Redemption of bonds payable definition
/The redemption of bonds payable refers to the repurchase of bonds by their issuer. There are several ways in which the issuer can accomplish this, which are as follows:
Redemption at maturity date. The most common redemption approach is for the issuer to repurchase bonds when they reach their maturity date. This purchase is made at the face value of the bonds.
Redemption at call date. The issuer can repurchase bonds when a call date is reached. This date is stated within the call feature in the bond agreement, and allows the issuer to call the bonds early in order to take advantage of a decline in the market interest rate; the issuer then sells replacement bonds at the lower market rate.
Sinking fund redemption. The issuer can repurchase bonds in accordance with a sinking fund requirement in the bond agreement. This clause mandates that the issuer repurchase a portion of the issued bonds each year, before the scheduled maturity date of the bond. This requirement is intended to reduce investor risk by forcing the issuer to gradually reduce the bond obligation over time, thereby shrinking the amount that will be payable as of the maturity date.
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Example of the Redemption of Bonds Payable
Albatross Corporation issued $500,000 worth of 10-year bonds at 5% interest on January 1, 2014. The bonds were set to mature on December 31, 2023. On the maturity date, XYZ Corporation redeems (retires) the bonds by paying back the principal to the bondholders.
When the bonds were initially issued, the company recorded the liability as a $500,000 debit to cash and a $500,000 credit to bonds payable. Each year, the company paid interest on the bonds, which it recorded with a $25,000 debit to the interest expense account and a $25,000 credit to the cash account. Albatross repeated this entry annually for ten years. On the maturity date, Albatross must pay back the $500,000 principal to the bondholders. The journal entry to record the redemption is a $500,000 debit to the bonds payable account and a $500,000 credit to the cash account.
If Albatross decided to redeem the bonds early at 98% of face value (a discount), it would instead record a $500,000 debit to the bonds payable account, a $490,000 credit to the cash account, and a $10,000 credit to the gain on bond redemption account.