Issues Related to Bonds Payable
Bonds Issued at a Premium or Discount Between Interest Dates
Bonds are likely to be sold between interest dates at either a discount or a premium. When this occurs, the discount or premium and the accrued interest must be accounted for separately. To demonstrate, assume that the Valenzuela Corporation issues $100,000, 12%, 5-year term bonds on March 1, 2020. The bonds are dated January 1, 2020. They are issued at a discount to yield 14% and pay interest semiannually on January 2 and July 1. The price of the bonds net of the discount is 93,0939, and the accrued interest is $2,000 ($100,000 x .06 x 2/6 = $2,000). The entry to record this issue is:
In this example, the cash proceeds that the firm receives of $95,094 consist of the proceeds from the bond of $93,094 plus the accrued interest of $2,000. The discount of $6,906 is the difference between the face value of and the issue price net of the interest of $93,094. The bonds payable are recorded at their face value of $100,000.
When the first interest payment is made, the below entry is made (assuming straight-line amortization). You should note that the discount is amortized over only 58 months, or 4 years and 10 months, not 5 years, because the bonds had a remaining life of only 58 months when they were issued on March 1, 2020. Subsequent interest payments and discount amortization should be made in the usual way.
Year-End Accruals of Interest Expense
It is likely that the issuing firm’s year-end will not coincide with an interest payment date. We showed the proper accounting procedures to handle this situation When bonds are issued at par. It is a simple extension to handle premiums or discounts in this situation. To demonstrate, we will use the data from the Valenzuela Corporation.
However, we will assume that the company’s year-end is September 30. An adjusting entry must be made on this date to record an interest accrual of three months since the last interest payment date on July 1, 2020. entry, assuming straight-line amortization, is:
As this entry shows, the cash interest must be accrued and the discount be amortized for three months. On January 2, 2021, when the interest is paid, the following entry is made:
In this entry, the Interest Payable account is debited, and Interest Expense is recorded for the three-month period from October 1, 2020, to January 2, 2021. The Discount on Bonds Payable is also amortized for the same three-month period.
Bond Issue Costs
When a corporation issues bonds, various expenses are incurred. Examples are printing and engraving, and legal and accounting costs. Furthermore, many bonds are marketed through investment bankers, who receive a commission for underwriting the bond issue. These costs result in the issuer’s receiving less cash than he or she otherwise would. Under current accounting principles, these costs are accumulated in a noncurrent asset account called Bond Issue Costs and are amortized over the life of the bond on a straight-line basis.
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.