(d) On the basis of the schedule above, prepare the journal entry to record the issuance of the bonds on January 1, 2011. Discount on Bonds Payable is a contra liability account with a debit balance, which is contrary to the normal credit balance of its parent Bonds Payable liability account. Classification of liabilities into current and non-current is important because it helps users of the https://simple-accounting.org/where-is-the-premium-or-discount-on-bonds-payable/ financial statements in assessing the financial strength of a business in both short-term and long-term. If a corporation redeems a bond prior to its maturity date, the carrying amount at the time should be compared to the amount of cash the issuing company must pay to call the bond. If the corporation pays more cash than what the bond is worth (the carrying amount), it experiences a loss.

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 https://simple-accounting.org/ bond, and use it to determine the amount of cash paid each interest period. As the premium is amortized, the balance in the premium account and the carrying value of the bond decreases.

Bonds Sold at a Discount — Journal Entries

See Table 2 for interest expense and carrying values over the life of the bond calculated using the effective interest method of amortization . The investors want to earn a higher effective interest rate on these bonds, so they only pay $950,000 for the bonds. The $50,000 amount is recorded in a Discount on Bonds Payable contra liability account. Over time, the balance in this account is reduced as more of it is recognized as interest expense. There are times when the contract rate that your corporation will pay is less than the market rate that other corporations will pay.

• Accountants have devised a more precise approach to account for bond issues called the effective-interest method.
• Thus, if the market rate is 10% and the contract rate is 12%, the bonds will sell at a premium as the result of investors bidding up their price.
• Lighting Process, Inc. issues $10,000 ten‐year bonds, with a coupon interest rate of 9% and semiannual interest payments payable on June 30 and Dec. 31, issued on July 1 when the market interest rate is 10%.
• This same journal entry for $6,000 is made every six months, on 6/30 and 12/31, for a total of 10 times over the term of the five-year bond.

In this case, the corporation is offering an 11% interest rate, or a payment of $5,500 every six months, when other companies are offering a 12% interest rate, or a payment of $6,000 every six months. As a result, the corporation will pay out $55,000 in interest over the five-year term. Comparable bonds on the market will pay out $60,000 over this same time frame.

Chapter 9: Long-Term Liabilities and Investment in Bonds

V     
Prepare the entries for the issuance of bonds
and interest expense. This entry records $1,000 interest expense on the $100,000 of bonds that were outstanding for one month. Valley collected $5,000 from the bondholders on May 31 as accrued interest and is now returning it to them.

As a result, the carrying amount decreases and gets closer and closer to face amount over time. There are four journal entries that relate to bonds that are issued at a premium. The carrying amount can be thought of as “what the bond is worth” at a given point in time. Initially, the carrying amount is the amount of cash received when the bond is issued.

Financial Statements

Ultimately, the unamortized portion of the bond’s discount or premium is either subtracted from or added to the bond’s face value to arrive at carrying value. Bonds are an agreement in which the issuer obtains financing in exchange for promising to make interest payments in a timely manner and repay the principal amount to the lender at maturity. Bonds payable represent a contractual obligation between a bond issuer and a bond purchaser. ¨ Both the straight-line and the
effective-interest methods of amortization result in the same total amount of
interest expense over the term of the bonds.

• Often, the final exchange price for a bond is the result of a serious negotiation process to determine the interest rate to be earned.
• The maturity date is the date that the corporation must pay back the full face amount to the bondholders.
• The “Bonds Payable” line item can be found in the liabilities section of the balance sheet.
• As a result, the carrying amount increases and gets closer and closer to face amount over time.

The bondholders are reimbursed for this accrued interest when they receive their first six months’ interest check. Discount in bonds payable could be found in the liabilities section of the balance sheet as a deduction to the bond payable amount reported. The difference is the amortization that reduces the premium on the bonds payable account. It is also true for a discounted bond, however, in that instance, the effects are reversed.

Question: The balance in Discount on Bonds Payable

Goodwill usually isn’t amortized (except by private companies in some circumstances) because its useful life is indeterminate. However, impairment to the book value of goodwill is measured as fair value dips below book value. Once you’ve gathering this information, you can use a carrying value calculator such as a bond price calculator to determine the carrying value of the bond.

• 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.
• On maturity, the book or carrying value will be equal to the face value of the bond.
• Furthermore, the reported interest rate appears to float (6.2 percent to 5.8 percent) as if a different rate was negotiated for each year.
• Premium on bonds payable is a contra account to bonds payable that increases its value and is added to bonds payable in the long‐term liability section of the balance sheet.
• The price of the bond is determined by computing the present value of the required cash flows using the effective interest rate negotiated by the two parties.
• When the market rate of interest was 12%, Newman Corporation
  issued $449,000, 11%, five-year bonds that pay interest
  semiannually.