Accounting For Bonds Payable

Initially, the carrying amount is the amount of cash received when the bond is issued. There are four journal entries that relate to bonds that are issued at a discount. If a manufacturer offers both zero-percent interest and a rebate, the car buyer can choose one or the other—but not both. Because some people will be attracted to buy because of lower payments over time and others will be interested due to the lower up- front purchase price. The deals are designed to appeal to different types of people with different buying preferences.

1. This method is a more accurate amortization technique, but also calls for a more complicated calculation, since the amount charged to expense changes in each accounting period.
2. In this case, the corporation is offering an 11% interest rate, or a payment of $5,500 every six months, when other companies are offering a 12% interest rate, or a payment of $6,000 every six months.
3. To compensate for the fact that the corporation will pay out $5,000 more in interest, it will charge investors $5,000 more to purchase the bonds and will collect $105,000 instead of $100,000.
4. A business or government may issue bonds when it needs a long-term source of cash funding.
5. At the end of the schedule (in the last period), the premium or discount should equal zero.

Another alternative for raising cash is to borrow the money and to pay it back at a future date. Banks and other traditional lending sources are one option where the corporation may go to take out a loan for the full amount needed. Each yearly income statement would include $9,544.40 of interest expense ($4,772.20 X 2). The straight-line approach suffers from the same limitations discussed earlier, and is acceptable only if the results are not materially different from those resulting with the effective-interest technique. The following T-account shows how the balance in Discount on Bonds Payable will be decreasing over the 5-year life of the bond. It is possible for a corporation to redeem only some of the bonds that it holds.

The income statement for all of 20X3 would include $6,294 of interest expense ($3,147 X 2). This method of accounting for bonds is known as the straight-line amortization method, as interest expense is recognized uniformly over the life of the bond. Notice that interest expense is the same each year, even though the net book value of the bond (bond plus remaining premium) is declining each year due to amortization.

What is the Amortization of Discount on Bonds Payable?

Comparable bonds on the market will pay out $60,000 over this same time frame. Bonds payable are recorded when a company issues bonds to generate cash. Thus, bonds payable appear on the liability side of the company’s balance sheet. If Schultz issues 100 of the 8%, 5-year bonds for $92,278 (when the market rate of interest is 10%), Schultz will what is a mortgage suspense account still have to repay a total of $140,000 ($4,000 every 6 months for 5 years, plus $100,000 at maturity). Thus, Schultz will repay $47,722 ($140,000 – $92,278) more than was borrowed. Spreading the $47,722 over 10 six-month periods produces periodic interest expense of $4,772.20 (not to be confused with the periodic cash payment of $4,000).

If a corporation redeems a bond prior to its maturity date, the carrying amount at the time should be compared to the amount of cash the issuing company must pay to call the bond. If the corporation pays more cash than what the bond is worth (the carrying amount), it experiences a loss. Some investors prefer to pay full price and have higher interest payments every six months. Others are attracted by paying less up front and being paid back the full face amount at maturity and are willing to live with the lower semi-annual interest payments. Both deals are equal in value but are structured to appeal to different markets. A bond is a loan contract, called a debenture, which spells out the terms and conditions of the loan agreement.

Discount on bonds payable definition

At the very least, the debenture states the face amount of the bond, the interest rate, and the term. The face amount is the amount that the bondholder is lending to the corporation. The contract rate of interest is similar to a rental fee that the corporation commits to pay for use of the lenders’ money. The maturity date is the date that the corporation must pay back the full face amount to the bondholders. None of the face amount of the bond is repaid before the maturity date. Another possibility is for the corporation to issue bonds, which are also a form of debt.

Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. It is important to note that a gain or loss is incurred on a transaction that is outside of what occurs in normal business operations and therefore is not categorized as an operating revenue or expense. You may have heard of ways car manufacturers encourage people to buy vehicles.

What is discount on bonds payable?

A corporation typically pays interest to bondholders semi-annually, which is twice per year. In this example the corporation will pay interest on June 30 and December 31. Besides keeping a running balance of each of the new accounts, the key number to determine is the carrying amount of a bond at any point in time. The following Accounts Summary Table summarizes the accounts relevant to issuing bonds.

Assume that a corporation prepares to issue bonds having a maturity amount of $10,000,000 and a stated interest rate of 6% (per year). However, when the bonds are actually sold to investors, the market interest rate is 6.1%. Since these bonds will be paying the investors less than the market rate of interest ($300,000 semiannually instead of $305,000), the investors will pay less than $10,000,000 for the bonds. If a bond is issued at a premium or at a discount, the amount will be amortized over the years through to its maturity. On issuance, a premium bond will create a “premium on bonds payable” balance. At every coupon payment, interest expense will be incurred on the bond.

There are times when the contract rate that your corporation will pay is less than the market rate that other corporations will pay. As a result, your corporation’s semi-annual interest payments will be lower than what investors could receive elsewhere. To be competitive and still attract investors, the bond must be issued at a discount. This means the corporation receives less cash than the face amount of the bond when it issues the bond. The corporation still pays the full face amount back to the bondholders on the maturity date.

What conditions cause a discount on bonds payable?

Notice that the premium on bonds payable is carried in a separate account (unlike accounting for investments in bonds covered in a prior chapter, where the premium was simply included with the Investment in Bonds account). To further explain, the interest amount on the $1,000, 8% bond is $40 every six months. Because the bonds have a 5-year life, there are 10 interest payments (or periods). The periodic interest is an annuity with a 10-period duration, while the maturity value is a lump-sum payment at the end of the tenth period.

Since a bond’s discount is caused by the difference between a bond’s stated interest rate and the market interest rate, the journal entry for amortizing the discount will involve the account Interest Expense. In this case, the corporation is offering a 12% interest rate, or a payment of $6,000 every six months, when other companies are offering an 11% interest rate, or a payment of $5,500 every six months. As a result, the corporation https://www.bookkeeping-reviews.com/claim-for-reimbursement-for-expenditures-on-official-business/ will pay out $60,000 in interest over the five-year term. Comparable bonds on the market will pay out $55,000 over this same time frame. In this case, the corporation is offering an 11% interest rate, or a payment of $5,500 every six months, when other companies are offering a 12% interest rate, or a payment of $6,000 every six months. As a result, the corporation will pay out $55,000 in interest over the five-year term.