Reacquisition of Debt

Definition

The term reacquisition of debt refers to one of two processes that a company can use to lower the amount of debt appearing on its balance sheet.  Reacquisition of debt can refer to the process of buying back bonds on the open market and holding them in treasury, or the exercising of a call feature.

Reacquiring these liabilities prior to their maturity date is referred to as early extinguishment of debt.  Accounting rules require companies to report the gain or loss that occurs with these transactions.

Explanation

Issuing long-term bonds represents an important source of financing for many companies. 
Oftentimes companies establish a sinking fund, which is used to repay investors when the bonds mature.  At this point, the debt is said to be extinguished.

If a company reacquires debt before the scheduled maturity date, the transaction is referred to as the early extinguishment of debt.  Debt is considered extinguished when there is no further obligation to an external party to transfer economic benefits.  When that occurs, the obligation can be removed from the company's balance sheet.

Reacquisition of debt refers to two processes:

  • Open Market Purchases:  in the same way investors can purchase bonds of the company on the open market, the issuing company can re-purchase bonds they've issued and hold them as treasury securities.
  • Call Features:  if the bonds contained a call feature, the company can exercise this right, paying bondholders the face value of the security plus an agreed-to premium.

Accounting rules require companies to report the gain or loss that occurs with early extinguishment of debt.  In the past, this was reported as an extraordinary item.  FASB ASC 470-50-45: Debt-Modifications and Extinguishments-Other Presentation Matters now states they are only classified as an extraordinary item if the event is considered both unusual in nature and infrequent in occurrence.

Example

Five years ago, Company A issued bonds at 98 with a face value of $1,000,000 and a term of 20 years.  The cost to issue these bonds was $20,000.  Company A has decided to exercise its right to call in the bonds, paying the holders of the security the agreed-to premium of 102.  The original discount on the bond was (1.00 - 0.98) x $1,000,000, or $20,000.

The loss on the reacquisition of the bonds is calculated as:

Reacquisition Price of Bonds ($1,000,000 x 1.02)   $1,020,000
Face Value of Bonds $1,000,000  
Less:  Unamortized Discount ($20,000 x 15 /20) $15,000  
Less:  Unamortized Bond Issue Cost ($20,000 x 15 /20) $15,000  
Net Carrying  Value of Securities   $970,000
Loss on Reacquisition of Bonds   $50,000

The journal entry to record the transaction would then be:

  Debit Credit
Bonds Payable $1,000,000  
Loss on Reacquisition of Bonds $50,000  
Discount on Bonds Payable   $15,000
Unamortized Bond Issue Costs   $15,000
Cash   $1,020,000

Related Terms

liabilities, long-term liabilities, interest expense, extinguishment of debt, in-substance defeasance