Thus, if the market rate is 14% and the contract rate is 12%, the bonds will sell at a discount. Since the 6-month period ending October 31 occurs within the same fiscal year, the bond interest entry would be: Each year Valley would make similar entries for the semiannual payments and the year-end accrued interest. Don't have a login? To record period interest payment and premium amortization. Also, for the interest payments, lets say they go as follows for the issuer: Cr. As we go through the journal entries, it is important to understand that we are analyzing the accounting transactions from the perspective of the issuer of the bond. Is the entry for the Investor: Dr. Investment in Bonds 98,000. Cr. The rate is called coupon rate (also called contract rate or stated rate). I make sense of this by thinking that if the investor bought it at a discount, part of the interest is increasing your investment (up to “THE FACE”-Gearty style) and vice versa for a premium. Income statement reports bond interest expense which represents cost of funds obtained through issuance of bonds. XPLAIND.com is a free educational website; of students, by students, and for students. The investor would make the opposite journal entries. We will credit cash since we are paying cash to the bondholders. Cr. Premium on Bonds Payable ($105,250 cash – $100,000 bond), Bond Interest Expense ($6,000 cash interest – 875 premium amortization), Premium on Bonds Payable ($5,250 premium / 6 interest payments). Good find. Bond Interest Expense ($100,000 x 12% x 4 months / 12 months), Cash   ($100,000 x 12% x 6 months / 12 months). Such issuance is journalized as follows: Similarly, if the coupon rate is lower than the market interest rate, the bonds are issued at a discount i.e. How do the journal entries go for the party that purchases the bond? You must be logged in to reply to this topic. In this example the premium amortization will be $5,250 discount amount / 6 interest payment (3 years x 2 interest payments each year). The discount will increase bond interest expense when we record the semiannual interest payment. If interest dates fall on other than balance sheet dates, the company must accrue interest in the proper periods. Example: For Issuer: Dr. Cash 98,000. The price investors pay for a given bond issue is equal to the present value of the bonds. The entry to record receipt of the bond amount at maturity would be: The entry to record the semi-annual interest payment and discount amortization would be: Just like with a discount, we would have completely amortized or removed the premium so the balance in the premium account would be zero. Bond interest payable ($100,000 x 12% x (5/12)). Here is a video example and then we will do our own example: For our example assume Jan 1 Carr issues $100,000, 12% 3-year bonds for a price of 95 1/2 or 95.50% with interest to be paid semi-annually on June 30 and December 30 for cash. Thanks in advance. The entry required is: This entry records the $5,000 received for the accrued interest as a debit to Cash and a credit to Bond Interest Payable. Bond Issuance. It equals coupon payment as adjusted for amortization of bond discount/premium as shown in the formula below: On 1 January 2001, Codestreet, Inc. issued 100,000, $100 face value bonds carrying a coupon rate of 8% payable semiannually. Appreciate the help, as my FAR exam is Thursday. In this scenario annual coupon rate is 8% but the bond will pay two payments each year so each periodic payment is $400,000 (= 8% ÷ 2 × $100 × 100,000). Bonds issued at a discount When we issue a bond at a discount, remember we are selling the bond for less than it is worth or less than we are required to pay back. Bonds Payable 100,000, Dr. Investment in Bonds 98,000, Cr. The firm would report the $2,000 Bond Interest Payable as a current liability on the December 31 balance sheet for each year. Positive covenants are certain obligations which the company has to fulfill during the term of bond, for example a bond indenture may require a company to maintain a times interest earned ratio of at least 3. When a bond is issued at its face amount, the issuer receives cash from the buyers of the bonds and records a liability for the bonds issued. The real world is more complicated. You are welcome to learn a range of topics from accounting, economics, finance and more. Market and contract rates of interest are likely to differ. Journal Entries- Fund Based vs. Government-Wide. A premium decreases the amount of interest expense we record semi-annually. The issuer must pay holders of the bonds a full six months’ interest at each interest date. In our example, the bond pays interest every 6 months on June 30 and December 31. The difference between the price we sell it and the amount we have to pay back is recorded in a liability account called Premium on Bonds Payable. Bond Interest Expense ($100,000 x 12% x 2 months / 12 months), Interest Payable (or Bond Interest Payable). The premium will decrease bond interest expense when we record the semiannual interest payment. On 2010 December 31, Valley issued 10-year, 12 per cent bonds with a $100,000 face value, for $100,000. But thats just my intuition, so if somebody knows for sure, that'd be great. Bond Interest Expense ($100,000 x 12% x 6 months / 12 months). ProfessorBDoug's Bond Premium Journal Entry. To record periodic interest payment and discount amortization. https://accounting.utep.edu/sglandon/c12/c12a.pdf, Yeah, I think page 3 and 4 on that pdf are sufficient confirmation for us. Computing long-term bond prices involves finding present values using compound interest. Bonds Payable 100,000. Selling bonds at a premium or a discount allows the purchasers of the bonds to earn the market rate of interest on their investment. For example, one hundred $1,000 face value bonds issued at 103 have a price of $103,000 (100 bonds x $1,000 each x 103%). Note that Valley does not need any interest adjusting entries because the interest payment date falls on the last day of the accounting period.