Early retirements of debt may occur because a company has generated sufficient cash reserves from operations and wants to stop paying interest on outstanding debt. Or interest rates may have changed, and the company wants to take advantage of more favorable borrowing opportunities; you have probably heard of individuals engaging in this type of strategy when they "refinance" a home loan.

Whether debt is being retired or refinanced in some other way, accounting rules dictate that the retired debt be removed from the books and the difference between the debt's net carrying value and the funds paid to retire the debt be recognized as a gain or loss.

Example

Assume that Cabano Corporation is retiring $200,000 face value of its 6% bonds payable. The last semi-annual interest payment occurred on April 30 and the bonds are being retired on June 30, 2010. The unamortized discount on the bonds on April 30, 2010, was $6,000, and there was a 5-year remaining life on the bonds as of that date. Further, Cabano is paying $210,000, plus accrued interest, to retire the bonds; this "early call" price was stipulated in the original bond covenant.

The first step to account for this bond retirement is to bring the accounting for interest up to date:

Interest Expense (debit): 2,200
Discount on Bonds Payable (credit): 200
Interest Payable (credit): 2,000

Then, the actual bond retirement can be recorded, with the difference between the up-to-date carrying value and the funds utilized recorded as a loss (debit) or gain (credit).

Bonds Payable (debit): 200,000
Interest Payable (debit): 2,000
Loss on Bond Retirement (debit): 15,800
Discount on Bonds Payable (credit): 5,800
Cash (credit): 212,000

Notice that Cabano's loss relates to the fact that it took a lot more cash ($210,000) to pay off the debt than was the debt's carrying value ($200,000 - $5,800 = $194,200).