Accounting for Bonds
Accounting for Bonds is not a difficult topic to comprehend, nor is it a difficult task to execute. The journal entries involved are pretty straight forward and setting up the amortization schedule is also intuitive. Accounting for Bonds is a continuation of “The Basics and Pricing of Debt Securities” post. If you have not read that post or if you are unfamiliar with how bonds are priced, please do so before reading this article as it will only help you understand the concepts better.
ACCOUNTING FOR BONDS
Once the bond’s issue price has been determined, the issuing organization needs to account for all of the related transactions including the initial issuance of the bond and then the subsequent interest expense on a periodic basis. So let’s begin by preparing the initial journal entries to record the cash sale and the subsequent interest expense / payments for the three types of bonds discussed in “The Basics and Pricing of Debt Securities” post.
ACCOUNTING FOR BONDS – THE PAR VALUE BOND
Our par value bond will be issued in line with the face value of the bond and so the journal entry to record the sale is very simple. All that needs to be recorded is a debit entry to cash for the face value of the bond and a credit to notes payable for the same amount. Our face value of the bond as discussed in “The Basics and Pricing of Debt Securities” was $100,000 and this is what the journal entry will look like.
Similarly, accounting for the payment of interest and the recognition of interest expense on a periodic basis are also very simple. When cash is paid at the end of a period, it is credited for that particular amount with a matching debit entry to recognize the interest expense. Our interest to be paid based on the par value example in “The Basics and Pricing of Debt Securities” post was $6,000 and this is what the journal entry will look like every June 30th and December 31st.
Lastly as far as the par value bond is concerned a journal entry at maturity is necessary to recognize the bond redemption from the investor. At the time a cash payment for the face value of the bond will be made by the issuer (credit to cash) and the accounting records are balanced by a debit to Notes Payable for the same face value. The journal entry will look like the following at the 10 year mark when the bond matures.
ACCOUNTING FOR BONDS – BOND ISSUED AT A PREMIUM
Based on the annual stated interest rate of 12% and the market / effective annual interest of 8%, the $100,000 face value bond issued for a 10 year term was priced at $127,182 in exercise 2 of the “The Basics and Pricing of Debt Securities” article. Since the bond will sell at a value greater than the face value, this is a premium bond. Accounting for the initial bond issue for cash is slightly different than what was done for the par value bond. Although cash will be debited for the full $127,182 (the carrying value), the credit amount to Notes Payable will only be $100,000 since that’s what will be redeemed when the bond matures. This will result in a deficit on the credit side of the entry. The balance has to be accounted for with an entry to an account called “Premium on Notes Payable”. The journal entry on January 1, 2009 looks like the following.
The premium on notes payable ($27,182)