Companies often issue bonds to secure financing for business operations. Bonds are long-term debt under basic accounting principles. Like many other accounting activities, bonds can have specific terms used by accountants. "Retirement of bond" is just one term associated with these debt instruments. The term has a specific definition for a business activity.
The retirement of bond indicates a company’s repayment of the bond amount to investors. This term often describes repayment when the bond reaches maturity. Companies can, however, retire bonds prior to the maturity date, resulting in a premium or discount on the bond. Companies must record the gain or loss on bond retirement in their general ledger.
Callable bonds represent a specific debt instrument issued by a firm. This instrument allows a company to recall the bond and retire it at any time prior to maturity. The purpose for callable bonds is to retire bonds issued at higher interest rates and reissue bonds at lower interest rates. This results in cash savings for the company as a lower interest guarantee goes with the reissued bonds.
Retirement of bond can also occur with convertible bonds. Companies issue these bonds with the intent to convert the debt to common stock in the future. This retires the debt instrument and converts it into an equity investment. Convertible bonds are quite common in deals that involve mergers and acquisitions. Companies will issue bonds and then convert them to stock to remove debt from financial statements, making them look more attractive to future investors.
Accountants can only record a retirement of bond once it occurs. Until that time, the company must report the bond as long-term debt on its balance sheet. Attempting to post bond retirement prior to converting the debt to stock or repaying investors will result in a material misstatement. Misstatements indicate that a company improperly applies accounting principles and has misleading information on financial statements.
- "Intermediate Accounting"; David Spiceland, et al.; 2007