Redeeming at Maturity
The journal entry to record the retirement of a bond: Debit Bonds Payable & Credit Cash.
Explain how to record the retirement of a bond at maturity
- Unless the bond matures in a year or less it is shown on the balance sheet in the long term liabilities section.
- At maturity, all due payments are made, and the issuer has no further obligations to the bond holders after the maturity date.
- On the balance sheet the Bonds Payable account can be shown as different issues or consolidated into a single balance.
- Keep in mind the carrying value – cash paid to retire bonds = gain or loss on bond retirement.
- maturity: Date when payment is due
A maturity date is the date when the bond issuer must pay off the bond. Maturity is generally an indication of when you as an investor will get your money back. Typically, bonds stop earning interest after they mature. As long as all due payments have been made, the issuer has no further obligations to the bondholders after the maturity date.
The carrying value of bonds at maturity will always equal their par value. In other words, par value (nominal, principal, par or face amount), the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end of the term. For a bond sold at discount, its carrying value will increase and equal their par value at maturity. For a bond sold at premium, its carrying value will decrease and equal the par value at maturity.
Some structured bonds can have a redemption amount that is different from the face amount and can be linked to performance of particular assets such as a stock or commodity index, foreign exchange rate or a fund. This can result in an investor receiving less or more than his original investment at maturity.
Bonds can be classified to coupon bonds and zero coupon bonds. For coupon bonds, the bond issuer is supposed to pay both the par value of the bond and the last coupon payment at maturity. In case of a zero coupon bond, only the amount of par value is paid when the bond is redeemed at maturity.
Bonds Payable & The Balance Sheet
Unless the bond matures in a year or less it is shown on the balance sheet in the long-term liabilities section. If current assets will be used to retire the bonds, a Bonds Payable account should be listed in the current liability section. If the bonds are to be retired and new ones issued, they should remain as a long-term liability. All bond discounts and premiums also appear on the balance sheet.
A separate account should be maintained for each bond issue. On the balance sheet, the Bonds Payable account can be shown as different issues or consolidated into a single balance. If a single balance is shown, then a schedule or note should disclose the details of the bond issues.
A description of bonds issued including the effective interest rate, maturity date, terms, and sinking fund requirements are included in the notes to financial statements.
Redeeming at Maturity
The journal entry to record the retirement of a bond:
Debit Bonds payable
Keep in mind the carrying value – cash paid to retire bonds = gain or loss on bond retirement
Redeeming Before Maturity
Early redemption happens on issuers or holders’ intentions, more likely as interest rates are falling and bonds contain embedded options.
Summarize what it means to redeem a bond before maturity
- Bonds can be redeemed at or before maturity. Early redemption may happen on bond issuers or bondholders’ intentions.
- Before maturity, the bond is bought back at a premium to compensate for lost interest. It is notable that early repurchase happens more often when the interest rate in the market is on decline and when it is a callable bond.
- Putable bonds give the holder the right to force the issuer to repay the bond before maturity. The price at which bonds are redeemed in this case is predetermined in bond covenants.
- premium: A bonus paid in addition to normal payments.
- high-yield bonds: In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade. These bonds have a higher risk of default or other adverse credit events, but typically pay higher yields than better quality bonds in order to make them attractive to investors.
- callable bond: a type of debt security that allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches its date of maturity
Bonds can be redeemed at or before maturity. Early redemption may happen on bond issuers or bondholders’ intentions.
For bond issuers, they can repurchase a bond at or before maturity. Redemption is made at the face value of the bond unless it occurs before maturity, in which case the bond is bought back at a premium to compensate for lost interest. The issuer has the right to redeem the bond at any time, although the earlier the redemption takes place, the higher the premium usually is. This provides an incentive for companies to do this as rarely as possible. It is notable that early repurchase happens more often when the interest rate in the market is on decline and when the bond contains an embedded option. It grants option-like features to the holder or the issuer. To be detailed, the bond issuer will repurchase bonds with callability.
Some bonds give the issuer the right to repay the bond before the maturity date on the call dates. These bonds are referred to as callable bonds. Most callable bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay a premium, the so-called call premium. This is mainly the case for high-yield bonds. These have very strict covenants. They restrict the issuer in its operations. To be free from these covenants, the issuer can repay the bonds early, but only at a high cost.
Bonds with embedded options can also be ones with putability. Some bonds give the holder the right to force the issuer to repay the bond before the maturity date on the put dates. These are referred to as retractable or putable bonds. In this case, the price at which bonds are redeemed is predetermined in bond covenants.