The accounting treatment for the issuance of bonds depends on whether the bonds are issued at par, a discount, or a premium. The bond issuing companies will record the transactions for the bond principal and the interest payments separately.
Let us discuss what is the issuance of bonds and what is the accounting treatment for them.
Issuance of Bonds
Companies issue bonds to raise capital from the market. Bonds are typically issued when companies require funding for long-term projects.
Bonds are issued with a face value of $100 or $1,000. Dividing bonds into smaller units help raise funds easily.
There are several types of bonds such as zero-coupon bonds, convertible bonds, high-yield bonds, and so on. The bond types vary by features carried by the bond such as the interest rate, frequency of coupon payments, maturity date, attached warrants, and so on.
Bondholders invest in bonds primarily to receive fixed income in the form of coupons. They also trade bonds in the secondary market as most of the bonds are issued at below par value creating an opportunity for profit for the investors.
Bonds when considered through the par value can be categorized into three types:
- Bonds issued at par
- Bonds issued above par (at a premium)
- Bonds issued below par (at a discount)
Accounting for Issuance of Bonds
The valuation of bonds at the issuance date is the present value of future payments using an interest rate that reflects the risk category of the issued bonds.
In many situations, the interest rate agreed upon by both parties may not reflect the actual risk-reward relation. It means the market will ratify the difference whether the interest rate should be increased or decreased.
In other words, a bond will be adjusted for market price and it will either sell at a premium or a discount. The resulting premium or discount is in the form of interest accumulated and amortized over the life of the bond.
The accounting treatment for the issuance of bonds will depend on the amortization of interest and the issue price of the bonds. In most cases, bonds will be issued at other than the par value.
The general journal entry to record the issuance of bonds will be:
| Account | Debit | Credit |
| Cash Proceeds | $ XXXX | |
| Bonds Payable | $ XXXX | |
| Premium (Difference) | $ XXXX |
If the cash proceeds are higher than the bonds payable amount, the resulting difference will be recorded as a premium on bonds. Contrarily, when the cash proceeds are lower than the bonds payable amount, it will be recorded as a discount.
Bonds Issued at Par
When bonds are issued at par, the coupon rate offered on the bond and the market interest rate will be the same.
Suppose ABC company issues a bond at a par value of $ 100,000 and a coupon rate of 5% with 5 years maturity. The market interest rate is also 5%.
Let us calculate the PV of bond principal payment and interest component first.
PV of bond = $ 100,000 × (0.78355) = $ 78,355
PV Factor 5%, 5 years = 0.78355
Coupon/Interest = $ 100,000 × 5% = $ 5,000
FV of Coupon/Interest = $ 5,000 × 4.329 = 21,645
Total Value = 78,355 + 21,645 = $ 100,000
The amortization table for the bond and its interest component is given below.
| Year | Coupon Payment (b) | Interest Expense (c) | Bond Premium (d) = b – c | Carrying Value of Bond (e) = d + f | Par Value of Bond (f) |
| Year0 | $ 21,645 | $ 21,645 | – | $ 100,000 | $ 100,000 |
| Year1 | $ 4,329 | $ 4,329 | – | $ 100,000 | $ 100,000 |
| Year2 | $ 4,329 | $ 4,329 | – | $ 100,000 | $ 100,000 |
| Year3 | $ 4,329 | $ 4,329 | – | $ 100,000 | $ 100,000 |
| Year4 | $ 4,329 | $ 4,329 | – | $ 100,000 | $ 100,000 |
| Year5 | $ 4,329 | $ 4,329 | – | $ 100,000 | $ 100,000 |
ABC Company will record the journal entries for the interest payment yearly. Since we have used the straight-line amortization method, the accounting entry will be the same every year. The Journal Entries to record the transactions will be recorded as below.
| Account | Debit | Credit |
| Interest Expense | $ 4,329 | |
| Premium on Bond | $ – | |
| Cash | $ 4,329 |
Since the bond is issued at par, the interest rate and coupon rates are the same. Hence, there will be no premium or discount on the issuance of bonds in this case.
Bonds issued at Premium
Suppose ABC company issues a bond at a par value of $ 100,000 and a coupon rate of 6% with 5 years maturity. The market interest rate is 5%.
Let us calculate the PV of bond principal payment and interest component first.
PV of bond = $ 100,000 × (0.78355) = $ 78,355
PV Factor 5%, 5 years = 0.78355
Coupon Payments = $ 100,000 × 6% = $ 6,000
FV of Coupon Payments = $ 6,000 × 4.329 = 25,974
Total Value = 78,355 + 25,974 = $ 104,329
Interest Expense = $ 100,000 × 5% = $ 5,000
FV of Interest Expense = $ 21,445
The Journal Entries to record the transactions will be recorded as below.
| Account | Debit | Credit |
| Cash Proceeds (PV) | $104,329 | |
| Bonds Payable | $100,00 | |
| Premium on Bond | $4,329 |
The amortization table for the interest payment and bond values will be as below.
| Year | Coupon Payment (b) | Interest Expense (c) | Bond Premium (d) = b – c | Carrying Value of Bond (e) = d + f | Par Value of Bond (f) |
| Year0 | $ 25,974 | $ 21,445 | $ 4,329 | $ 104,329 | $ 100,000 |
| Year1 | $ 4,289 | $ 5,194 | $ 3,464 | $ 103,464 | $ 100,000 |
| Year2 | $ 4,289 | $ 5,194 | $ 2,599 | $ 102,599 | $ 100,000 |
| Year3 | $ 4,289 | $ 5,194 | $ 1,734 | $ 101,734 | $ 100,000 |
| Year4 | $ 4,289 | $ 5,194 | $ 865 | $ 100,869 | $ 100,000 |
| Year5 | $ 4,289 | $ 5,194 | $ 0 | $ 100,000 | $ 100,000 |
Similarly, the journal entry to record the interest expense will be:
| Account | Debit | Credit |
| Interest Expense | $ 5,194 | |
| Premium on Bond | $ 865 | |
| Cash | $ 4,289 |
Bonds Issued at Discount
Now let us suppose ABC company issues a bond at a par value of $ 100,000 and a coupon rate of 6% with 5 years maturity. The market interest rate is 7%.
Let us calculate the PV of bond principal payment and interest component first.
PV of bond = $ 100,000 × (0.713) = $ 71,300
PV Factor 7%, 5 years = 0.713
Coupon Payments = $ 100,000 × 6% = $ 6,000
FV of Coupon Payments = $ 6,000 × 4.100 = 24,600
Total Value = 71,300 + 24,600 = $ 95,900
Interest Expense = $ 100,000 × 7% = $ 7,000
FV of Interest Expense = $7,000 × 4.100 =$ 28,700
The Journal Entries to record the transactions will be recorded as below.
| Account | Debit | Credit |
| Cash Proceeds (PV) | $ 95,900 | |
| Bonds Payable | $ 100,00 | |
| Discount on Bond | $ 4,100 |
The amortization table for the interest payment and bond values will be as below.
| Year | Coupon Payment (b) | Interest Expense (c) | Bond Discount (d) = b – c | Carrying Value of Bond (e) = d + f | Par Value of Bond (f) |
| Year0 | $ 24,600 | $ 28,700 | ($ 4,100) | $ 95,900 | $ 100,000 |
| Year1 | $ 4,920 | $ 5,740 | ($ 3,280) | $ 96,720 | $ 100,000 |
| Year2 | $ 4,920 | $ 5,740 | ($ 2,460) | $ 97,540 | $ 100,000 |
| Year3 | $ 4,920 | $ 5,740 | ($ 1,640) | $ 98,360 | $ 100,000 |
| Year4 | $ 4,920 | $ 5,740 | ($ 820) | $ 99,180 | $ 100,000 |
| Year5 | $ 4,920 | $ 5,740 | $ 0 | $ 100,000 | $ 100,000 |
The journal entry to record the interest expense will be:
| Account | Debit | Credit |
| Interest Expense | $ 5,194 | |
| Premium on Bond | $ 865 | |
| Cash | $ 4,289 |