Accounting for Issuance of Bonds Example and Journal Entry

Mechanically, this payment could be recorded in more than one way but the following journal entry is probably the easiest to follow. Interest expense for the first two months was recorded in Year One with interest for the next four months recorded here in Year Two. Therefore, to service the Series I notes issued above, Marriott will be required to make annual interest payments of $22,312,500 ($350 million face value × the stated interest rate of 6.375 percent).

In this article, we will illustrate only the straight-line method for amortizing the premium bonds. In this article, we will illustrate only the straight-line method for amortizing the quarterly tax calculator discount bonds. At the maturity date, which is on December 31, 2039, the bonds will need to retire. Thus, ABC Co needs to repay back the principal of the bonds to the bondholders.

Specific rules dictate the process and judgment for determining fair value. If a company’s debt is traded in a public market, the valuation would be based on its observable price (“Level 1”). If the debt does not have a clearly determinable market, pricing would be tied to similar securities (“Level 2”). Management may develop their own pricing models in the rare case where the value is not otherwise observable (“Level 3”). Whether the debt is being retired or refinanced in some other way, accounting rules dictate that the extinguished obligation be removed from the books. The difference between the old debt’s net carrying value and the amounts used for the payoff should be recognized as a gain or loss.

Interest Payment: Issued at a Premium

When it is time to redeem the bonds, all premiums and discounts should have been amortized, so the entry is simply a debit to the bonds payable account and a credit to the cash account. Bonds Payable is the promissory note which the company uses to raise funds from the investor. Company sells bonds to the investors and promise to pay the annual interest plus principal on the maturity date. It is the long term debt which issues by the company, government, and other entities. It must be classified as long-term liability unless it going to mature within a year.

The amount of the premium amortization is simply the difference between the interest expense and the cash payment. 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. Since we originally credited Bond Premium when the bonds were issued, we need to debit the account each time the interest is paid to bondholders because the carrying value of the bond has changed. Note that the company received more for the bonds than face value, but it is only paying interest on $100,000. The interest expense is calculated by taking the Carrying Value ($100,000) multiplied by the market interest rate (5%). The company is obligated by the bond indenture to pay 5% per year based on the face value of the bond.

Suppose ABC company issues a bond at a par value of $ 100,000 and a coupon rate of 6% with 5 years maturity. ABC Company will record the journal entries for the interest payment yearly. Since we have used the straight-line amortization method, the accounting entry will be the same https://www.kelleysbookkeeping.com/accounting-methods-to-determine-salvage-value/ every year. The Journal Entries to record the transactions will be recorded as below. Suppose ABC company issues a bond at a par value of $ 100,000 and a coupon rate of 5% with 5 years maturity. At the end of 5 years, the company will retire the bonds by paying the amount owed.

1. Issuers usually quote bond prices as percentages of face value—100 means 100% of face value, 97 means a discounted price of  97%of face value, and 103 means a premium price of 103% of face value.
2. The bond issuing companies will record the transactions for the bond principal and the interest payments separately.
3. The discounted price is the total present value of total cash flow discounted at the market rate.
4. Let’s suppose, ABC Co has received the authorization to issue $500,000 of 10%, 20-year bonds.

The contract rate of interest is also called the stated, coupon, or nominal rate is the rate used to pay interest. Firms state this rate in the bond indenture, print it on the face of each bond, and use it to determine the amount of cash paid each interest period. The issuer needs to recognize the financial liability when publishing bonds into the capital market and cash is received.

For example, one hundred $1,000 face value bonds issued at 103 have a price of $103,000 (100 bonds x $1,000 each x 103%). Regardless of the issue price, at maturity the issuer of the bonds must pay the investor(s) the face value (or principal amount) of the bonds. Note that Valley does not need any interest adjusting entries because the interest payment date falls on the last day of the accounting period. At the end of ninth year, Valley would reclassify the bonds as a current liability because they will be paid within the next year. The appropriate expense for this period is $8,000 or $400,000 × 6 percent × 4/12 year.

Interest Payment: Issued at a Discount

Even bonds are issued at a premium or discounted, we need to calculate the carrying value and compare with the cash payment to calculate the gain or lose. The discounted price is the total present value of total cash flow discounted at the market rate. 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. Bonds Issue at discounted means that company sell bonds at a price which lower than par value. Due to the market rate and coupon rate, company may issue the bonds with discount to the investor.

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. As we go through the journal entries, it is important to understand that we are analyzing the accounting transactions from the perspective of the issuer of the bond. For example, on the issue date of a bond, the borrower receives cash while the lender pays cash. The same as discount bonds, in accordance with the GAAP, the premium on bonds is also recorded separately from the bonds payable account. The premium on bonds payable is added to the par value to arrive at the carrying value of the bonds. When bonds are issued and sold at discount, the interest expense will need to be calculated and recorded based on either the straight-line method or effective interest method.

Accounting for Issuance of Bonds

The bonds will pay interest semiannually each year; June 30 and December 31. Notes and bonds can contain an almost infinite list of other agreements. Many of these are promises made by the debtor to help ensure that money will be available to make required payments. The stated amount of interest is paid on the dates identified in the contract. Payments can range from monthly to quarterly to semiannually to annually to the final day of the debt term. Other debts, serial debts, require serial payments where a portion of the face value is paid periodically over time.

Then, the actual bond retirement can be recorded, with the difference between the up-to-date carrying value and the funds utilized being recorded as a loss (debit) or gain (credit). Notice that Cabano’s loss relates to the fact that it took more cash to pay off the debt than was the debt’s carrying value of $194,200 ($200,000 minus $5,800). As the market rate is also 6%, so company can issue bonds at par value. In simple words, bonds are the contracts between lender and borrower, the amount of contract depends on the face value. However, the lender can receive the principal before the maturity date by selling contract to the capital market. The borrower will pay back the principal to whoever holds the contract on maturity date.

Let us discuss what is the issuance of bonds and what is the accounting treatment for them. Because 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 pie charts below show the amount of the $1,073.64 payment allocated to interest and loan reduction for the first and final payments, respectively, on the 30-year loan.

The Discount will disappear over time as it is amortized, but it will increase the interest expense, which we will see in subsequent journal entries. It is contra because it increases the amount of the Bonds Payable liability account. 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. Because of the time lag caused by underwriting, it is not unusual for the market rate of the bond to be different from the stated interest rate. The difference in the stated rate and the market rate determine the accounting treatment of the transactions involving bonds.

The interest payments will be the same because of the rate stipulated in the bond indenture, regardless of what the market rate does. The amount of interest cost that we will recognize in the journal entries, however, will change over the course of the bond term, assuming that we are using the effective interest. 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.