the issuer wants to refinance.
- Open-market purchase: the issuer buys its bonds from investors at the current market price. When market rates have risen since issue, bond prices fall, and buying them back below their carrying amount produces a gain.
- Tender offer: the issuer offers to buy bonds from all holders at a stated price, often a premium to market, to retire a large amount at once or to remove restrictive covenants.
- Conversion: holders of a convertible bond exchange it for common shares. Under the common book value method the carrying amount is transferred to equity and no gain or loss is recognized.
- Sinking fund: a bond sinking fund requires the issuer to retire part of the issue each year, by lottery call at par or by market purchase.
Worked example: open-market repurchase
A company has $5,000,000 of 4 percent bonds outstanding, issued at a premium. The unamortized premium is $60,000 and unamortized issue costs are $20,000, so the carrying amount is:
That gives $5,000,000 plus $60,000 minus $20,000, or $5,040,000. After market interest rates rise, the bonds trade at 92. The company buys back $2,000,000 face value for $1,840,000. The carrying amount of the bonds retired is 40 percent of the total, or $2,016,000, made up of $2,000,000 face value, $24,000 premium and minus $8,000 issue costs. The gain is $2,016,000 minus $1,840,000, or $176,000. The entry debits bonds payable $2,000,000 and premium on bonds payable $24,000, and credits unamortized issue costs $8,000, cash $1,840,000 and gain on retirement of bonds $176,000.
Under US GAAP, gains and losses on extinguishment are recognized in income in the period of retirement, generally as part of other income or expense; the extraordinary item category was eliminated in 2015. Cash paid to retire bonds is shown as a financing outflow on the statement of cash flows, and in the indirect method a gain is subtracted from net income to avoid double counting. Under IFRS 9, a financial liability is derecognized when it is extinguished, with the difference recognized in profit or loss.
A gain from buying back debt cheaply is real in accounting terms, but analysts often exclude it from core earnings because it reflects market rate movements rather than operations. When bonds are retired with the proceeds of new borrowing, a form of refinancing, the issuer weighs any premium paid and new bond issue costs against the interest saved. In-substance defeasance, setting aside risk-free securities in a trust to cover the debt without legally discharging it, does not count as extinguishment under current US GAAP.