2. Section 3: Bond Retirement
Chapter 22
Long-Term Bonds
Section 3: Bond Retirement
Section Objectives
This final section of chapter 22 explains how to record the transactions of a bond sinking fund investment and the eventual retirement of a bond.
Record the transactions of a bond sinking fund investment.
Record an increase or decrease in retained earnings appropriated for bond retirement.
Record retirement of bonds payable.

3. When a bond matures, it is Retired.
The bond is paid.
The liability is removed from company’s balance sheet.
New Partner Given Credit for Amount Invested
2017
April 1
Bonds Payable ,000.00
Cash ,000.00
Bond retired at maturity.
When a bond is paid off, the bond is retired and removed from the books of the company.

4. Objective 8.
Record The Transactions Of A Bond Sinking Fund Investment.
One way to financially prepare for the retirement of bonds is to set up a fund and periodically contribute to it.

5. What is a bond sinking fund investment?
QUESTION:
What is a bond sinking fund investment?
A bond sinking fund investment is a fund established to accumulate assets to pay off bonds when they mature.
ANSWER:
A bond sinking fund investment is a fund established to accumulate assets to pay off bonds when they mature.

6. Bond Sinking Fund The cash put into the fund is invested.
The net earnings of the fund will reduce the amount that the corporation will have to add each year after the first year.
A corporation uses the bond sinking fund to save a constant amount every month or year to pay off its bonds at the maturity date. The net earnings of the fund will reduce the amount that the corporation will have to add each year after the first year.

7. Bond Sinking Fund Investment
Example:
FLORAK decides to accumulate $30,000 per year in a bond sinking fund for each of the last five years the bonds are outstanding.
Let’s look at a sinking fund created by FLORAK corporation.

8. Bond Sinking Fund Investment
Journal entry to record first annual installment:
New Partner Given Credit for Amount Invested
2012
April 1
Bond Sinking Fund Investment ,000.00
Cash ,000.00
first annual installment
of bond sinking fund
To record the first annual installment, the Bond Sinking Fund Investment account is debited for $30,000.

9. Bond Sinking Fund Investment
Journal entry to record net income earned by sinking fund for the year:
New Partner Given Credit for Amount Invested
2013
April 1
Bond Sinking Fund Investment ,760.00
Income from Sinking Fund Investment ,760.00
Net income earned by
Sinking Fund during the year.
Each year the sinking fund earns income. To record the earnings of the fund the corporation credits Income from Sinking Fund Investment and debits the Bond Sinking Fund Investment account.

10. Bond Sinking Fund Investment
Journal entry to record second annual installment:
New Partner Given Credit for Amount Invested
2013
April 1
Bond Sinking Fund Investment ,240.00
Cash ,240.00
($30,000 first year installment less $1,760 first year income equals $28,240)
Since the fund had earnings of $1,760 in its first year, the amount that the company must invest in the fund this second year is reduced to $28,240.
This procedure is repeated each year, until the entire amount needed to retire funds is reached.

11. Bond Sinking Fund Investment
Journal entry to record retirement of bonds:
New Partner Given Credit for Amount Invested
2017
April 1
10% Bonds Payable, ,000.00
Bond Sinking Fund Investment ,000.00
Bonds retired at maturity
using balance in sinking
fund.
When the bonds payable mature and must be paid off, the money comes from the Bond Sinking Fund Investment account.

12. Objective 9.
Record An Increase Or Decrease In Retained Earnings Appropriated For Bond Retirement.
Sometimes retained earnings are appropriated for bond retirement.

13. Retained Earnings Appropriated for Bond Retirement
The bond contract might require that retained earnings are appropriated while the bonds are outstanding.
As covered in Chapter 21, when retained earnings are appropriated, they are restricted from dividend payments.

14. Retained Earnings Appropriated for Bond Retirement
FLORAK’S Board of Directors decides to appropriate $30,000 of retained earnings during each of the last five years the bonds are outstanding.
Record annual appropriation in years :
New Partner Given Credit for Amount Invested
2012
April 1
Retained Earnings ,000.00
Retained Earnings Appropriated for Bond Retirement ,000.00
When retained earnings are appropriated for future bond retirements:
Dr Retained Earnings
Cr Retained Earnings Appropriated for Bond Retirement.
Remember, since appropriations may affect dividend payments, any restrictions should be disclosed in the corporation’s financial statements.
Appears on the balance sheet under the heading “Appropriated Retained Earnings.”

15. Retained Earnings Appropriated for Bond Retirement
In year that bond matures, record close-out of appropriation account:
New Partner Given Credit for Amount Invested
2017
April 1
Retained Earnings Appropriated for Bond Retirement ,000.00
Retained Earnings ,000.00
At the end of five years, $150,000 has been accumulated in the account for the bond retirement.
In this year of bond maturity, the corporation will record a close-out of the appropriation account.
$30,000 x 5 years= $150,000

16. Objective 10. Record Retirement Of Bonds Payable.
When bonds are retired, the corporation stops paying interest on them and those bonds are “out of circulation.”

17. Retirement of Bonds
Recall that on April 1, 2010, FLORAK Corporation issued $50,000 face value, 10%, 10 year bonds at a discount.
Maturity date is January 1, 2017.
Interest is paid on January 1 and July 1 of each year.
Bonds were issued at
Discount of $1,120 is amortized on a straight-line basis
over the remaining 7 years until the bonds due date.
They decide to retire the bonds one year after issuance
(April, 1, 2011).
In the FLORAK Corporation example, the company decides to retire the discounted bonds one year after issuance.

18. Early Retirement of Bonds
Corporation could have surplus cash, so bonds are retired early.
Interest rate decreases could result in an early retirement of bonds.
Sometimes it is advantageous to retire bonds early. (interest rate on bonds is too high).
A gain or loss may be incurred on the early retirement of a bond if its book value is different than the proceeds required to pay it off early.

19. How much discount is amortized in each six-month interest period?
QUESTION:
How much discount is amortized in each six-month interest period?
$1,120 discount
÷ months (remaining life of bond)
$ per month X months
ANSWER:
For the discounted bonds which the company wants to retire early, we need to calculate the carrying value of the bonds. First, we need to calculate how much of the discount has been amortized. We know that $80 of the discount was amortized every six months. . . $

20. Retirement of Bonds
On April 1, 2011, FLORAK Corporation purchased and retired $50,000 face value of the bonds (originally issued at a discount).
Represents 50% of total bonds outstanding.
Purchased at 101 plus accrued interest.
The company is retiring 50% of the bonds or a face amount of $50,000. They are paying 101% of this face amount plus any accrued interest to the bondholders.

21. What is the amount of unamortized discount that remains at time of retirement?
Answer:
Discount on Bonds Payable
Beg. Bal 1,120
/1/10
adj. entry
/1/11
960
The amount of unamortized Discount that remains at time of retirement is $960.
At time of retirement. . .

22. What is the Carrying Value of the Bonds at Retirement?
Bonds Payable
Discount on Bonds Payable
50,000
1,120
/1/10
adj
/1/11
50,000
960
In order to figure if there was a gain or loss on the early retirement, we still need to know what the carrying value of the bonds were. If we examine the balances in the Bonds Payable account and its contra account, the Discount on Bonds Payable account, we see that the carrying value of the bonds is $49,040.
At time of retirement. . .
Carrying Value of bonds = $49,040

23. What is the total book value to be removed?
REMINDER: Gain or loss is the difference between book value of bonds retired and what is paid for them.
QUESTION:
What is the total book value to be removed?
$50,000 face value
960 discount book value
Face value – discount
ANSWER:
$49,040
The gain or loss incurred on early retirement is the difference between (carrying value) book value of bonds retired and what is paid for them. The carrying value of the bonds is $49,040

24. What is the interest up to
Record bond interest expense up the date of retirement. . .
QUESTION:
What is the interest up to
the date of retirement?
$50,000 face value
X % interest rate
Interest = principal X rate X time
5,000
X /12 period to retirement
ANSWER:
Before retiring the bonds and taking them off of the books, we need to record any interest expense up to the date of retirement.
$ 1,250
2011
Apr Bond Interest Expense ,250
Bond Interest Payable ,250
Cash ,500

25. What is the cash payment for
REMINDER: Gain or loss is the difference between book value of bonds retired and what is paid for them.
QUESTION:
What is the cash payment for
repurchase price?
$50,000 face value
X purchase price
$50,500 repurchase price
Repurchase price = face value X 1.01
ANSWER:
The corporation agreed to pay 101% of the face amount of the bonds which would be equal to $50,500.
$50,500 cash payment

26. What is the gain or loss on the transaction?
REMINDER: Gain or loss is the difference between book value of bonds retired and what is paid for them.
QUESTION:
What is the gain or loss on the transaction?
$49,040 book value
– ,500 repurchase price
Book value - repurchase price
$ 1,460 loss on early retirement of bonds
ANSWER:
The difference between the book value of $49,040 and the repurchase price of $50,500 is $1,460. This is recorded as a loss on early retirement of bonds.

27. Record Loss on Early Retirement
2011
Apr Bonds Payable ,000.00
Loss on Early Retirement of Bonds ,460.00
Cash ,500.00
Discount on Bonds Payable
The journal entry on April 1 to record the early retirement is shown here. In the journal entry the Bonds Payable face amount of $50,000 is removed along with the unamortized balance of the discount. The loss of $1,460 is also recorded in the Loss on Early Retirement of Bonds account.

28. Complete the following sentences: bond sinking fund investment
SECTION R E V I W
Complete the following sentences:
______________ occurs when a bond is paid and the liability is removed from the balance sheet.
Bond retirement
A __________________________ is a fund used to accumulate assets to pay off bonds when they mature.
bond sinking fund investment
Let’s review. . .
Net earnings of the bond sinking fund will ______ the amount the corporation will have to add each year after the first year.
reduce

29. Complete the following sentences:R E V I W
SECTION
Complete the following sentences:
Bonds payable are usually retired at the ____________.
maturity date
Bonds may be retired early because a corporation has ____________.
surplus cash
Decreases in the ___________ could result in an early retirement of bonds.
interest rate

30. College Accounting, 11th Edition
Thank You
for using
College Accounting, 11th Edition
Price • Haddock • Brock