The maturity amount, which occurs at the end of the 10th six-month period, is represented by “FV” . 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.
Journal Entries for Interest Expense – Annual Financial Statements
This amount must be amortized over the life of bonds, it is the balancing figure between interest expense and interest paid to investors (Please see the example below). At the maturity date, bonds carry amount must be equal to bonds par value. For example, the company ABC issue $300,000, three-year, 8% bonds for $312,000 which is 104% of their face value. The interest is payable at the end of each year for the three years periods of the bonds. The transaction will record cash receive $ 12,000 from bond issuer.
The difference between the price we sell it and the amount we have to pay back is recorded in a liability account called Premium on Bonds Payable. Just like with a discount, the premium amount will be removed over the life of the bond by amortizing (which simply means dividing) it over the life of the bond. The premium will decrease bond interest expense when we record the semiannual interest payment. When we issue a bond at a discount, remember we are selling the bond for less than it is worth or less than we are required to pay back.
Journal Entries for Interest Expense – Monthly Financial Statements
At the end of the 3rd year, the $15,000 bond discount will be become zero ($15,000 – $5,000 – $5,000 – $5,000) and the carrying value of the bonds payable will equal $500,000 ($500,000 – $0). In this case, the carrying value of the bonds payable on the balance sheet will equal bonds payable minus the bond discount. This reduces the premium on bonds payable and the interest expense by the amortized amount. Let us take the same example of bonds accounting for discount bond with a market interest rate of 9%. The following table summarizes the effect of the change in the market interest rate on an existing $100,000 bond with a stated interest rate of 9% and maturing in 5 years.
amortization of bond premium
This means that when a bond’s book value decreases, the amount of interest expense will decrease. In short, the effective interest rate method is more logical than the straight-line method of amortizing bond premium. The difference between the present value of $67,600 and the single future principal payment of $100,000 is $32,400.
Journal Entry for Bonds issue at Discount
- On the other hand, when the bond interest rate is lower than the market rate, the investors will not want to purchase it.
- This is because the carrying value of bonds payable equal bonds payable minus bonds discount or the bonds payable plus bond premium.
- The amount received for the bond (excluding accrued interest) that is in excess of the bond’s face amount is known as the premium on bonds payable, bond premium, or premium.
- This discount on bonds payable account is the contra account of the bonds payable account.
This journal entry will reduce the interest expense on the income statement that we record at the time of interest payment. Hence, we need to make the amortization of the bond discount in order to have the carrying value of bonds payable equaling the face value of the bond at the end of the bond maturity. On the statement of financial position, the premium on bonds payable is added to the face value of bonds payable which increases the carrying amount of the bonds.
The cash went up by 47,000, but notice what happens with our liabilities. Well, the discount is going to lower this value by that 3,000 leaving us with 47,000 in our liabilities there. When a corporation is preparing a bond to be issued/sold to investors, it may have to anticipate the interest rate to appear on the face of the bond and in its legal contract.
The effective interest rate (also called the yield) is the minimum rate of interest that investors accept on bonds of a particular risk category. The higher the risk category, the higher the minimum rate of interest that investors accept. The contract rate of interest is also called the stated, coupon, or nominal rate is the rate used to pay interest. Firms state this rate in the bond indenture, print it on the face of each bond, and use it to determine the amount of cash paid each interest period. In accounting, we may issue a bond at a discount or at a premium which results in the carrying value of the bonds payable recorded on the balance sheet being lower or higher than the face value of the bond. The systematic allocation of the premium on bonds payable (reported as a credit in a liability account) to Bond Interest Expense over the life of the bonds.
Straight-Line Amortization of Bond Discount on Annual Financial Statements
Liabilities also include amounts received in advance for a future sale or for a future service to be performed. The bond’s total present value of $96,149 is approximately the bond’s market value and issue price. 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. Keep in mind that a bond’s stated cash amounts—the ones shown in our timeline—will not change during the life of the bond.
- In other words, if the bonds are a long-term liability, both Bonds Payable and Premium on Bonds Payable will be reported on the balance sheet as long-term liabilities.
- When the same amount of bond discount is recorded each year, it is referred to as straight-line amortization.
- The investors fear that when their bond investment matures, they will be repaid with dollars of significantly less purchasing power.
- When bond interest rates are discussed, the term basis point is often used.
- Let’s assume that on January 1, 2024 a corporation issues a 9% $100,000 bond at its face amount.
We calculate these two present values by discounting the future cash amounts by the market interest rate per semiannual period. Below is a comparison of the amount of interest expense reported under the effective interest rate method and the straight-line method. Note that under the effective interest rate bond premium journal entry method the interest expense for each year is decreasing as the book value of the bond decreases.
Note that under the effective interest rate method the interest expense for each year is increasing as the book value of the bond increases. Under the straight-line method the interest expense remains at a constant amount even though the book value of the bond is increasing. The accounting profession prefers the effective interest rate method, but allows the straight-line method when the amount of bond discount is not significant.
Regardless of when the bonds are physically issued, interest starts to accrue from the most recent interest date. Firms report bonds to be selling at a stated price “plus accrued interest.” The issuer must pay holders of the bonds a full six months’ interest at each interest date. Thus, investors purchasing bonds after the bonds begin to accrue interest must pay the seller for the unearned interest accrued since the preceding interest date. The bondholders are reimbursed for this accrued interest when they receive their first six months’ interest check.
Note that in 2024 the corporation’s entries included 11 monthly adjusting entries to accrue $750 of interest expense plus the June 30 and December 31 entries to record the semiannual interest payments. The issuer needs to recognize the financial liability when publishing bonds into the capital market and cash is received. The company has the obligation to pay interest and principal at the specific date. Bonds will be issued at par value when the coupon rate equal to market rate, there is no discount or premium on bond.
Some valuable items that cannot be measured and expressed in dollars include the company’s outstanding reputation, its customer base, the value of successful consumer brands, and its management team. As a result these items are not reported among the assets appearing on the balance sheet. Bonds are a form of long-term debt and might be referred to as a debt security. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. This interest payment will start from June 30, 2020, until December 31, 2039.
