8. Retiring Bonds

Let's talk about retiring bonds. When you retire a bond, you're basically just taking it out of circulation. Now, you could have, let's say, the bond is mature. So once the bond reaches maturity, you take it out of circulation, or you retire it by paying the face value. Remember we said all bonds have some face value, some market rate, and some term printed on them. So if this bond has a face value of 100,000, at the end, we're promising to pay 100,000. So this is how you would retire a bond at maturity.

You just decrease the bond payable, and you decrease your cash because you paid cash to satisfy this promise of paying back the face value when it reaches maturity. Now, some bonds will have provisions in them. They'll have legal language that says, "We can call this bond early." We can say, "Okay, we wanna buy this bond back." So instead of allowing it to run all the way to maturity, the company can say, "I wanna call it at any time." So they can call it based on whatever it says on the bond, whatever the legal language is. You'll often see it written like this, callable at, we'll say, 106.

Now what this 106 means is 106% of face value. Why it's represented as just 106, I have no idea. But it'll say callable at 106 or callable at 102 3/4, or callable at 98 7/8. All this means is 102.75% and 98 7/8% of face value.

It's always, always, always calculated on face value. Let's do an example, and let's say that on December 31, there was a bond that looked like this. The bond payable was 100,000, and the premium was 5,000. So there was an unamortized premium left. Then on January 1, we decide to call at 106. So in your mind, what you need to be thinking is, we have decided to buy back this bond for 106% of the face value. And you can tell that the face value is 100,000 because that's what we put in the bond payable account.

Remember, we have premium and discount accounts to hold the other stuff. The face value goes in the bond payable account. Right off the bat, you're gonna see, okay, well, if I'm paying 106% times 100,000, I'm gonna need $106,000 in cash to buy it back. Because I'm paying 106% of 100,000, this comes out to be the cash amount that you have to pay in order to satisfy this 106 provision. So we can start by saying our cash is gonna go down by 106,000.

We also know that the bond payable is being retired, so we can get rid of that. Additionally, this premium is attached to this bond payable. These two guys go hand in hand. They come from the same place, so we're getting rid of this premium also.

Now, my astute students will notice that we've got 100,000 plus 5,000 and then 106 on the other side. So we're missing $1,000, and we're missing it right here. And I can tell that because now this is 106 on this side, and this is 106 on the credit side. So what is this $1,000? Before I tell you, let's think through it logically. If you paid $106,000 for something that we decided was worth 105,000, because it's the bond plus the premium, we agree that that's worth 105, and we paid 106.

So in your mind, you must be thinking, we overpaid for that bond. We paid too much. And another way to state that is we had to take a loss on retirement. So we took a $1,000 loss on retiring this bond payable.

And there are a couple of ways to remember that. The first one is the one I just walked you through. You paid 106 for something that was worth 105. Logically, that means you have to take a loss. Another way to remember that is we're plugging the gap to make this equation balance. So we put the 1,000 there on the debit side. And if you'll remember, expenses are debits, and revenues are credits.

So this is most like an expense. So we say losses are equivalent to expenses and are debits, and gains are equivalent to revenues and are credits. So if you didn't know the name of this account, definitely don't call it a gain because you can remember revenues are credits, expenses are debits. I wouldn't call gains and expenses equivalent. I would call losses and expenses equivalent. Those are pretty much the same idea. So if you're just plugging a gap to make your journal entry balance, remember, expenses go on the debit side, and expenses and losses are pretty similar, so we're just gonna call this a loss. Let me show you another example.

What if we had this same bond, but we decided, or rather it's written on the bond, that we can call it at 102? So instead of having to call it at 106, we can call it at 102. Something that's not gonna change is the face value of the bond is still gonna be 100,000. However, our cash, if we call this one at 102, our cash is 102,000. The premium still goes away. We still have to get rid of that premium because, like I said, those two are attached.

Now you'll see that we've got 105 on the debit side and 102 on the credit side. So we're missing 3,000 here, and as you can guess, that would be a gain. So you'd have gain on retirement. Leave yourself some more room than I did. And if you think about it, this makes sense also because you paid $102,000 for something that was worth $105,000. So you got a good deal. You made a gain, and your gain is the $3,000 used to plug the gap. Or you could say face value plus premium minus discount, which there isn't any, minus the cash we had to pay gives us the $3,000 gain.

Let's do that for up here. Face value plus premium minus the cash we have to pay gives us our $1,000 loss. And I like this gain/loss stuff because there are a bunch of different ways to get there. You can see you can do this formula. You can just start doing the journal entry. It really doesn't matter because it comes out to be pretty straightforward. And this formula here, we can simplify that to say carrying value minus cash paid equals gain or loss. 'Cause if you'll remember, carrying value is face value plus any premium minus any discount. So functionally, what we're saying is, what is it worth on our books?

What did we pay for it? And the difference is a gain or a loss, which is why, if we look all the way back up here, which is why there's no gain or loss at maturity. Because if you'll remember, as the bond approaches maturity, the carrying value approaches the face value such that at maturity, the carrying value equals the face value. Because over time, we're amortizing this premium or we're amortizing this discount. So if a bond makes it all the way to maturity, the carrying value is going to be equal to the face value. So if you wanna do that formula again, carrying value minus cash paid equals gain/loss.

Well, carrying value is gonna be 100 and the cash we pay is gonna be the face value at 100. So that's how you know that at maturity there is no gain or loss because carrying value is going to be equal to face value, which is the amount we pay to get the bond back.