The issuance cost will reduce the bonds payable balance from $ 10 million on the initial recording. The journal entry is debiting debt issue expense $ 120,000 and credit debt issuance cost $ 120,000. 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. Present value calculations are used to determine a bond’s market value and to calculate the true or effective interest rate paid by the corporation and earned by the investor.
Bonds typically pay interest semiannually at a fixed rate until the bonds mature many years into the future. If the bonds’ interest rate is less than the market rates when the bonds are offered, the bonds will sell at a discount. If the bonds’ interest rate is greater than the market rate when the bonds are offered, the bonds will sell at a premium.
As the normal balance of the bond discount is on the debit side of the T-account, we need to credit the bond discount to remove it from the balance sheet. Likewise, in this journal entry, we credit the bond discount account to remove the remaining unamortized amount of the bond discount from the balance sheet. In this case, we need to make the journal entry for bond interest payment by debiting the interest expense account and crediting the cash account. When a company decides to issue bonds, it incurs various costs that must be accounted for accurately. These expenses can be categorized into several types, each with its own implications for financial reporting and compliance.
In this case, after issuing the bonds, we usually need to pay the interest amount to the bondholder annually or semi-annually based on the coupon rate stated on the bond. This is the compensation (besides the discount) that we give to the bondholder for buying the bonds we issue. There are several types of bonds such as zero-coupon bonds, convertible bonds, high-yield bonds, and so on. The bond types vary by features carried by the bond such as the interest rate, frequency of coupon payments, maturity date, attached warrants, and so on. Bonds issued at face value between interest dates Companies do not always issue bonds on the date they start to bear interest.
In short, the effective interest rate bond issue cost journal entry method is more logical than the straight-line method of amortizing bond premium. It is reasonable that a bond promising to pay 9% interest will sell for more than its face value when the market is expecting to earn only 8% interest. In other words, the 9% bond will be paying $500 more semiannually than the bond market is expecting ($4,500 vs. $4,000). If investors will be receiving an additional $500 semiannually for 10 semiannual periods, they are willing to pay $4,100 more than the bond’s face amount of $100,000.
The bond’s life of 5 years is multiplied by 2 to arrive at 10 semiannual periods. The following T-account shows how the balance in the account Premium on Bonds Payable will decrease over the 5-year life of the bonds under the straight-line method of amortization. While the issuing corporation is incurring interest expense of $24.66 per day on the 9% $100,000 bond, the bondholders will be earning interest revenue of $24.66 per day. With bondholders buying and selling their bond investments on any given day, there needs to be a mechanism to compensate each bondholder for the interest earned during the days a bond was held. The accepted technique is for the buyer of a bond to pay the seller of the bond the amount of interest that has accrued as of the date of the sale. For example, we issued $100,000, five-year, 6% bonds for $110,000 which is 110% of their face value.
Over the life of the bond, the balance in the account Premium on Bonds Payable must be reduced to $0. In our example, the bond premium of $4,100 must be reduced to $0 during the bond’s 5-year life. By reducing the bond premium to $0, the bond’s book value will be decreasing from $104,100 on January 1, 2024 to $100,000 when the bonds mature on December 31, 2028. Reducing the bond premium in a logical and systematic manner is referred to as amortization. The account Premium on Bonds Payable is a liability account that will always appear on the balance sheet with the account Bonds Payable.
Notice that under both methods of amortization, the book value at the time the bonds were issued ($96,149) moves toward the bond’s maturity value of $100,000. The reason is that the bond discount of $3,851 is being reduced to $0 as the bond discount is amortized to interest expense. Notice that under both methods of amortization, the book value at the time the bonds were issued ($104,100) moves toward the bond’s maturity value of $100,000.
Each year Valley would make similar entries for the semiannual payments and the year-end accrued interest. The firm would report the $2,000 Bond Interest Payable as a current liability on the December 31 balance sheet for each year. Thus, at the end of December 31, 2039, ABC Co will fully pay all the principal and interest of the bonds. The total interest expense is $ 3.1 million (check Interest Expenses Column) which is equal to the total interest paid of $ 2.5 million plus the issuance cost of $ 0.6 million. At the end of year 5, the bonds payable will reach the $ 10 million amount (check Carry Amount Column), and it will reverse to zero when the company paid off the bonds. The company still required to amortize the issuance cost over the term of the bond.
In the below section, we cover the journal entry for each type of issuance. If a bond issuance is paid off early, then any remaining bond issuance costs that are still capitalized at that time should be charged to expense when the remaining bonds are retired. IFRS suggests that the company must recalculate the interest rate using the effective interest method. The issuance cost is part of the finance cost that company spends to obtain the debt/bonds. The debt issuing cost will be recorded as the assets and amortized over the bonds life. The company will require to capitalize the debit issuing cost as the assets on the balance sheet when the company issue debt and paid for the fees.
Accurate and transparent reporting of bond issuance costs is fundamental for maintaining investor confidence and regulatory compliance. Companies must ensure that these costs are clearly disclosed in their financial statements, providing stakeholders with a comprehensive understanding of the financial impact. This level of detail helps investors and analysts assess the true cost of borrowing and its effect on the company’s financial health.
Companies operating in multiple jurisdictions must navigate these differences carefully to ensure compliance and accurate financial reporting. Software tools like QuickBooks and SAP can facilitate the amortization process by automating the calculations and ensuring compliance with accounting standards. These tools can generate amortization schedules, track the carrying amount of the bond, and provide detailed reports that help in financial analysis and decision-making. Utilizing such software not only streamlines the process but also reduces the risk of errors, ensuring that the financial statements are accurate and reliable. Now let us suppose ABC company issues a bond at a par value of $ 100,000 and a coupon rate of 6% with 5 years maturity.
This means for each day that a bond is outstanding, the corporation will incur one day of interest expense and will have a liability for the interest it has incurred but has not paid. If the corporation has issued a 9% $100,000 bond, then each day it will have interest expense of $24.66 ($100,000 x 9% x 1/365). Throughout our explanation of bonds payable we will use the term stated interest rate or stated rate. Usually a bond’s stated interest rate is fixed or locked-in for the life of the bond.
They can do so with no detail to describe the fees paid out of the proceeds. Under GASB Statement 34, the full face amount of the issued bond debt should be recorded in the capital project fund as an OFS. Note that Valley does not need any interest adjusting entries because the interest payment date falls on the last day of the accounting period. At the end of ninth year, Valley would reclassify the bonds as a current liability because they will be paid within the next year. Alternatively, the total interest expense to be presented in the income statement is calculated by taking the contracted interest minus the premium on bonds.
