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.

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 150,000.00 Cash 150,000.00 Bond retired at maturity. When a bond is paid off, the bond is retired and removed from the books of the company.

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.

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.

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.

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.

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 30,000.00 Cash 30,000.00 first annual installment of bond sinking fund To record the first annual installment, the Bond Sinking Fund Investment account is debited for $30,000.

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 1,760.00 Income from Sinking Fund Investment 1,760.00 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.

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 28,240.00 Cash 28,240.00 ($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.

Bond Sinking Fund Investment Journal entry to record retirement of bonds: New Partner Given Credit for Amount Invested 2017 April 1 10% Bonds Payable, 2017 150,000.00 Bond Sinking Fund Investment 150,000.00 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.

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

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.

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 2012- 2017: New Partner Given Credit for Amount Invested 2012 April 1 Retained Earnings 30,000.00 Retained Earnings Appropriated for Bond Retirement 30,000.00 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.”

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 150,000.00 Retained Earnings 150,000.00 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

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.”

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 97.76. 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.

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.

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 ÷ 84 months (remaining life of bond) $ 13.333 per month X 6 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. . . $ 80

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.

What is the amount of unamortized discount that remains at time of retirement? Answer: Discount on Bonds Payable Beg. Bal 1,120 80 10/1/10 40 adj. entry 40 4/1/11 960 The amount of unamortized Discount that remains at time of retirement is $960. At time of retirement. . .

What is the Carrying Value of the Bonds at Retirement? Bonds Payable Discount on Bonds Payable 50,000 1,120 80 10/1/10 40 adj 40 4/1/11 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

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

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 10% interest rate Interest = principal X rate X time 5,000 X 3/12 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 1 Bond Interest Expense 1,250 Bond Interest Payable 1,250 Cash 2,500

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 1.01 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

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 – 50,500 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.

Record Loss on Early Retirement 2011 Apr. 1 Bonds Payable 50,000.00 Loss on Early Retirement of Bonds 1,460.00 Cash 50,500.00 Discount on Bonds Payable 960.00 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.

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

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

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