Question

Why would a company wish to reduce its bond indebtedness before its bonds reach maturity? Indicate how this can be done and the correct accounting treatment for such transaction.

Answer 1

A company may try to reduce its bond indebtedness before the bond reaches the maturity since maturity dates of few bonds may be very long and to take the advantage of prevailing lower interest rate. And moreover when the maturity date reaches the company should discharge all the bonds at once which increases a large cash outflow to the company.

A company may consider an alternative investment that could generate the increased cash flow, than a bond could generate, in short period of time.

1. The indebtedness can be reduced by purchasing the bonds in the open market and then retiring them. This can help the company to reduce the huge cash outflow.

or

2. Issue of bonds callable after certain date and then calling some or all of them to reduce the indebtedness.