Learning about Bond Retirement before Maturity

Bond Retirement before Maturity

Issuers sometimes wish to retire some or all of their bonds prior to maturity. For instance, if interest rates decline greatly, an issuer may wish to replace high-interest-paying bonds with new low-interest bonds. Two common ways to retire bonds before maturity are to (1) exercise a call option or (2) purchase them on the open market. In the first instance, an issuer can reserve the right to retire bonds early by issuing callable bonds. The bond indenture can give the issuer an option to call the bonds before they mature by paying the par value plus a call premium to bondholders. In the second case, the issuer retires bonds by repurchasing them on the open market at their current price. Whether bonds are called or repurchased, the issuer is unlikely to pay a price that exactly equals their carrying value. When a difference exists between the bonds’ carrying value and the amount paid, the issuer records a gain or loss equal to the difference.

To illustrate the accounting for retiring callable bonds, assume that a company issued callable bonds with a par value of $100,000. The call option requires the issuer to pay a call premium of $3,000 to bondholders in addition to the par value. Next, assume that after the June 30, 2011, interest payment, the bonds have a carrying value of $104,500. Then on July 1, 2011, the issuer calls these bonds and pays $103,000 to bondholders. The issuer recognizes a $1,500 gain from the difference between the bonds’ carrying value of $104,500 and the retirement price of $103,000. The issuer records this bond retirement as follows.

Point: Bond retirement is also referred to as bond redemption.

Point: Gains and losses from retiring bonds were previously reported as extraordinary items. New standards require that they now be judged by the “unusual and infrequent” criteria for reporting purposes.

 
 
An issuer usually must call all bonds when it exercises a call option. However, to retire as many or as few bonds as it desires, an issuer can purchase them on the open market. If it retires less than the entire class of bonds, it recognizes a gain or loss for the difference between the carrying value of those bonds retired and the amount paid to acquire them.