Bonds Issued At Par or Face Value
https://learn.financestrategists.com/finance-terms/bonds/Bonds will be issued at par or face value if the stated interest rate equals the prevailing rate for similar investments at the issue date. Because bonds can be issued on an interest date or between interest dates, both cases will be discussed.
Bonds Issued on an Interest Date
If bonds are issued at par or face value on an interest date, the entry is straightforward: Cash is debited, and Bonds Payable is credited for the total dollar amount of the bond issue.
For example, assume that on January 2, 2020, the Valenzuela Corporation issues $100,000, 5-year term bonds with a stated interest rate of 12%. The bonds pay interest every January 2 and July 1. The bonds were issued to yield 12%, which is another way of saying that they were issued at par, and thus the company received the full $100,000. The journal entry to record this bond issue is:
The Valenzuela Corporation is required to make semiannual interest payments of $6,000 or $100,000 x 6%. The entry on July 1, 2020, is:
The next interest payment is due on January 2, 2021. The corporation’s year-end is December 31, and the firm must make an adjusting entry to record interest expense for the six-month period, July 1 to December 31. This adjusting entry and the entry to record the subsequent payment are:
In this case, the interest accrual is for the entire 6-month period, because the last interest payment was on July 1. If the year-end were other than December 31, the interest accrual would be (or less than six months.
Bonds Issued At Par Between Interest Dates
Bonds are often issued between interest dates. When this occurs, the investors pay the issuing corporation for the interest that has accrued since the last interest date. This is because the investors receive the entire six months’ interest on the next interest payment date, regardless of how long they held the bonds. This procedure has definite record-keeping advantages for the issuer, whether or not the bonds are registered.
If the bonds are registered, the corporation does not have to maintain records of when each of the particular bonds in the bond issue was purchased or to compute individual partial interest payments. Interest on unregistered or coupon bonds is paid by authorized banks upon presentation of the coupon. Banks, however, will not-honor a partial coupon. These problems are alleviated by the fact that the accrued interest is collected from the investors when the bonds are sold, thus allowing the corporation to pay all of the investors the full six months’ interest.
For example, now assume that the Valenzuela Corporation issues $100,000, 5-year, 12% bonds on March 2020. bonds, dated January 2, 2020, pay interest semiannually on January 2 and July 1. In this situation, the investor must pay the Valenzuela Corporation for 2 months of accrued interest (from January 2 to February 28), or $2,000 ($100,000 x .06 x 2/6 = $2,000). The entry to record this transaction is:
Several points should be emphasized about this entry. Bonds Payable is always credited for the face amount of the issue, and so the accrued interest element must be accounted for separately. This is done by crediting Interest Payable for the two months of accrued interest, or $2,000. Interest Payable is credited because these funds will be repaid on the next interest date. Cash is debited for the entire proceeds. When the next interest payment is made on July 1, the following entry is recorded:
In this entry, Cash is credited for $6,000, Interest Payable is debited for $2,000, and Interest Expense is debited for $4,000. The result is that there is a zero balance in the Interest Payable account and a $4,000 balance in the Interest Expense account. This $4,000 balance represents the actual interest expense that the Valenzuela Corporation incurred from March I, 2020 to July 1, 2020 ($100,000 x .06 x 4/6). These relationships are illustrated in the diagram below and in the relevant T accounts.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.