Discount on Bonds Payable Definition, Example Journal Entries

In other words, a discount on bond payable means that the bond was sold for less than the amount the issuer will have to pay back in the future. This means the issuer receives $47,000 in cash, even though the bond’s face value is $50,000. The $3,000 difference is the discount, which will be amortized over the bond’s life. A zero coupon bond is a bond which does not have coupons and therefore does not make interest payments. So issuing bonds is a way of raising larger amounts of finance from multiple investors.

Such bonds were known as bearer bonds and the bonds had coupons attached that the bearer would “clip” and deposit at the bearer’s bank. Bonds allow corporations to use financial leverage or to trade on equity. The reason is that a corporation issuing bonds can control larger amounts of assets without increasing its common stock. The bond’s total present value of $96,149 is approximately the bond’s market value and issue price. 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. Keep in mind that a bond’s stated cash amounts—the ones shown in our timeline—will not change during the life of the bond.

Over the life of the bonds the bond issue costs are amortized to interest expense. Over the life of the bond, the balance in the account Discount on Bonds Payable must be reduced to $0. Reducing this account balance in a logical manner is known as amortizing or amortization. Since a bond’s discount is caused by the difference between a bond’s stated interest rate and the market interest rate, the journal entry for amortizing the discount will involve the account Interest Expense. discount on bonds payable on balance sheet Let’s assume that on January 1, 2024 a corporation issues a 9% $100,000 bond at its face amount.

Calculating the Present Value of a 9% Bond in an 8% Market

The bond payable will stipulate the interest rate and the term, known as the maturity date. At the maturity date the investor will receive repayment of the principal amount invested and interest. Bonds are transferable, and an investor can sell their bond before the maturity date.

• The journal entries for the years 2025 through 2028 will be similar if all of the bonds remain outstanding.
• Take time to verify the factors by reference to the appropriate tables, spreadsheet, or calculator routine.
• Because we’re actually going to make that payment and that’s going to be in the amount of $2,250, getting rid of the liability for interest payable.
• Mathematically, to calculate bond yield to maturity, we need to find the internal rate of return (IRR) of the bond if held to its maturity date.
• As a result, interest expense each year is not exactly equal to the effective rate of interest (6%) that was implicit in the pricing of the bonds.
• An organization with a bond payable will commonly make periodic payments to its bondholders towards the interest owed on the bonds.

Present Value of a Bond’s Interest Payments

Each yearly income statement would include $9,544.40 of interest expense ($4,772.20 X 2). The straight-line approach suffers from the same limitations discussed earlier, and is acceptable only if the results are not materially different from those resulting with the effective-interest technique. Accountants have devised a more precise approach to account for bond issues called the effective-interest method. Be aware that the more theoretically correct effective-interest method is actually the required method, except in those cases where the straight-line results do not differ materially. Effective-interest techniques are introduced in a following section of this chapter.

Over the life of the bonds, the initial debit balance in Discount on Bonds Payable will decrease as it is amortized to Bond Interest Expense. As the company decides to buyback bonds before maturity, so the carrying amount is different from par value. We need to calculate the carrying amount and compare it with the purchase price to calculate gain or lose. Bond price is the present value of future cash flow discount at market interest rate.

• The bond will pay interest of $4,500 (9% x $100,000 x 6/12 of a year) on each June 30 and December 31.
• They will use the present value of future cash flow with market rate to calculate the bond selling price.
• This article will cover accounting for bonds payable and how bonds payable are accounted for in the normal course of the business.
• On maturity, due to amortization of premium/discount, the carrying value will become same as face value on the debt instrument.
• We will use present value tables with factors rounded to three decimal places and will round some dollar amounts to the nearest dollar.
• Now, the only difference is that actually, when I say cash, we’re not paying it in cash on December 31st, right?

Journal Entry of Discount on Bond Payable

When the bonds issue at premium or discount, there will be a different balance between par value and cash received. The difference is premium/discount on bonds payable, which will impact the bonds carrying value presented in the balance sheet. The situation of bonds payable arises when a company issues bonds to the prospective investors in the financial market to raise funds to meet the business expenditures. In this case the company becomes the borrower and the investors become the lender. Since there is a borrower-lender relationship, it naturally creates a liability for the issuer in the balance sheet, in this form of debt. Now, the only difference is that actually, when I say cash, we’re not paying it in cash on December 31st, right?

The corporation issuing the bond is borrowing money from an investor who becomes a lender and bondholder. By the end of third years, the discounted bonds payable balance will be zero, and bonds carry value will be $ 100,000. Thus, in case the bond is issued at a premium, the carrying amount will be face value plus premium(unamortised). In case it is issued at a discount, varying amount will be face value minus discount (unamortised). In case the bond is issued at par, then the carrying value or book value will be same as the face value of the bond since there is no discount or premium.

Date: May 3-4, 2025 Time: 8:30-11:30 AM EST Venue: OnlineInstructor: Dheeraj Vaidya, CFA, FRM

Some valuable items that cannot be measured and expressed in dollars include the company’s outstanding reputation, its customer base, the value of successful consumer brands, and its management team. As a result these items are not reported among the assets appearing on the balance sheet. The accounting term that means an entry will be made on the left side of an account. Liabilities also include amounts received in advance for a future sale or for a future service to be performed. (Some corporations have preferred stock in addition to their common stock.) Shares of common stock provide evidence of ownership in a corporation.

Bonds Issued At A Discount

So, this is technically our interest payable that we have as of December 31st is the $2,250. Our journal entry is going to look very similar, except instead of cash, we’re going to have interest payable in this one. So, we know that we’re going to be paying interest tomorrow on January 1st. So, we have this liability to pay $2,250, for the 6 months that have passed.

Holders of common stock elect the corporation’s directors and share in the distribution of profits of the company via dividends. If the corporation were to liquidate, the secured lenders would be paid first, followed by unsecured lenders, preferred stockholders (if any), and lastly the common stockholders. Bonds that do not have specific collateral and instead rely on the corporation’s general financial position are referred to as unsecured bonds or debentures. Bonds that mature on a single maturity date are known as term bonds.

A business will issue bonds payable if it wants to obtain funding from long term investors by way of loans. The accounting process carried out when working with bonds payable is illustrated in the following example. 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. The reason is that the bond premium of $4,100 is being amortized to interest expense over the life of the bond. When a bond is sold at a premium, the amount of the bond premium must be amortized to interest expense over the life of the bond. In our example, there will be a $100,000 principal payment on the bond’s maturity date at the end of the 10th semiannual period.

The market interest rate is used to discount both the bond’s future interest payments and the principal payment occurring on the maturity date. The market value of an existing bond will fluctuate with changes in the market interest rates and with changes in the financial condition of the corporation that issued the bond. For example, an existing bond that promises to pay 9% interest for the next 20 years will become less valuable if market interest rates rise to 10%. Likewise, a 9% bond will become more valuable if market interest rates decrease to 8%.

Journal Entries for Interest Expense – Annual Financial Statements

The recorded interest expense is less than the statement amount as a result of the premium amortization. The appropriate accounting treatment for issuance costs is to capitalize them upon original issuance and then expense them over the remaining life of the bond until maturity. Additionally, if bonds are paid off before their maturity date, the remaining unamortized issuance costs will be expensed as of the payoff date. We calculate these two present values by discounting the future cash amounts by the market interest rate per semiannual period. Notice that the first column of the PV of 1 Table has the heading of “n“. This column represents the number of identical periods that interest will be compounded.