It is reasonable that a bond promising to pay 9% interest will sell for less than its face value when the market is expecting to earn 10% interest. In other words, the 9% $100,000 bond will be paying $500 less semiannually than the bond market is expecting ($4,500 vs. $5,000). Since investors will be receiving $500 less every six months than the market is requiring, the investors will not pay the full $100,000 of a bond’s face value. The $3,851 ($96,149 present value vs. $100,000 face value) is referred to as Discount on Bonds Payable, Bond Discount, Unamortized Bond Discount, or Discount. Next, let’s assume that just prior to offering the bond to investors on January 1, the market interest rate for this bond increases to 10%.

Advance Your Accounting and Bookkeeping Career

• Each of the interest payments occurs at the end of each of the 10 six-month time periods.
• To record this action, the company woulddebit Bonds Payable and credit Cash.
• The piecharts below show the amount of the $1,073.64 payment allocated tointerest and loan reduction for the first and final payments,respectively, on the 30-year loan.
• The bond is issued on February 1 at its par value plus accrued interest.
• Due to the market rate and coupon rate, company may issue the bonds with discount to the investor.
• They did this because thecost of the premium plus the 5% interest on the face value ismathematically the same as receiving the face value but paying 4%interest.
• The bond’s life of 5 years is multiplied by 2 to arrive at 10 semiannual periods.

With municipal Accounting For Architects bonds, interest payments are exemptfrom federal tax. So the same investor receiving $1,000 of interestfrom a municipal bond would pay no income tax on the interestincome. This tax-exempt status of municipal bonds allows the entityto attract investors and fund projects more easily. It looks like the issuer will have to pay back $104,460, butthis is not quite true. If the bonds were to be paid off today, thefull $104,460 would have to be paid back.

#1 – Straight Line Method

The balance sheet reports information as of a date (a point in time). The income statement, statement of cash flows, statement of comprehensive income, and the statement of stockholders’ equity report information for a period of time (or time interval) such as a year, quarter, or month. This account is a non-operating or “other” expense for the cost of borrowed money or other credit. The following table summarizes the effect of the change in the market interest rate on an existing $100,000 bond with a stated interest rate of 9% and maturing in 5 years.

When Market Interest Rates Increase

This is because the carrying value of bonds payable equal bonds payable minus bonds discount or the bonds payable plus bond premium. Hence, once the balance of bond discount or bond premium becomes zero, the carrying value of the bonds payable will equal the balance of bonds payable itself which is the face value of the bonds. In other words, we amortize the bond discount or bond premium to eliminate the discount or premium amount of the issued bond by transferring it to the interest expense account. And the amortization can be done through the straight-line method if the amount of bond discount or bond premium is immaterial. On the other hand, if the discount or premium amount is material or significant to financial statements, we need to amortize it through the effective interest rate method.

Amortization of bond discount using effective interest rate

This method of tracking amortized cost is called ledger account the straight-line method. There is another conceptually superior approach to amortization, called the effective-interest method, which will be revealed in later chapters. However, it is a bit more complex and the straight-line method presented here is acceptable so long as its results are not materially different than would result under the effective-interest method.

• The firm would report the $2,000 Bond Interest Payable as a current liability on the December 31 balance sheet for each year.
• It will contain the date, the account name and amount to be debited, and the account name and amount to be credited.
• Note that under either method, the interest expense and thecarrying value of the bonds stays the same.
• The coupon rate is the fixed annual interest rate that the bond issuer pays to the bondholder.
• On January 1, 2018, ABC Company issued 50,000 of 9% bonds maturing in 5 years.
• For example, on March 1, the company ABC issues a $200,000 bond with a five-year period at a premium which it sells for $205,000.

Jayster Company issued bonds at a discount. The semi-annual journal entry for interest expense will include:

Material securities disclosures are the public statements that companies make to inform investors… Financial forecasting stands as a cornerstone in the edifice of corporate financial planning,… The difference of $7,580 between the face value of bond of $100,000 and the proceeds of $92,420 represents the discount on bond. This interest payment will start from June 30, 2020, until December 31, 2039. For the past 52 bond premium amortization journal entry years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. The difference between an interest rate of 6.5% and 6.75% is 25 basis points.