Accounting for Issuance of Bonds (Example and Journal Entry)

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.

See also  What Is Conventional Mortgage? (All you need to know)

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:

AccountDebitCredit
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.

YearCoupon Payment (b)Interest Expense (c)Bond Premium (d) = b – cCarrying Value of Bond (e) = d + fPar 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.

See also  ERG Theory of Motivation: What is it? and How does it work?
AccountDebitCredit
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.

AccountDebitCredit
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.

YearCoupon Payment (b)Interest Expense (c)Bond Premium (d) = b – cCarrying Value of Bond (e) = d + fPar 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:

AccountDebitCredit
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%.

See also  What are the Depository Receipts? Types, Advantages, And Limitations

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.

AccountDebitCredit
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.

YearCoupon Payment (b)Interest Expense (c)Bond Discount (d) = b – cCarrying Value of Bond (e) = d + fPar 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:

AccountDebitCredit
Interest Expense $ 5,194
Premium on Bond$ 865 
Cash$ 4,289