Early Retirement of Bonds – Current Liabilities

After bonds are sold to investors, they are often subsequently traded (bought and sold) among investors. The market value of bonds that are traded among investors varies from day to day as prevailing interest rates rise and fall. This occurs because the bond contract specifies a set of cash payments to be made to bondholders, and the present value of a given set of future cash flows changes whenever there is a change in the rates used to make the present value calculations. For example, market interest rates on corporate bonds fell dramatically in the 1990s and as a result the value of existing bonds increased substantially. If monetary authorities begin to tighten money and increase interest rates in subsequent years, the market value of existing bonds will again decline.

Fluctuations in the market prices of outstanding bonds do not result in additional cash inflows and outflows for the issuing company. Consistent with the historical cost principle, the reported value of bonds in the financial statements of the issuing company is not revised to reflect changes in market interest rates and market prices of the outstanding bonds. For this reason, changes in market rates of interest may motivate firms to buy back their outstanding bonds prior to their scheduled maturity dates. If market rates of interest have changed subsequent to the issuance of the bonds, then the current market prices of the bonds may differ substantially from values shown on the books of the issuing firm. If the firm does repurchase its own bonds, any difference between the reported value and the repurchase price must be recognized as an extraordinary gain or loss by the issuer when the transaction is completed.

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