The objective of this investment is that when the debt gets matured or the life of the asset expires, investments are sold and the proceeds are used to repay the debt or replace the asset. He final step in setting up a sinking fund is calculating the exact amount to pay into the fund in regular period payments. Fund owners calculate the exact payment amount that will accumulate over fund life to meet the spending need. With sinking funds, account holders set the periodic payment amounts so as to bring fund accumulation to a specific target value by the end of the fund’s life. By the 18th century, the term was in use in Great Britain for funds created for the purpose of reducing national debt. By the middle of the 19th Century, the term was in common use in the United States, referring primarily to funding pools for the purpose of retiring corporate and public debt from bond issues. Creditors, investors, and companies benefit from the creation of a sinking fund.
Under the defeasance rules, the income statement shows the gain from the extinguishment of debt. Another alternative would be simply to fulfill the periodic payment requirement of the sinking fund debenture by making a deposit with the trustee. The corporation delivers the repurchased securities to the trustee thus satisfying the bond indenture agreement. The formal loan agreement specifies the authorized dollar amount of the issue, the term of the bonds, maturity date, and periodic interest with payment dates.
Accounting for Retirement of Bonds
Note that the total gain is spread throughout the three-year time frame. A sinking fund is a type of fund that is created and set up purposely for repaying debt. The owner of the account sets aside a certain amount of money regularly and uses it only for a specific purpose. Often, it is used by corporations for bonds and deposits money to buy back issued bonds or parts of bonds before the maturity date arrives. It is also one way of enticing investors because the fund helps convince them that the issuer will not default on their payments. A bond sinking fund is similar to restricted cash in the sense that the company must put aside to buy back bonds that the company had issued. A separate trustee would hold the cash for the company, which is why it is labeled as restricted cash.
- If the balance is long-term, and legally restricted balance is noncurrent and should be treated as an investment or other asset If the use of compensating balance is not restricted, full disclosure is required.
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- The percentage of payment applied to each debt is predefined or is selected by the issuer.
- The options are to repurchase them periodically on the open market, or at a specific call price, or at the lower of the market price or a specific call price, or to only repurchase at the maturity date of the bonds.
- Sinking fund transactions can, in principle, impact all five accounting system account categories.
Paying the debt early via a sinking fund saves a company interest expense and prevents the company from being put in financial difficulties in the long-term if economic or financial conditions worsen. Also, the sinking fund allows ExxonMobil the option to borrow more money if needed. In our example bond sinking fund on balance sheet above, let’s say by year three, the company needed to issue another bond for additional capital. Since only $8 billion of the $20 billion in original debt remains, it would likely be able to borrow more capital since the company has had such a solid track record of paying off its debt early.
Nature of Business
The interest income from such an investment is a Revenue account transaction. Regular payments to the fund usually come from the Equity account or the profit reserve account. Firms may also transfer to the fund from other cash accounts, like Cash on Hand or Bank. As the premium is amortized, the balance in the premium account and the carrying value of the bond decreases. The amount of premium amortized for the last payment is equal to the balance in the premium on bonds payable account.
Do savings bonds go on a balance sheet?
Cash and cash equivalents under the current assets section of a balance sheet represent the amount of money the company has in the bank, whether in the form of cash, savings bonds, certificates of deposit, or money invested in money market funds.