Principles of Financial Accounting: Long Term Liabilities Bond Redemption Before Maturity At Maturity

What It Is

Bond redemption refers to the process of repaying a bond before its maturity date. This can be done by the issuer (e.g., a company) buying back the bond from the investor or by the investor selling the bond back to the issuer. Bond redemption can occur at a premium or discount to the face value of the bond. For example, if a company issues a $10,000 bond with a 5% annual interest rate and a 3-year term, and the market interest rate increases, the bond's market value may decrease to $9,500. If the company decides to redeem the bond after 2 years, it may have to pay $9,500 to the investor.

Key Concepts & Formulas

• Face Value: The initial value of the bond, also known as the par value. Example: A bond with a face value of $10,000.
• Market Value: The current value of the bond, which may be higher or lower than the face value. Example: A bond with a market value of $9,500.
• Premium: The amount by which the market value exceeds the face value. Example: A bond with a premium of $500 ($9,500 - $9,000).
• Discount: The amount by which the market value is less than the face value. Example: A bond with a discount of $500 ($9,000 - $9,500).
• Redemption Price: The price at which the bond is redeemed, which may be the face value, market value, or a negotiated price. Example: A bond redeemed at a price of $9,500.
• Redemption Yield: The yield to maturity of the bond at the time of redemption. Example: A bond with a redemption yield of 5%.
• Bond Redemption Formula: Redemption Price = Face Value + Accrued Interest. Example: A bond with a face value of $10,000 and accrued interest of $500 has a redemption price of $10,500.
• Accrued Interest: The interest that has accrued on the bond since the last interest payment date. Example: A bond with an annual interest rate of 5% and a remaining term of 1 year has accrued interest of $500.
• Bond Redemption Journal Entry: Dr. Bond Redemption Expense and Cr. Bond Payable. Example: A bond redemption journal entry for a bond with a face value of $10,000 and accrued interest of $500.

Journal Entry Examples

1. Dr. Bond Redemption Expense $9,500 Cr. Bond Payable $9,500 The bond is redeemed at a price of $9,500, which is the market value of the bond.

2. Dr. Bond Redemption Expense $10,000 Cr. Bond Payable $10,000 The bond is redeemed at the face value of $10,000.

Common Mistakes

1. Mistake: Confusing the face value and market value of the bond.
   Correction: The face value is the initial value of the bond, while the market value is the current value of the bond. Remember: Face value is like the original price, while market value is like the current price.
2. Mistake: Forgetting to include accrued interest in the bond redemption journal entry.
   Correction: Accrued interest is the interest that has accrued on the bond since the last interest payment date. Remember: Accrued interest is like the interest that has been earned but not yet paid.
3. Mistake: Using the wrong account for bond redemption expense.
   Correction: Bond redemption expense is a contra-revenue account that represents the cost of redeeming the bond. Remember: Contra-revenue accounts are like the opposite of revenue accounts.

Exam Tips

1. Tip: When answering bond redemption questions, make sure to include accrued interest in the journal entry.
2. Tip: Be careful when using the face value and market value of the bond, as they may be different.
3. Tip: Remember that bond redemption expense is a contra-revenue account.

Quick Practice

1. A company issues a $10,000 bond with a 5% annual interest rate and a 3-year term. After 2 years, the market value of the bond decreases to $9,500. What is the adjusting entry for the bond redemption? Answer: Dr. Bond Redemption Expense $9,500 and Cr. Bond Payable $9,500.
2. A bond has a face value of $10,000 and accrued interest of $500. What is the bond redemption price? Answer: $10,500.
3. A company redeems a bond at a price of $9,000. What is the bond redemption expense? Answer: $9,000.

Last-Minute Cram Sheet

1. ⚠️ Bond Redemption Expense is a contra-revenue account.
2. Face Value is the initial value of the bond.
3. Market Value is the current value of the bond.
4. Premium is the amount by which the market value exceeds the face value.
5. Discount is the amount by which the market value is less than the face value.
6. Redemption Price is the price at which the bond is redeemed.
7. Accrued Interest is the interest that has accrued on the bond since the last interest payment date.
8. Bond Redemption Formula: Redemption Price = Face Value + Accrued Interest.
9. ⚠️ Dividends are NOT an expense – they go directly to retained earnings.
10. Normal Balance: Debit balances are normal for asset, expense, and dividend accounts, while credit balances are normal for liability, revenue, and equity accounts.