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How Are Bond Payable

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ACCOUNT PAYABLE

How Are Bond Payable Accounted?

Published 9 years ago on Feb 7, 2009
By Lie Dharma Putra

In accounting for liabilities, a controller must consider many reporting and disclosure
responsibilities. Two of those many reporting concern are: “Bonds payable may be i
between interest dates at a premium or discount” and “Bonds may be amortized
the straight-line method or effective interest method”. How are bonds payable
accounted? What journal entry made for bond payable? This post emphasize to th
main concerns specifically.

The cost of a corporate bond is expressed in terms of “yield“. Two types of yield are:

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Simple Yield = Nominal

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[2]. Yield to Maturity (Effective Interest Rate). The equation is somewhat complex
not worry, we will get this done through some easy case examples  for the mome
is the equation:

[[Nominal interest + [Discount/Years] ?

[Premium]/Years]/[Present value of bond +
Maturity value]/2

EXAMPLE: A $100,000, 10 percent five-year bond is issued at $96.

The simple yield is:

Nominal interest/Present value of bond = $10,000/$96,000 = 10.42%

Important: When a bond is issued at a discount,

the yield (effective interest rate) exceeds the
nominal (face, coupon) interest rate. When a bond
is issued at a premium, the yield is below the
nominal interest rate.

The two methods of amortizing bond discount or bond premium are:

1. Straight-line method – It results in a constant dollar amount of amortization but a diffe

effective rate each period.

2. Effective interest method – It results in a constant rate of interest but different dollar a
each period. This method is preferred over the straight-line method.
The amortization journal entry is:

[Debit]. Interest expense = [Yield × Carrying value of bond at the beginning of the yea
[Credit]. Discount
[Credit]. Cash = [Nominal interest × Face value of bond]

Note: In the early years, the amortization amount

under the effective interest method is lower
relative to the straight-line method (either for
discount or premium).

EXAMPLE: On 1/1/20X8, a $100,000 bond is issued at $95,624. The yield rate is 7 perc
the nominal interest rate is 6 percent. The following schedule is the basis for the j
entries:

Date                  Debit            Credit           Credit           Carrying

                         Interest         Cash            Discount       Value
                         Expense
1/1/20X8                                                                       $95,624
12/31/20X8     $6,694          $6,000         $694               96,318
12/31/20X9       6,742            6,000           742               97,060

The entry on 12/31/20X8 is:

[Debit]. Interest expense = $6694

[Credit]. Cash = $6000
[Credit]. Discount = $694
At maturity, the bond will be worth its face value of $100,000. When bonds are i
between interest dates, the journal entry is:

[Debit]. Cash
[Credit]. Bonds payable
[Credit]. Premium (or debit discount)
[Credit]. Interest expense

EXAMPLE: A $100,000, 5 percent bond having a life of five years is issued at 110 on 4
The bonds are dated 1/1/20X8. Interest is payable on 1/1 and 7/1. Straight line amor
is used.

The journal entries are:

On the 4/1/20X8:

[Debit]. Cash (110,000 + 1,250) = $111,250

[Credit]. Bonds payable = $100,000
[Credit]. Premium on bonds payable = $10,000
[Credit]. Bond interest expense = $1,250
(Note: 100,000 × 5% × 3/12 = 1,250)

On the 7/1/20X8:  

[Debit]. Bond interest expense = $2,500

[Credit]. Cash = $2,500
(Note: 100,000 × 5% × 6/12 = 2,500)

and;

[Debit]. Premium on bonds payable = $526.50

[Credit]. Bond interest expense = $526.50
Note: The $526 came from the following calculation:
4/1/20X8—1/1/2012 = 4 years, 9 months = 57 months
$10, 000/ 57 = $175.50 per month
$175.50 × 3 months = $526.50

On the 12/31/20X8:

[Debit]. Bond interest expense = $2,500

[Credit]. Interest payable = $2,500

and;

[Debit]. Premium on bonds payable = $1,053

[Credit]. Bond interest expense = $1,053

On the 1/1/20X9:

[Debit]. Interest payable = $2,500

[Credit]. Cash = $2,500

Bonds payable is presented on the balance sheet at its present value in this man

Bonds payable
Add: Premium
Less: Discount
Equal: Carrying value

Bond issue costs are the expenditures in issuing the bonds such as legal, registr
and printing fees. Bond issue costs are preferably deferred and amortized over the li
bond. They are shown under Deferred Charges.
In computing the price of a bond, the face amount is discounted using the “
of $1 table“. The interest payments are discounted using the “present value of an o
annuity of $1 table“. The yield serves as the “discount rate“.

EXAMPLE: A $50,000, 10-year bond is issued with interest payable semiannually at an

percent nominal interest rate. The yield rate is 10 percent. The present value of $1 tab
for n = 20, i = 5% is 0.37689. The present value of annuity of $1 table factor for n = 20,
12.46221. The price of the bond equals:

Present value of principal = $50,000 × 0.37689 = $18,844.50

[Add] Present value of interest payments = $20,000 × 12.46221 = 24,924.42
[Equal] Price of the bond = $43,768.92

Let’s expand a little bit with the following question…..

What If Bonds Are Converted to Stock?

In converting a bond into stock, three alternative methods may be used: (1)
bond, (2) market value of bond, and (3) market value of stock. Under the book va
bond method, no gain or loss on bond conversion arises because the book value of th
the basis to credit equity. This method is preferred. Under the market value method
or loss will result because the book value of the bond will be different from the marke
of bond or market value of stock, which is the basis to credit the equity accounts.

EXAMPLE: A $100,000 bond with unamortized premium of $8,420.50 is converted to

stock. There are 100 bonds ($100,000/$1,000). Each bond is converted into 50 shares o
Thus, there are 5,000 shares of common stock. Par value is $15 per share. The market
the stock is $25 per share. The market value of the bond is 120.

Using the book value method, journal entry for the conversion is:

[Debit]. Bonds payable = $100,000

[Debit]. Premium on bonds payable = $8,420.50
[Credit]. Common stock (5,000 × 15) = $75,000
[Credit]. Premium on common stock = $33,420.50

Using the market value of stock method, the journal entry is:

[Debit]. Bonds payable = $100,000

[Debit]. Premium on bonds payable = $8,420.50
[Debit]. Loss on conversion = $16,579.50
[Credit]. Common stock = $75,000
[Credit]. Premium on common stock = $50,000
(Note: 5,000 × $25 = $125,000)

Using the market value of the bond method, the journal entry is:

[Debit]. Bonds payable = $100,000

[Debit]. Premium on bonds payable = $8,420.50
[Debit]. Loss on conversion = $11,579.50
[Credit]. Common stock = $75,000
[Credit]. Premium on common stock = $45,000
(Note: $100,000 × 120% = $120,000)

As mentioned at the beginning of this post; bonds payable is only one of many con
that a controller should consider about accounting for liabilities. There are still
issues to be considered, for example: debt may be extinguished prior to the maturity d
when the company can issue new debt at a lower interest rate, estimated liabilities mu
recognized when it is probable that an asset has been impaired or liability has been in
by year-end, and the amount of loss can be reasonably estimated, an accrued liability
recognized for future absences, for example, sick leave or vacation time, special termi
benefits such as early retirement may also be offered to and accepted by employees, s
term debt may be rolled over to long-term debt, requiring special reporting, a callable
obligation by the creditor may exist, long-term purchase obligations have to be disclo
many more.
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RELATED TOPICS: # AMORTIZATION JOURNAL ENTRY # BOND CONVERTED TO STOCK #BOND PAYABLE
#BOOK VALUE OF BOND METHOD # COMPUTING PRICE OF BOND # COST OF CORPORATE BOND
#EFFECTIVE INTEREST METHOD # EFFECTIVE INTEREST RATE # HOW ARE BOND PAYABLE ACCOUNTED?
#JOURNAL ENTRY FOR BOND PAYABLE # MARKET VALUE OF BOND METHOD # MARKET VALUE OF STOCK METH
#SIMPLE YIELD OF BOND # STRAIGHT LINE METHOD # TWO METHOD AMORTIZING BOND DISCOUNT
#WHAT JOURNAL ENTRY MADE FOR BOND PAYABLE? # YIELD OF MATURITY

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