Accounting for bonds for investors is similar to the approach used for issuers. The difference is that an investor records an asset, where the bond is an investment rather than a liability.
A company’s account for Investment in Bonds can be classified as either a current asset or a long-term investment, depending on the marketability of the bonds and management’s intention as to when the bonds will be converted into cash.
Therefore, bonds can be purchased to invest idle cash on a short-term basis, to make a long-term investment in another company, or to accumulate funds for future expansion plans.
Accounting for the Acquisition of Bonds
The acquisition price of bonds includes their purchase price, brokerage commission, and any other costs related to the purchase. Bonds may be purchased at their face value, at a discount or premium, and at or between interest dates.
In practice, the debit to the Investment in Bonds account is made at cost, including all acquisition costs but excluding the accrued interest element.
A separate account is not maintained for the premium or discount. This practice varies from the accounting procedures used by the issuer and the recommendation found in official pronouncements.
However, the investor seldom purchases an entire bond issue, and the amount of the discount or premium is not material.
If bonds are purchased between interest dates, the investor must pay the issuer or the previous bondholder for any interest accrued since the last interest date. This is because the purchaser will collect the full six months’ interest on the next interest date.
To illustrate these procedures, assume that the Cinzano Corporation purchased 12 $1,000, 10%, 5-year bonds on 1 March 2020. The bonds were dated 1 January 2020. The total face value of the bonds was $12,000.
The bonds pay interest semi-annually on 2 January and 1 July and were purchased at a price of $98. The entry below is made to record this investment:
The Investment in Bonds account is recorded at $11,760, net of the discount of $240 (12,000 – $11,760).
The figure of $11,760 also represents the carrying value of the bonds at their purchase date.
As shown above, Interest Receivable is debited for the two months’ interest that has accrued since the last payment date on 2 January. The receivable is debited because the investor will receive all six months’ interest on 1 July 2020.