Accounting for Issuance of Bonds Example and Journal Entry

Essentially, the company incurs the additional interest, amounting to $7,024, at the time of issuance by receiving only $92,976 rather than $100,000. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. In this entry, Cash is credited for $6,000, Interest Payable is debited for $2,000, and Interest Expense is debited for $4,000. Interest Payable is credited because these funds will be repaid on the next interest date. This is done by crediting Interest Payable for the 2 months of accrued interest, or $2,000. In this case, the interest accrual is for the entire 6-month period because the last interest payment was on 1 July.

• Another way to think about amortization is to understand that, with each cash payment, we need to reduce the amount carried on the books in the Bond Premium account.
• The amount of the premium amortization is simply the difference between the interest expense and the cash payment.
• However, after paying the interest at the end of the third year, we decide to redeem those $100,000 bonds back in order to save the cost of interest by paying a total amount of $105,000.
• If the company had issued 5% bonds that paid interest semiannually, interest payments would be made twice a year, but each interest payment would only be half an annual interest payment.

The difference between cash receive and par value is recorded as discounted on bonds payable. The unamortized amount will be net off with bonds payable to present in the balance sheet. When a company issues bonds, it incurs a long-term liability on which periodic interest payments must be made, usually twice a year. If interest dates fall on other than balance sheet dates, the company must accrue interest in the proper periods. The following examples illustrate the accounting for bonds issued at face value on an interest date and issued at face value between interest dates. The premium on bonds payable is treated as an adjunct liability account.

Accounting for bonds

You may wonder why don’t we discount cash flow bonds value which will be paid at the end of 3rd year. When the coupon rate equal to the effective interest rate, the present value of bond value and annual interest is equal to the par value. As shown above, if the market rate is lower than the contract rate, the bonds will sell for more than their face value. Thus, if the market rate is 10% and the contract rate is 12%, the bonds will sell at a premium as the result of investors bidding up their price. However, if the market rate is higher than the contract rate, the bonds will sell for less than their face value.

• It is important to understand the nature of the Discount on Bonds Payable account.
• If interest dates fall on other than balance sheet dates, the company must accrue interest in the proper periods.
• As mentioned above, as per the straight-line method, the amortization of bond discount is calculated by dividing the total interest on bonds by the total number of periods until the maturity date.
• This is because we have a $6,000 bond discount that we have not amortized yet on the balance sheet.
• As the normal balance of the bond discount is on the debit side of the T-account, we need to credit the bond discount to remove it from the balance sheet.
• The Premium will disappear over
  time as it is amortized, but it will decrease the interest expense,
  which we will see in subsequent journal entries.

If the estimates are true, this means that all 176 employees of the company will not receive year-end bonuses, which represent a significant portion of their pay. A mortgage calculator provides monthly payment estimates for a long-term loan like a mortgage. Mortgages are long-term liabilities that are used to finance real estate purchases. We tend to think of them as home loans, but they can also be used for commercial real estate purchases.

Accounting for Bond Amortization

Since the market rate and the stated rate are
different, we again need to account for the difference between the
amount of interest expense and the cash paid to bondholders. On the date that the bonds were issued, the company received
cash of $104,460.00 but agreed to pay $100,000.00 in the future for
100 bonds with a $1,000 face value. The difference in the amount
received and the amount owed is called the premium. Since they promised to pay 5% while similar
bonds earn 4%, the company received more cash up front. They did this because the
cost of the premium plus the 5% interest on the face value is
mathematically the same as receiving the face value but paying 4%
interest.

Which of these is most important for your financial advisor to have?

Likewise, the normal balance of the bond premium account is on the credit side. In accounting, it is very important to recognize both elements into the financial statement. The financial liability will initially measure by using discounted cash flow of interest payment and bonds nominal value. Subsequently, we need to record the additional balance which arises from the difference between interest expense and interest paid.

The amortization of bond discount can be done with the straight-line method or the effective interest rate method depending on if the amount of discount is material or not. If the discounted amount is material the company need to amortize the bond discount with the effective interest rate method as it is a more accurate method compared to the straight-line method. For example, on February 1, the company ABC issues a $100,000 bond with a five-year period at a discount which it sells for $97,000 only.

Accounting For a Bond Issue

The amount of
the discount amortization is simply the difference between the
interest expense and the cash payment. Since we originally debited
Bond Discount when the bonds were issued, we need to credit the
account each time the interest is paid to bondholders because the
carrying value of the bond has changed. Note that the company
received less for the bonds than face value but is paying interest
on the $100,000. The interest expense is calculated by taking the Carrying Value ($91,800) multiplied by the market interest rate (7%). The amount of the cash payment in this example is calculated by taking the face value of the bond ($100,000) and multiplying it by the stated rate (5%). Since the market rate and the stated rate are different, we need to account for the difference between the amount of interest expense and the cash paid to bondholders.

(Figure)Assume you are a newly hired accountant for a local manufacturing firm. Bondholders receive the stated rate times the principle, so they would receive $6,000. Because equipment leasing the ultimate guide for small business owners interest is calculated based on the outstanding loan balance, the amount of interest paid in the first payment is much more than the amount of interest in the final payment.

The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Bonds Payable is always credited for the face amount of the issue, and so the accrued interest element must be accounted for separately. The corporation’s year-end is 31 December, and the firm must make an adjusting entry to record interest expense for the 6-month period from 1 July to 31 December. The accounting for bonds involves a number of transactions over the life of a bond. The accounting for these transactions from the perspective of the issuer is noted below.

Accounting for Bonds Issued at a Discount FAQs

At some point, a company will need to record bond
retirement, when the company pays the obligation. For example, earlier we
demonstrated the issuance of a five-year bond, along with its first
two interest payments. If we had carried out recording all five
interest payments, the next step would have been the maturity and
retirement of the bond. At this stage, the bond issuer would pay
the maturity value of the bond to the owner of the bond, whether
that is the original owner or a secondary investor. Under both IFRS and US GAAP, the general definition of a
long-term liability is similar.

The interest expense is calculated by taking the Carrying Value ($93,226) multiplied by the market interest rate (7%). The amount of the cash payment in this example is calculated by taking the face value of the bond ($100,000) multiplied by the stated rate (5%). Again, we need to account for the difference between the amount of interest expense and the cash paid to bondholders by crediting the Bond Discount account. Municipal bonds, like other bonds, pay periodic interest based on the stated interest rate and the face value at the end of the bond term. However, corporate bonds often pay a higher rate of interest than municipal bonds. Despite the lower interest rate, one benefit of municipal bonds relates to the tax treatment of the periodic interest payments for investors.