Accounting for Bonds Issued at a Discount

By mayo 27, 2022febrero 8th, 2024No Comments

The Interest is usually paid back in a series of payments over several years (usually, semi-annually) and is called the Yield or a Coupon payment. Discounts also occur when the bond supply exceeds demand when the bond’s credit rating is lowered, or when the perceived risk of default increases. Conversely, falling interest rates or an improved credit rating may cause a bond to trade at a premium.

  1. If the amounts of interest expense are similar under the two methods, the straight‐line method may be used.
  2. The straight-line and effective-interest methods are two common ways to calculate amortization.
  3. When a company issues bonds to generate cash, bonds payable are recorded and listed as a liability on the company’s balance sheet.
  4. The bond’s carrying value will increase to $95,700, and the process will continue until the bond’s carrying value reaches $100,000 at the end of its term.
  5. Over the life of the bonds, the initial debit balance in Discount on Bonds Payable will decrease as it is amortized to Bond Interest Expense.
  6. The entry to record the issuance of the bonds increases (debits) cash for the $9,377 received, increases (debits) discount on bonds payable for $623, and increases (credits) bonds payable for the $10,000 maturity amount.

If the prevailing market interest rate is above the stated rate, bonds will be issued at a discount. Conversely, if the prevailing interest rate is below the stated rate, bonds will be issued at a premium. Discount amortizations must be carefully documented as they are likely to be reviewed by auditors. The effective-interest method to amortize the discount on bonds payable is often preferred by auditors because of the clarity the method provides. A bond issued at a discount has its market price below the face value, creating a capital appreciation upon maturity since the higher face value is paid when the bond matures.

The interest expense is amortized over the twenty periods during which interest is paid. Amortization of the discount may be done using the straight‐line or the effective interest method. Currently, generally accepted accounting principles require use of the effective interest method of amortization unless the results under the two methods are not significantly different. If the amounts of interest expense are similar under the two methods, the straight‐line method may be used.

Bonds Sold at a Discount – Journal Entries

See Table 3 for interest expense and carrying value calculations over the life of the bond using the straight‐line method of amortization . Thomson Reuters can help you better serve clients by delivering expert guidance on amortization and other cost recovery issues for more tax-efficient decisions. A bond, which is a limited-life intangible asset, is essentially a loan agreement between the issuer of the bond (i.e., corporation, government, or municipality) and the bond holder.

Recordkeeping for Discount Amortizations

Consulting with a qualified accountant or financial expert is advisable to ensure compliance with applicable accounting standards and regulations. Assume the investors pay $9,800,000 for the bonds having a face or maturity value of $10,000,000. The difference of $200,000 will be recorded by the issuing corporation as a debit to Discount on Bonds Payable, a debit to Cash for $9,800,000, and a credit to Bonds Payable for $10,000,000. The difference between the amount received and the face or maturity amount is recorded in the corporation’s general ledger contra liability account Discount on Bonds Payable. This amount will then be amortized to Bond Interest Expense over the life of the bonds. After the payment is recorded, the carrying value of the bonds payable on the balance sheet increases to $9,408 because the discount has decreased to $592 ($623–$31).

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The amount of discount amortized for the last payment is equal to the balance in the discount on bonds payable account. As with the straight‐line method of amortization, at the maturity of the bonds, the discount account’s balance will be zero and the bond’s carrying value will be the same as its principal amount. See Table 2 for interest expense and carrying values over the life of the bond calculated using the effective interest method of amortization . As the premium is amortized, the balance in the premium account and the carrying value of the bond decreases. The amount of premium amortized for the last payment is equal to the balance in the premium on bonds payable account. See Table 4 for interest expense and carrying value calculations over the life of the bonds using the effective interest method of amortizing the premium.

However, due to the matching concept, this cost of $7,024 cannot be expensed when the bonds are issued but must be written off over the life of the bond. It is important to understand the nature of the discount on bonds payable account. In effect, the discount should be thought of as an additional interest expense that should be amortized over the life of the bond.

When the same amount of bond discount is recorded each year, it is referred to as straight-line amortization. In this example, the straight-line amortization would be $770.20 ($3,851 divided by the 5-year life of the bond). The format of the journal entry for amortization of the bond discount is the same under either method of amortization – only the amounts recorded in each period will change.

This entry records $5,000 received for the accrued interest as a debit to Cash and a credit to Bond Interest Payable. A bond that is issued at a discount is a bond that has been issued for less than the par value of the bond. The difference between the par value and the purchase price is referred to as the “discount.”

At maturity, the General Journal entry to record the principal repayment is shown in the entry that follows Table 4 . A bond is sold at a discount when the coupon rate (the interest rate stated on the bond) is less than the prevailing market interest rates for similar bonds. In other words, investors would demand a discount on the purchase price to compensate for the lower interest payments they would receive.

Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Bondholders receive only $6,000 every 6 months, whereas comparable investments yielding 14% are paying $7,000 every 6 months ($100,000 x .07). The difference between the face value of the bonds ($100,000) and the cash ABC Corporation receives ($98,000) is $2,000. Browse all our upcoming and on-demand webcasts and virtual events hosted by leading tax, audit, and accounting experts.

In this case, the bond holder essentially assumes the same role as a bank lending a 30-year mortgage to a home buyer. Much like the bank receiving regular payments over the life of the mortgage loan, the bond holder receives regular payments of both principal and interest until the bond reaches maturity. In other words, a discount on bond payable means that the bond was sold for less than the amount the issuer will have to pay back in the future. When a bond is issued at a premium, the carrying value is higher than the face value of the bond.