Accounting for Bonds Payable: Types, Journal Entries, and Example

This entry is not very different from the previous entry we made. The main difference here is that we have interest payable because we haven’t paid it yet till January 1st. The issuance cost incurred will be accounted for based on the jurisdiction of the organization issuing the bond. If a governmental entity accounting under GASB issues the bond, the issuance cost will be expensed as incurred on the statement of net activities. If an organization following FASB standards issues the bond, the total issuance cost will be deferred and amortized over the life of the bond.

• When a bond is sold at a discount, the amount of the bond discount must be amortized to interest expense over the life of the bond.
• Since investors will be receiving $500 less every six months than the market is requiring, the investors will not pay the full $100,000 of a bond’s face value.
• (Some corporations have preferred stock in addition to their common stock.) Shares of common stock provide evidence of ownership in a corporation.
• Auditors prefer that a company use the effective interest method to amortize the discount on bonds payable, given its higher level of precision.
• So that’s an increase to our liabilities of 300 and then our interest expense, well that’s a decrease to equity, right?

Let’s use the following formula to compute the present value of the maturity amount only of the bond described above. The maturity amount, which occurs at the end of the 10th six-month period, is represented by “FV” . The following T-account shows how the balance in Discount on Bonds Payable will be decreasing over the 5-year life of the bond. In case of discount, the Bonds Payable Discount account is debited. As we note from above, Durect Corp had Bonds payables in its current liability and long-term liability sections. This will increase the interest expense to make it equal to the effective rate of return to the bondholder.

Discount Bonds:Interest Expense, Amortization, and Interest Payable

The bond is dated January 1, 2024 and requires interest payments on each June 30 and December 31 until the bond matures at the end of 5 years. Each semiannual interest payment will be $4,500 ($100,000 x 9% x 6/12). The corporation is also required to pay $100,000 of principal to the bondholders on the bond’s maturity date of December 31, 2028. At the end of the third year, premium bonds payable will be zero and the carrying amount of bonds payable will be $ 100,000. So the journal entry is debit bonds payable and credit cash paid to investors. This carrying amount of bonds payable on balance sheet is what the issuer will get from the investor when the bond is issued.

The day the note payable is issued and you get the cash from the bank is called the inception date. Let’s assume you receive the proceeds of the note payable on January 1, 2017. While the concepts discussed herein are intended to help business owners understand general accounting concepts, always speak with a CPA regarding your particular financial situation. The answer to certain tax and accounting issues is often highly dependent on the fact situation presented and discount on bonds payable on balance sheet your overall financial status. We’ve amortized it to interest expense over the life of the bond.

Straight-Line Amortization of Bond Discount on Annual Financial Statements

There are various fees that a corporation must pay when issuing bonds. These fees include payments to attorneys, accounting firms, and securities consultants. These costs are referred to as issue costs and are recorded in the account Bond Issue Costs. Beginning in 2016, the unamortized amount of the bond issue costs are reported as a deduction from the amount of the liability bonds payable.

• At the end of the 5 years the entire discount will have been charged to the profit and loss account and the discount on the bonds payable account will be zero.
• The accounting for bonds payable can be considered as the treatment of long-term liability.
• The bond is dated as of January 1, 2024 and has a maturity date of December 31, 2028.
• In other words, these bonds are issued at a discount, and a bond discount will be recognized in the financial statements of the issuing organization.
• So issuing bonds is a way of raising larger amounts of finance from multiple investors.
• Since the corporation issuing a bond is required to pay interest, and since the interest is paid on only two dates per year, the interest on a bond will be accruing daily.

Amortizing Bond Discount with the Effective Interest Rate Method

Recall that this calculation determines the present value of the stream of interest payments only. The present value of the maturity amount will be calculated next. Recall that this calculation determined the present value of the stream of interest payments. The journal entries for the remaining years will be similar if all of the bonds remain outstanding. The journal entries for the years 2025 through 2028 will be similar if all of the bonds remain outstanding.

Each semiannual interest payment of $4,500 ($100,000 x 9% x 6/12) occurring at the end of each of the 10 semiannual periods is represented by “PMT”. The bond’s life of 5 years is multiplied by 2 to arrive at 10 semiannual periods. As we had seen, the market value of an existing bond will move in the opposite direction of the change in market interest rates. If the corporation issuing the above bond has an accounting year ending on December 31, the corporation will incur twelve months of interest expense in each of the years that the bonds are outstanding.

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. The 8% market rate of interest equates to a semiannual rate of 4%, the 6% market rate scenario equates to a 3% semiannual rate, and the 10% rate is 5% per semiannual period. Discount bonds payable are the bonds issued at a discount by the companies and happen when the coupon rate is less than the prevailing market interest rate. For example, a business may issue a 5 year bond on which it will pay interest to the investor. At the end of the 5 year period on the maturity date, the business will need to pay the investor the market price for the bond.

Timeline for Interest and Principal Payments

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. In this case, the entity will determine its issue price by calculating the present value (PV) (PV) of coupon payments and maturity amount. The bond’s present value is calculated by discounting the coupon amount and maturity amount with a rate of return of similar bonds in the market.

Both the above are two types of debt instruments available for investing in financial market, through which companies raise funds for financing operations. Below is an example of Nike’s Bond of $1 bn and $500 million issued in 2016.

So on the balance sheet, carry value is $ 102,577 which is the present value of cash flow. Discount on Bonds Payable is a contra liability account with a debit balance, which is contrary to the normal credit balance of its parent Bonds Payable liability account. Continuing with the above example, let’s understand the journal entry of discount on bonds payable in the books of XYZ Inc. To determine how much discount the company should offer while issuing its bond, the concept of the TVM is applied. Accordingly, the issue price of a bond is the total present value of all coupon payments and the current value of the redemption amount. Discount on bonds payable occurs when a bond’s stated interest rate is less than the bond market’s interest rate.

What is the Amortization of Discount on Bonds Payable?

The accounting method under which revenues are recognized on the income statement when they are earned (rather than when the cash is received). Next, let’s assume that after the bond had been sold to investors, the market interest rate decreased to 8%. The corporation must continue to pay $4,500 of interest every six months as promised in its bond agreement ($100,000 x 9% x 6/12) and the bondholder will receive $4,500 every six months. Since the market is now demanding only $4,000 every six months (market interest rate of 8% x $100,000 x 6/12 of a year) and the existing bond is paying $4,500, the existing bond will become more valuable.

Can Companies Issue Stock to Pay Debt?

For instance, let us assume ABC Inc. is planning to raise funds through the issue of a 5-year bond, having a par value of US $ 1000 at a coupon rate of 5%p.a. However, the prevailing market interest rate was 6% at the time of the issue. Now, the company has to issue its bond at a discount to compensate for the return on investment of the bondholders.