Financial Accounting: An Integrated Statements Approach, 2nd Edition

the face value. A corporation may also redeem its bonds by purchasing them on the

open market.

A corporation usually redeems its bonds at a price different from that of the car-

rying amount (or book value) of the bonds. The carrying amount of bonds payable is

the balance of the bonds payable account (face amount of the bonds) less any un-

amortized discount or plus any unamortized premium. If the price paid for redemp-

tion is below the bond carrying amount, the difference in these two amounts is recorded

as a gain. If the price paid for the redemption is above the carrying amount, a loss is

recorded. Gains and losses on the redemption of bonds are reported on the income

statement.^6

To illustrate, assume that on June 30, a corporation has a bond issue of $100,000

outstanding, on which there is an unamortized premium of $4,000. If the corpora-

tion calls the entire bond issue for $105,000 on June 30, the redemption is recorded as

follows:

Instead of calling the entire bond issue, assume that the corporation purchases

one-fourth ($25,000) of the bonds for $24,000 on June 30, the redemption is recorded

as follows:

In the preceding entry, only a portion of the premium relating to the redeemed

bonds is written off. The difference between the carrying amount of the bonds pur-

chased, $26,000 ($25,000 $1,000), and the price paid for the redemption, $24,000, is

recorded as a gain.

Zero-Coupon Bonds

Some corporations issue bonds that provide for only the payment of the face amount

at the maturity date. Such bonds are called zero-coupon bonds. Because they do not

provide for interest payments, these bonds sell at a large discount. For example, $1,000

ofGeneral Motor Acceptance Corp. (GMAC)face value zero-coupon bonds maturing

in 2015 were selling for $465.50 on November 8, 2005.

The accounting for zero-coupon bonds is similar to that for interest-bearing bonds

that have been sold at a discount. The discount is amortized as interest expense over

the life of the bonds. To illustrate, assume that a $100,000 zero-coupon bond due in

5 years is issued at $53,273 on January 1, 2007. The entry to record the issuing of the

bonds follows on the next page.

458 Chapter 10 Liabilities

June 30 Bonds Payable 25,000

Premium on Bonds Payable 1,000

Cash 24,000

Gain on Redemption of Bonds 2,000

June 30 Bonds Payable 100,000

Premium on Bonds Payable 4,000

Loss on Bonds Payable 1,000

Cash 105,000

International Perspective

International Accounting

Standards give companies

the option of recording

certain financial instru-

ments such as bonds at

either their fair value or

their amortized cost.

6 As we will discuss in Chapter 12, gains and losses on bond redemptions are reported separately on the

income statement as extraordinary items.

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