Bond Basics
- A bond is a long-term loan where a company borrows money from investors.
- The bondholder is the investor who gives money to the company.
- The face value is the amount the company must repay at maturity.
- The contractual interest rate determines how much cash interest is paid each year.
- The market interest rate is the rate investors demand for lending money.
- A bond sells at face value when the contractual rate equals the market rate.
Types of Bonds
- A secured bond is backed by specific assets as collateral.
- An unsecured bond has no collateral and depends on the company’s credit.
- A convertible bond can be exchanged for shares of the company.
- A callable bond can be bought back early by the company.
Issuing Bonds – Face Value, Discount, Premium
- A bond sells at a discount when the market rate is higher than the contractual rate.
- A bond sells at a premium when the market rate is lower than the contractual rate.
- Bonds are quoted as a percentage of their face value.
- A discount increases the total cost of borrowing.
- A premium decreases the total cost of borrowing.
Accounting for Bond Issuance
- Issuing a bond at face value is recorded as: Cash → Bonds Payable.
- Issuing a bond at a discount is recorded as: Cash, Discount on Bonds Payable → Bonds Payable.
- Issuing a bond at a premium is recorded as: Cash → Bonds Payable, Premium on Bonds Payable.
Interest Concepts
- Cash interest paid = Face value × Contractual interest rate.
- Interest expense = Carrying value × Market (effective) interest rate.
- Amortization amount = Interest expense − Cash interest paid.
Effective-Interest Method
- The effective-interest method makes interest expense a constant percentage of carrying value.
- Discount amortization increases the carrying value of the bond each period.
- Premium amortization decreases the carrying value of the bond each period.
- The carrying value moves toward face value as the bond approaches maturity.
Discount Bonds – Accounting
- A discount increases total interest expense over the bond’s life.
- Interest expense is higher than cash interest paid for a discount bond.
- The carrying value rises each period until it reaches face value.
- The journal entry for interest on a discount bond is:
- Interest Expense, Discount on Bonds Payable → Interest Payable.
Premium Bonds – Accounting
- A premium reduces total interest expense over the bond’s life.
- Interest expense is lower than cash interest paid for a premium bond.
- The carrying value decreases each period until it reaches face value.
- The journal entry for interest on a premium bond is:
- Interest Expense → Premium on Bonds Payable, Interest Payable.
Bond Formulas (for all amortization schedules)
- Interest expense = Beginning carrying value × Effective interest rate.
- Cash interest paid = Face value × Contractual interest rate.
- Amortization = Interest expense − Cash interest paid.
- New carrying value for a discount = Old carrying value + Amortization.
- New carrying value for a premium = Old carrying value − Amortization.
Redeeming Bonds at Maturity
At maturity, the company records:
Bonds Payable
→ Cash.
No gain or loss occurs at maturity because carrying value equals face value.
Redeeming Bonds Before Maturity
- Early redemption compares the carrying value with the cash paid.
- A gain occurs when cash paid is less than carrying value.
- A loss occurs when cash paid is greater than carrying value.
- The journal entry for early redemption includes:
- Bonds Payable, Gain/Loss → Cash.
Long-Term Notes Payable (e.g., Mortgage Loans)
- A long-term note may be secured by a mortgage on specific assets.
- Each installment payment includes interest on the unpaid balance and a reduction of principal.
- Interest decreases over time while principal repayment increases.
- The loan is first recorded as: Cash → Mortgage Payable.
- A payment is recorded as: Interest Expense, Mortgage Payable → Cash.
Lease Liabilities
- A lease gives the lessee the right to use property for a period of time.
- A lessee records a lease liability for leases longer than one year.
- The lease liability equals the present value of future lease payments.
- Initial recognition is recorded as: Right-of-Use Asset → Lease Liability.
- The lessor records: Lease Receivable → Leased Asset.
A company issues €100,000 bonds for €98,000. Contract rate 10%, market rate higher. What is the journal entry?
Bonds issued below face value → discount.
Journal entry:
Cash 98,000
Discount on Bonds Payable 2,000
–> Bonds Payable 100,000
Discount = extra interest cost over the bond’s life.
Face value €100,000, issue price €98,000. Market rate 10.5348%.
Compute year 1 interest expense, discount amortization, and journal entry.
Interest expense = 98,000 × 10.5348% = 10,324
Cash interest = 100,000 × 10% = 10,000
Discount amortization = 324
Journal entry:
Interest Expense 10,324
–>Discount on Bonds Payable 324
–>Interest Payable 10,000
New carrying value = 98,000 + 324 = 98,324
Use new carrying value €98,324. Compute year 2 interest and entry.
Interest expense = 98,324 × 10.5348% = 10,358
Cash interest = 10,000
Amortization = 358
Journal entry:
Interest Expense 10,358
–> Discount on Bonds Payable 358
–> Interest Payable 10,000
New carrying value = 98,324 + 358 = 98,682
Company issues €100,000 bonds for €102,000. What is the journal entry?
Bonds issued above face value → premium.
Journal entry:
Cash 102,000
Bonds Payable 100,000
Premium on Bonds Payable 2,000
Premium reduces interest expense over time.
Face value €100,000, issue price €102,000. Market rate 9.4794%. Compute year 1 interest and entry.
Interest expense = 102,000 × 9.4794% = 9,669
Cash interest = 10,000
Premium amortization = 10,000 − 9,669 = 331
Journal entry:
Interest Expense 9,669
–>Premium on Bonds Payable 331
–>Interest Payable 10,000
New carrying value = 102,000 − 331 = 101,669
Company pays off €100,000 bonds at maturity. What is the entry?
Carrying value = face value → no gain/loss.
Journal entry:
Bonds Payable 100,000
Cash 100,000
Carrying value = face value → no gain/loss.
Journal entry:
Bonds Payable 100,000
Cash 100,000
Cash paid = 103,000
Loss = 103,000 − 100,476 = 2,524
Journal entry:
Bonds Payable 100,476
Loss on Bond Redemption 2,524
Cash 103,000
Carrying value = £496,000. Company redeems at 98% (£490,000). Compute gain/loss + entry.
Gain = 496,000 − 490,000 = 6,000
Journal entry:
Bonds Payable 496,000
Gain on Bond Redemption 6,000
Cash 490,000
Company takes a HK$500,000, 8%, 20-year mortgage note. What is the initial entry?
Journal entry:
Cash 500,000
Mortgage Payable 500,000
Annual payment = HK$50,926.
Year 1 interest = 500,000 × 8% = 40,000
Compute principal reduction + entry.
Principal reduction = 50,926 − 40,000 = 10,926
Journal entry:
Interest Expense 40,000
Mortgage Payable 10,926
Cash 50,926
New balance = 500,000 − 10,926 = 489,074
PV of lease payments = €190,000. How does the lessee record the lease?
Journal entry:
Right-of-Use Asset 190,000
Lease Liability 190,000
