How to Include Journal Entries When Accounting for Bonds

At the end of 5 years, the company will retire the bonds by paying the amount owed. To record this action, the company would debit Bonds Payable and credit Cash. Remember that the bond payable retirement debit entry will always be the face amount of the bonds since, when the bond matures, any discount or premium will have been completely amortized. At some point, a company will need to record bond retirement, when the company pays the obligation.

In this section, we will introduce the basic concepts and principles of bond accounting and explain how to apply them in different scenarios.
Note that Valley does not need any interest adjusting entries because the interest payment date falls on the last day of the accounting period.
This includes cash received when the bond is issued, which is recorded on the balance sheet.
On January 1, 2023, the company issued $100,000 of 5% bonds at 98, with a maturity date of December 31, 2027.
The issuance price is the amount that the investor pays to buy the bond from the issuer, which may be equal to, higher than, or lower than the face value.

Redemption of bonds before maturity example

If the bonds were to be paid off today, the full $104,460 would have to be paid back. The bondholders have bonds that say the issuer will pay them $100,000, so that is all that is owed at maturity. The premium will disappear over time and will reduce the amount of interest incurred. First, we will explore the case when the stated interest rate is equal to the market interest rate when the bonds are issued.

Accounting for Issuance of Bonds

The journal entry is debiting cash of $ 12,000 credit interest income of $ 10,760, Investment on bond of $ 1,240. As the interest rate is higher than the market, many people are looking to buy bonds and it increases the price. The issuer will be able to sell at a premium, and they have to calculate the bond price. This variance must be credited from balance sheet by allocating over the bond hold period. The issuer has the obligation to the interest-based on the par value and interest rate on the bonds.

In this journal entry, the gain on redemption of bonds is a difference between the cash payment we make to purchase the bonds back and the carrying value of bonds payable which in this case is the bonds payable itself. This example demonstrates the least complicated method of a bond issuance and retirement at maturity. There are other possibilities that can be much more complicated and beyond the scope of this course.

When Market Interest Rates Decrease

The interest expense or income is the amount that the bond issuer or the bondholder records on the income statement as the cost or benefit of borrowing or lending money through the bond. It is equal to the coupon interest plus or minus the amortization of bond premium or discount. One simple way to understand bonds issued at a premium is to view the accounting relative to counting money!

Under the accrual basis of accounting, expenses are matched with revenues on the income statement when the expenses expire or title has transferred to the buyer, rather than at the time when expenses are paid. It will contain the date, the account name and amount to be debited, and the account name and amount to be credited. Each journal entry must have the dollars of debits equal to the dollars of credits. This account is a non-operating or “other” expense for the cost of borrowed money or other credit. 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.

Even with these benefits considered, governments and municipalities issue bonds more often than public or private organizations. When an organization requires additional funds, a common action is to borrow money from a bank. However, issuing debt securities, such as bonds, is another way organizations can bond in accounting borrow funds.

The second entry is to record the interest expense and the amortization of the discount for the last period. The carrying value is the book value of the bond, which is the face value minus any unamortized discount or plus any unamortized premium. The discount or premium is the difference between the face value and the issue price of the bond, which is amortized over the life of the bond using the effective interest method or the straight-line method. Bond valuation involves determining the present value and fair value of a bond. The present value is the current worth of future cash flows generated by the bond, while the fair value represents the market price at which the bond should trade.

Bonds Payable in Accounting

Things that are resources owned by a company and which have future economic value that can be measured and can be expressed in dollars. Examples include cash, investments, accounts receivable, inventory, supplies, land, buildings, equipment, and vehicles. The systematic reduction of a loan’s principal balance through equal payment amounts which cover interest and principal repayment. (Some corporations have preferred stock in addition to their common stock.) Shares of common stock provide evidence of ownership in a corporation. Holders of common stock elect the corporation’s directors and share in the distribution of profits of the company via dividends. If the corporation were to liquidate, the secured lenders would be paid first, followed by unsecured lenders, preferred stockholders (if any), and lastly the common stockholders.

Amortizing Bond Discount with the Effective Interest Rate Method

Present value calculations discount a bond’s fixed cash payments of interest and principal by the market interest rate for the bond. The accounting treatment for the issuance of bonds depends on whether the bonds are issued at par, a discount, or a premium. The bond issuing companies will record the transactions for the bond principal and the interest payments separately.