Presentation on theme: "Long-Term Liabilities, Bonds Payable, and Classification of Liabilities on the Balance Sheet Chapter 11 Chapter 11 covers long-term liabilities, bonds."— Presentation transcript:
1Long-Term Liabilities, Bonds Payable, and Classification of Liabilities on the Balance Sheet Chapter 11Chapter 11 covers long-term liabilities, bonds payable, and classification of liabilities on the balance sheet.11111
2Long-Term Notes Payable Most long-term notes are paid in installmentsPrincipal due within a year–a current assetPrincipal not due with in a year–long-term assetCurrent plus long-term equals total amount of debtInterest accrues as normalRecall that most long-term notes payable are paid in installments. The current portion of notes payable is the principal amount that will be paid within one year—a current liability. The remaining portion is long-term. Consider the $20,000 note payable in the previous chapter, signed on May 1, The note will be paid over four years with payments of $5,000 plus interest due each May 1. Remember that the amount due May 1, 2014, $5,000, is current.Notice that the reclassification entry on May 1 does not change the total amount of debt. It only reclassifies $5,000 of the total debt from long-term to current. The remaining 4 months, January through April will be recorded on May 1. In December eight months total interest ($20,000 times 6% times 8/12 = $800) for the $800 interest accrued on the note as of December 31, 2013.
4Long-Term Notes Payable: Payments Yearly payment would include:Installment amountPreviously accrued interest at year-end adjustingAccrued interest since year-end adjustingJournal entry:Now it’s May 1, 2014, and the company must make its first installment payment of $5,000 principal plus interest on the note. Recall the 8 months of interest already recorded at the end of December, The accrual of four months’ interest is recorded when the first installment payment is made.The journal entry would include a debit to Interest expense for the four months’ interest to accrue for January through April. It would also include a debit to Interest payable for the interest accrued at the end of December A debit to Long-term notes payable for the $5,000 installment payment due and a credit to Cash for the installment payment and 12 months worth of interest—5,000 plus $800 accrued interest at December 21 and $400 for interest accrued for the months of January through April 2014.Notice the entry debited the Long-term notes payable account—not the Current portion of long-term notes payable. Why? Because each year, $5,000 of the note balance becomes due (is current). When we make payments on the note, we just reduce the Long-term notes payable (one entry), rather than making the payment and then doing another reclassification entry, like we did on May 1, 2013.
5Long-Term Notes Payable: Payments Entry included a debit to Long-term notes payableCurrent portion of long-term notes is unchangedNet long-term notes payable equals $15,000Current portion $5,000Long-term portion $10,000The amount owed on the note is $15,000—the $20,000 original note minus the $5,000 payment on May 1, $10,000 is included in the Long-term notes payable account and $5,000 is in the Current portion of long-term notes payable equaling the $15,000 total due.
6Mortgages PayableDebts backed with a security interest in specific propertyTitle transfers if the mortgage isn’t paidDiffers from notes payableSecure interest in propertySpecifies monthly paymentMortgages payable are long-term debts that are backed with a security interest in specific property. The mortgage will state that the borrower promises to transfer the legal title to specific assets if the mortgage isn’t paid on schedule. This is very similar to the long-term notes payable we just covered. The main difference is the mortgage payable is secured with specific assets, whereas long-term notes are not secured with specific assets. Like long-term notes payable, the total mortgage payable amount will have a portion due within one year (current) and a portion that is due more than one year from a specific date.Commonly, mortgages will specify a monthly payment of principal and interest to the lender (usually a bank). The most common type of mortgage is on property—for example, a mortgage on your home. The principal portion of the total mortgage payable that is due within one year is current. To figure the amount of each payment to apply to the mortgage payable and how much is interest expense, we create an amortization schedule.
7Amortization Schedule Details each payment’s allocation between principal and interestThe principal portion of the total mortgage payable that is due within one year is current. To figure the amount of each payment to apply to the mortgage payable and how much is interest expense, we create an amortization schedule. An amortization schedule details each loan payment’s allocation between principal and interest.
8Mortgages Payable Mortgage payment includes Interest expense from amortization tablePrincipal reduction form amortization tablePayment amount agreed uponSo after reviewing the amortization schedule, we would reclassify the portion of the $100,075 mortgage balance that is current as a debit to Mortgage payable and a credit to Current portion of mortgage payable for $1, The current portion of the mortgage is payable each year-end on December 31 rather than monthly, since the change to the account is not material from month to month.
9S11-1: Accounting for a long-term note payable On January 1, 2014, LeMay-Finn, Co., signed a $200,000, five-year, 6% note. The loan required LeMay-Finn to make payments on December 31 of $40,000 principal plus interest.1. Journalize the issuance of the note on January 1, 2014.Journal EntryDATEACCOUNTSDEBITCREDITJan 1Cash200,000Long-term notes payableShort Exercise 11-1 reviews accounting for a long-term note payable.
10S11-1: Accounting for a long-term note payable (Continued)2. Journalize the reclassification of the current portion of the note payable.Journal EntryDATEACCOUNTSDEBITCREDITJan 1Long-term notes payable40,000Current portion of long-term notes payableThe exercise continues on this slide.
11S11-1: Accounting for a long-term note payable (Continued)3. Journalize the first note payment on December 31, 2014.Journal EntryDATEACCOUNTSDEBITCREDITDec 31Interest expense12,000Long-term notes payable40,000Cash52,000The exercise continues.
13Bonds Payable Long-term liability Financing in large amounts Multiple lenders = bondholdersBond certificate evidence of loanAmount borrowed (principal)Maturity dateInterest rateBondholders receive interestNormally two times a yearPrincipal paid at maturityLarge companies need large amounts of money to finance operations. They may borrow long-term from banks or issue bonds payable to the public to raise the money. Bonds payable are groups of long-term notes payable issued to multiple lenders, called bondholders. By issuing bonds payable, a company can borrow millions of dollars from thousands of investors, rather than depending on a loan from one single bank or lender. Each investor can buy a specified amount of bonds.Each bondholder gets a bond certificate, which shows the name of the company that borrowed the money, exactly like a note payable. The certificate states the principal, which is the amount the company has borrowed. The bond’s principal amount is also called maturity value, or par value. The company must then pay each bondholder the principal amount at a specific future date, called the maturity date.People buy bonds to earn interest. The bond certificate states the interest rate that the company will pay and the dates the interest is due, generally semi-annually (twice a year).
14Bond Terminology Principal–amount to be paid back Also called maturity value, face value or par valueMaturity date–date of principal paybackStated interest rate–also termed face rate, coupon rate, or nominal rateRate of interest paid to bondholdersCash payments during life of bondLike a note, each bond containsPrincipalRateTimeBond terminology is important to understand.Principal amount (also called maturity value, or par value):The amount the borrower must pay back to the bondholders on the maturity date.Maturity date: The date on which the borrower must pay the principal amount to the bondholders.Stated interest rate: The annual rate of interest that the borrower pays the bondholders.
15Types of Bonds Term bonds All mature at same date Serial bonds Mature in installments at regular intervalsSecured bondsBacked by assets if company fails to payDebentureUnsecured; not backed by company’s assetsThere are various types of bonds, including the following:• Term bonds all mature at the same specified time. For example, $100,000 of term bonds may all mature 5 years from today.• Serial bonds mature in installments at regular intervals. For example, a $500,000, 5-year serial bond may mature in $100,000 annual installments over a 5-year period.• Secured bonds give the bondholder the right to take specified assets of the issuer if the issuer fails to pay principal or interest. A mortgage on a house is an example of a secured bond.• Debentures are unsecured bonds that aren’t backed by assets. They are backed only by the goodwill of the bond issuer.
16Bond Pricing (Selling Price) Fluctuates like stockBased upon maturity date and interest rateMaturity (Par) value100% face valueDiscount (Bond discount)Below 100% facePremium (Bond premium)Above 100% facePrice does not affect payment at maturityA bond can be issued at any price agreed upon by the issuer and the bondholders. There are three basic categories of bond prices. A bond can be issued at:• Maturity (par) value. Example: A $1,000 bond issued for $1,000. A bond issued at par has no discount or premium.• Discount (or Bond Discount), a price below maturity (par) value. Example: A $1,000 bond issued for $980. The discount is $20 ($1,000 – $980).• Premium (or Bond Premium), a price above maturity (par) value. Example: A $1,000 bond issued for $1,015. The premium is $15 ($1,015 – $1,000).The issue price of a bond does not affect the required payment at maturity. In all of the preceding cases, the company must pay the maturity value of the bonds when they mature.
17Bond Prices Quoted as a percent of maturity value A $1,000 bond quoted at would sell for $1,015 ($1,000 X 101.5)A $1,000 bond quoted at would sell for $ ($1,000 X 89.75)Issue price determines amount receivedPayments equal face amount of principal and interestBond prices are quoted as a percentage of maturity value. For example:• A $1,000 bond quoted at 100 is bought or sold for 100% of maturity value, ($1,000. x 1.00).• A $1,000 bond quoted at has a price of $1,015 ($1,000 × 1.015).• A $1,000 bond quoted at has a price of $ ($1,000 × .8975).
18Bond Prices Determining the Market Value of Bonds Market value is a function of the three factors that determine present value:the dollar amounts to be received,the length of time until the amounts are received, andthe market rate of interest.
19Issue price of bonds payable Bond Interest RatesStated interest rateRate used to calculate interest the borrower pays each yearRemains constantMarket interest rateRate investors demand for loaning moneyVaries dailyStated interest rateMarketinterestrateIssue price of bonds payable9%=Maturity value<10%Discount (below maturity value)>8%Premium (above maturity value)Bonds are sold at their market price, which is the present value of the interest payments the bondholder will receive while holding the bond plus the bond principal paid at the end of the bond’s life. Two interest rates work together to set the price of a bond:• The stated interest rate determines the amount of cash interest the borrower pays each year. The stated interest rate is printed on the bond and does not change from year to year.• The market interest rate (also known as the effective interest rate) is the rate that investors demand to earn for loaning their money. The market interest rate varies daily. A company may issue bonds with a stated interest rate that differs from the market interest rate, due to the time gap between the decision of what the stated rate should be and the actual issuance of the bonds.If the stated rate is equal to the market rate, the bonds will be issued at their maturity value. If the stated rate is less than the market rate, the bonds will sell below maturity value–a discount. Conversely, if the stated rate is greater than the market rate, bonds will be issued above maturity value–a premium. This is because the bonds are paying better interest than the market indicates; the market pays more because the bond is paying more interest.
20Interest rates and bond prices Example Stated Rate = MKT Bond Sells at Face value
21Interest rates and bond prices Example Stated Rate > MKT Bond Sells at Premium1.081.08
22Interest rates and bond prices Example Stated Rate < MKT Bond Sells at Discount1.121.12
23Bond Price ComponentsPrevious slides used to demo concept of sale of bond at:FacePremiumDiscountPricing of bonds is more complex than illustration on previous slidesBond price a function of 2 itemsPresent value of the lump sum(principal) PLUSPresent value of the annuity interest payments
24S11-3: Determining bond prices Bond prices depend on the market rate of interest, stated rate of interest, and time. Determine whether the following bonds payable will be issued at maturity value, at a premium, or at a discount.The market interest rate is 6%. Boise, Corp., issues bonds payable with a stated rate of 5 3/4%.Dallas, Inc., issued 8% bonds payable when the market rate was 7 1/4%.DiscountShort Exercise 11-3 reviews how to determine bond prices.Premium
25S11-3: Determining bond prices (Continued)Cleveland Corporation issued 7% bonds when the market interest rate was 7%.d. Atlanta Company issued bonds payable that pay stated interest of 7 1/2%. At issuance, the market interest rate was 9 1/4%.Par valueThe exercise continues on this slide.Discount
26Compute the price of the following 7% bonds of United Telecom. S11-4: Pricing bondsBond prices depend on the market rate of interest, stated rate of interest, and time.Compute the price of the following 7% bonds of United Telecom.$500,000 issued at$500,000 issued at$500,000 issued at$500,000 issued at$383,750$523,750Short Exercise 11-4 reviews pricing bonds.$478,750$521,259
27Issuing Bonds Payable at Maturity (Par) Value Maturity value equals 100% bond valueCash received equals principal amount of bondIssuing journal entryInterest payments–semi-annually$100,000 x 9% x 6/12 = $4,500The journal entry to record issuing a bond payable at maturity value includes a debit to Cash and a credit to Bonds payable. In this example, maturity value is $100,000 and the interest rate is 9%. These bonds pay interest semi-annually as do most bonds. Every six months, the company pays interest of $4,000 to the bondholders. This is computed by the interest formula—$100,000 x 9% x 6/12. Interest expense is debited and Cash is credited.
29Issuing Bonds Payable at Maturity (Par) Value Interest payments continue over the bond’s lifeEvery 6 months interest is paidAt maturity date, the principal is paid backWhen the bonds mature, Bonds payable is debited, which will zero out the account. Cash is credited to record payment to the bondholders.
31S11-5: Journalizing bond transactions Vernon Corporation issued a $110,000, 6.5%, 15-year bond payable.Journalize the following transactions for Vernon and include an explanation for each entryIssuance of the bond payable at par on January 1, 2012Journal EntryDATEACCOUNTSDEBITCREDITJan 1Cash110,000Bonds payableIssued bonds payable.Short Exercise 11-5 reviews your knowledge of journalizing bond transactions.
33S11-5: Journalizing bond transactions Vernon Corporation issued a $110,000, 6.5%, 15-year bond payableJournalize the following transactions for Vernon and include an explanation for each entry:b. Payment of semiannual cash interest on July 1, 2012Journal EntryDATEACCOUNTSDEBITCREDITJul 1Interest expense3,575CashPaid semiannual interest.The exercise continues on this slide.
35S11-5: Journalizing bond transactions (Continued)Journalize the following transactions for Vernon and include an explanation for each entry:c. Payment of the bond payable at maturity. (Give the date.)Journal EntryDATEACCOUNTSDEBITCREDITJanBonds payable110,000CashPaid off bonds payable at maturity.The exercise continues.
36Issuing Bonds Payable at a Discount Market interest 10%, bond stated rate 9%Cash received is less than the principal amountThe journal entryBond account balancesMarket conditions may force a company to accept a discount price for its bonds. Suppose a company issues $100,000 of its 9%, five year bonds that pay interest semiannually when the market interest rate is 10%. The market price of the bonds drops to , which means % of par value. The company receives $96,149 ($100, ) at issuance and makes this journal entry—debit Cash for the amount received, and credit Bonds payable for the maturity value of the bond. The difference of $3,851 is the discount and has its own account. Discount on bonds payable is a contra account to Bonds payable.
37Issuing Bonds Payable at a Discount Balance sheet presentationImmediately after issuanceInterest payments–semi-annually$100,000 X 9% X 6/12 = $4,500What happens to the $3,851 discount?Bonds payable minus the discount gives the carrying amount of the bonds (known as carrying value). The balance sheet presents the carrying value of the bonds. It displays the maturity value of the bonds, less any bond discount, to arrive at the carrying value.
38Issuing Bonds Payable at a Discount The discount is amortizedGradual reduction of over timeDividing into equal amounts for each interest periodThe discount becomes additional interest expenseStraight-line amortizationSimilar to straight-line depreciationBond life yields the interest periods5 year life at 2 times a year = 10 periodsDiscount divided by periods = amortized amountWhat happens to the $3,851 discount? The discount is additional interest expense to Smart Touch. The discount raises the company’s true interest expense on the bonds to the market interest rate of 10%. The discount becomes interest expense for the company through the process called amortization, the gradual reduction of an item over time.Amortize a bond discount by dividing it into equal amounts for each interest period. This method is called straight-line amortization and it works very much like the straight-line depreciation method. Therefore, 1/5 years (1 year out of 5 year life) times 6/12 of the year (semi-annually) or 1/10 of the $3,851 bond discount ($385, rounded) is amortized each interest period. Cash payment equals the regular stated interest payment. Interest expense of $4,885 for each six-month period is the sum of the stated interest ($4,500, which is paid in cash) plus the amortization of discount, $385.
39Issuing Bonds Payable at a Discount Interest payments continue over the bond’s lifeEvery 6 months, interest is paidDiscount is amortized each payment period, reducing the accountAt maturity, the Discount account is zero and the carrying value is equal to maturity valueAt maturity date, the principal is paid backThis same entry would be made again on December 31, So, the bond discount balance would be: $3,851 – $385 (from June 30 entry) – $385 (from December 31 entry) = $3,081 balance in the Discount on bonds payable account on December 31, 2013.Discount on bonds payable has a debit balance. Therefore, we credit the Discount on bonds payable account to amortize (reduce) its balance. Ten amortization entries will decrease the Discount to zero (with rounding). Then the carrying amount of the bonds payable will be $100,000 at maturity.
40S11-7: Journalizing bond transactions Origin, Inc. issued a $40,000, 5%, 10-year bond payable at a price of 90 on January 1, 2012.1. Journalize the issuance of the bond payable on January 1, 2012.Journal EntryDATEACCOUNTSDEBITCREDITJan 1Cash36,000Discount on bonds payable4,000Bonds payable40,000Short Exercise 11-7 reviews journalizing bond transactions.
41S11-7: Journalizing bond transactions (Continued)2. Journalize the payment of semiannual interest and amortization of the bond discount or premium on July 1, 2012, using the straight-line method to amortize the bond discount or premium.Journal EntryDATEACCOUNTSDEBITCREDITJan 1Interest expense1,200Discount on bonds payable200Cash1,000The exercise continues on this slide.
42Issuing Bonds Payable at a Premium Market interest 8%, bond stated rate 9%Investors pay a premium to acquire themCash received is more than the principal amountIssuing journal entryBond account balancesTo illustrate a bond premium, assume that the market interest rate is 8% when the company issues its 9%, five-year bonds. These 9% bonds are attractive in an 8% market, and investors will pay a premium to acquire them.The Bonds payable account and the Premium on bonds payable account each carries a credit balance. The Premium is an adjunct account to Bonds payable. Adjunct accounts are related accounts that have the same normal balance and that are reported together on the balance sheet.
43Issuing Bonds Payable at a Premium Balance Sheet presentationImmediately after issuanceInterest payments–semi-annually$100,000 X 9% X 6/12 = $4,500What happens to the $4,100 premium?The balance sheet presents the carrying value of the bonds. It displays the maturity value of the bonds, plus any bond premium, to arrive at the carrying value.The 1% difference between the bonds’ 9% stated interest rate and the 8% market rate creates the $4,100 premium ($104,100 – $100,000 face). The company borrows $104,100, but must pay back only $100,000 at maturity. The premium is like a saving of interest expense. The premium cuts the cost of borrowing and reduces interest expense to 8%, the market rate. The amortization of bond premium decreases interest expense over the life of the bonds.
44Issuing Bonds Payable at a Premium The premium is amortizedGradual reduction of over timeDividing into equal amounts for each interest periodThe premium reduces Interest expenseStraight-line amortizationSimilar to straight-line depreciationBond life yields the interest periods5 year life at 2 times a year = 10 periodsPremium divided by periods = amortized amountIn our example, the beginning premium is $4,100, and there are 10 semiannual interest periods during the bonds’ five-year life. Therefore, 1/5 years times 6/12 months or 1/10 of the $4,100 (410) of bond premium is amortized each interest period. Interest expense of $4,090 is the stated interest ($4,500, which is paid in cash) minus the amortization of the premium of $410.
45Issuing Bonds Payable at a Premium Interest payments continue over the bond’s lifeEvery 6 months, interest is paidPremium is amortized each payment period, reducing the accountAt maturity, the Premium account is zero and the carrying value is equal to maturity valueAt maturity date, the principal is paid backThis same entry would be made again on December 31, So, the bond discount balance would be $3,851 – $385 (from June 30 entry) – $385 (from December 31 entry) = $3,081 balance in the Discount on bonds payable account on December 31, 2013.Discount on bonds payable has a debit balance. Therefore we credit the Discount on bonds payable account to amortize (reduce) its balance. Ten amortization entries will decrease the Discount to zero (with rounding). Then the carrying amount of the bonds payable will be $100,000 at maturity.
46S11-8: Journalizing bond transactions Worthington Mutual Insurance Company issued a $50,000, 5%, 10-year bond payable at a price of 108 on January 1, 2012.1. Journalize the issuance of the bond payable on January 1, 2012.Journal EntryDATEACCOUNTSDEBITCREDITJan 1Cash54,000Premium on bonds payable4,000Bonds payable50,000Short Exercise 11-8 focuses on journalizing bond transactions.
47S11-8: Journalizing bond transactions (Continued)2. Journalize the payment of semiannual interest and amortization of the bond discount or premium on July 1, 2012, using the straight-line method to amortize the bond discount or premium.Journal EntryDATEACCOUNTSDEBITCREDITJul 1Interest expense1,050Premium on bonds payable200Cash1,250The exercise continues.
48Adjusting Entries for Bonds Payable Interest payments seldom occur at year-endInterest must be accrued at year-endA payable account is credited for the liabilityEach interest entry must include amortization of discount or premiumActual interest payment dateOctober, November, and DecemberCompanies may issue bonds payable when they need cash. The interest payment dates rarely are set on December 31, so interest expense must be accrued at year-end. The accrual entry records the interest expense and amortizes any bond discount or premium.January, February, and March
49Bonds Issued Between Interest Payment Dates Interest accrues from stated issue datePayments occur on stated interest payment datesFull payment to bondholders, regardless of their purchase datePayments cannot be split, full payments are madeInterest accrued prior to issuance is collected at actual issue dateJournal entryCorporations can also issue bonds between interest dates. If they do so, however, they must account for the accrued interest. Companies cannot split interest payments. They pay in either six-month or annual amounts as stated on the bond certificate. On the next interest date, Smart Touch will pay six months’ interest to whomever owns the bonds at that time. But the company will have interest expense only for the three months the bonds have been outstanding (April, May, and June).
50Bonds Issued Between Interest Payment Dates Next interest payment dateInterest payment recorded for normal six monthsInterest expense is equal to three months issuedInterest payable decreased for the cash received at issue dateCash payment is always equal to the six month periodOn the next interest date, a company will pay six months’ interest to whomever owns the bonds at that time. But the company will have interest expense only for the three months the bonds have been outstanding. Remove the interest payable recorded at the bonds’ issuance, record interest expense for the time the bonds were held, and record payment.
511. Journalize the issuance of the bonds payable on May 1, 2012. S11-10: Journalizing bond transactions—issuance between interest payment datesSilk Realty issued $300,000 of 8%, 10-year bonds payable at par value on May 1, 2012, four months after the bond’s original issue date of January 1, 2012.1. Journalize the issuance of the bonds payable on May 1, 2012.Journal EntryDATEACCOUNTSDEBITCREDITMay 1Cash308,000Bonds payable300,000Interest payable8,000Short Exercise reviews journalizing bond transactions, when issued between interest payment dates.
52S11-10: Journalizing bond transactions—issuance between interest payment dates (Continued)2. Journalize the payment of the first semiannual interest amount on July 1, 2012.Journal EntryDATEACCOUNTSDEBITCREDITMay 1Interest payable8,000Interest expense4,000Cash12,000The exercise continues on this slide.
53Liabilities on the Balance Sheet Reports all current and long-term liabilities* Amounts assumedPayroll liabilities recordedCurrent portion of long-term liabilitiesAt the end of each period, a company reports all of its current and long-term liabilities on the balance sheet. As we have seen throughout, there are two categories of liabilities—current and long-term.Long-term liabilities
54S11-12: Preparing the liabilities section of the balance sheet Blue Socks’ account balances at June 30, 2014, include the following:Prepare the liabilities section of Blue Socks’ balance sheet at June 30, 2014.Short Exercise reviews preparation of the liabilities section of the balance sheet.
55S11-12: Preparing the liabilities section of the balance sheet The solutions to the exercise is presented on this slide.
59Retiring Bonds Payable Why?Remove the cash responsibilityLower market interest ratesLow value of the bondsHow?Callable bonds—the company may call, or pay off, the bonds at a specified price.Price is usually at 100% or higher as incentive to buy originallyIssuer has flexibility to payoff at willPurchases by market purchase or direct with bondholder involve same journal entryNormally, companies wait until maturity to pay off, or retire, their bonds payable. The basic retirement entry debits Bonds payable and credits Cash, as we saw in the chapter. But companies sometimes retire their bonds prior to maturity. The main reason for retiring bonds early is to relieve the pressure of paying the interest payments.Some bonds are callable, which means the company may call, or pay off, the bonds at a specified price. The call price is usually 100 or a few percentage points above maturity value, perhaps 101 or 102 to provide an incentive to the bond holder. Callable bonds give the issuer the flexibility to pay off the bonds when it benefits the company. An alternative to calling the bonds is to purchase them in the open market at their current market price. Whether the bonds are called or purchased in the open market, the journal entry is the same.
60Retiring Bonds Payable Assume:$100,000 bondsDiscount $3,081Current bond market price $95Call price $100Suppose on December 31, 2013, a company has $100,000 of bonds payable outstanding with a remaining discount balance of $3,081 (the original discount of $3,851 [$100,000 - $96,149] less the straight-line amortization of $385 in June and less the amortization of $385 in December).Lower interest rates have convinced management to pay off these bonds now. These bonds are callable at 100. If the market price of the bonds is 95, should the company call the bonds at 100 or purchase them in the open market at 95? The market price is lower than the call price, so the company should buy the bonds on the open market at their market price. Retiring the bonds on December 31, 2013, at 95 results in a gain of $1,919
61Retiring Bonds Payable Journal entryClose Bond payable and any discount or premium accountCredit Cash for the amount paidA difference between carry value and purchase costs results in a gain or lossCarrying value exceeds purchase price = gainPurchase value exceeds carrying value = lossThe journal entry removes the bonds from the books and records a gain on retirement. Any existing premium would be removed with a debit. If a company retired only half of these bonds, it would remove only half the discount or premium. A difference between carry value and purchase costs results in a gain or loss. If the carry value exceeds purchase price then a gain is recorded for the difference. If the purchase value exceeds carry value then a loss is recorded for the difference.