BONDS PAYABLE INTERMEDIATE ACCOUNTING 2 Flashcards

Company A recorded the bond sale in its accounting records by increasing Cash in Bank , Bonds Payable and the Discount on Bonds Payable (debit contra-liability). Evermaster Corporation issued $100,000 of 8% term bonds on January 1, 2015, due on January 1, 2020, with interest payable each July 1 and January 1. Since investors required an effective interest rate of 10%, they paid $92,278 for the $100,000 of bonds, creating a $7722 discount. EIRA gives decreasing interest expenses over time for premium bonds and increasing interest expenses for discount bonds.

This method of accounting for bonds is known as the straight-line amortization method, as interest expense is recognized uniformly over the life of the bond. Notice that interest expense is the same each year, even though the net book value of the bond is declining each year due to amortization. While the business may not make periodic interest payments, interest income is still generated. The interest income is merely accumulated and paid at the end of the bond’s term.

Journal Entry Format

Instead, the entity will sell the bond at lower than face value. When the bond’s term is over, the issuing business will repay the bond at its face value. The bondholder generates a return paying less than what he receives in payment at the end of the bond’s term. The redemption amount generally equals how much the original investor paid to acquire the bond.

Debt equals present value of the future interest and principal payments. For book values the discount rate is the rate when debt was incurred. Bonds that result in a premium or a discount should be amortized by either applying the effective interest method or the straight-line method. For your exam, it is very important that you understand how to calculate the periodic amortization expense that will be applied to the premium or the discount. The income statement for all of 20X3 would include $6,294 of interest expense ($3,147 X 2).

Business Operations

The coupon rate of interest is 10% and has a market rate of interest at 8%. For the remaining eight periods (there are 10 accrual or payment periods for a semi-annual bond with a maturity of five years), use the amortizing a premium on bonds payable same structure presented above to calculate the amortizable bond premium. For a bond investor, the premium paid for a bond represents part of the cost basis of the bond, which is important for tax purposes.

A subordinated debenture bond means the bond is repaid after other unsecured debt, as noted in the bond agreement. Bonds are secured when specific company assets are pledged to serve as collateral for the bondholders. If the company fails to make payments according to the bond terms, the owners of secured bonds may require the assets to be sold to generate cash for the payments. Price a $10,000,000, 6%, 10-year bond which pays interest semi-annually when the market rate is 5%. K & A Company has a level-coupon bond outstanding that pays coupon interest of $100 per year and has 20 years to maturity.

Accounting for Bond Premiums and Discounts

The reality is that there are two major component of a bond that the FAR exam wants you to know about. 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. For 20X1, interest expense can be seen to be roughly 5.8% of the bond liability ($6,294 expense divided by beginning of year liability of $108,530). For 20X4, interest expense is roughly 6.1% ($6,294 expense divided by beginning of year liability of $103,412). The present value factors are taken from the present value tables (annuity and lump-sum, respectively). Take time to verify the factors by reference to the appropriate tables, spreadsheet, or calculator routine.

After the payment is recorded, the carrying value of the bonds payable on the balance sheet increases to $9,408 because the discount has decreased to $592 ($623–$31). The effective interest rate method uses the market interest rate at the time that the bond was issued. In our example, the market interest rate on January 1, 2022 was 4% per semiannual period for 10 semiannual periods. For a zero-coupon bond, the amortization is exactly like the discount bond. The only difference is that the bond is issued at a deep discount and there are no coupon payments. So, the total interest expense for the year comprises the discount amortization for the year.