Boa Ideia
Part of each scheduled payment reduces the face value of the obligation so that no large amount remains to be paid on the maturity date. As mentioned above, as per the straight-line method, the amortization of bond discount is calculated by dividing the total interest on bonds by the total number of periods until the maturity date. When the bond is issued at par, the cash receipt from the bond issuance is equal to the par or face value of the bond.
For example, earlier we
demonstrated the issuance of a five-year bond, along with its first
two interest payments. If we had carried out recording all five
interest payments, the next step would have been the maturity and
retirement of the bond. At this stage, the bond issuer would pay
the maturity value of the bond to the owner of the bond, whether
that is the original owner or a secondary investor. At some point, a company will need to record bond retirement, when the company pays the obligation. For example, earlier we demonstrated the issuance of a five-year bond, along with its first two interest payments.
In the short term, company will be able to raise funds without issuing share equity. In the future, even the bonds are converted, it will increase the stock price which will benefit the current shareholders as well. Based on the table above, financial liability balance is $ 1,944,358 which need to reverse from balance sheet, so it will impact the additional paid-in capital which is the balancing figure. Bondholder may decide to convert bonds to equity share at the maturity date when the share price increase.
Any reduction of risk makes a note or bond instrument more appealing to potential lenders. For example, some loans (often dealing with the purchase of real estate) are mortgage agreements that provide the creditor with an interest in identified property. The recent downturn in the housing market has seen many debtor defaults that have led to bank foreclosures on homes across the country.
The straight-line approach suffers from the same limitations discussed earlier, and is acceptable only if the results are not materially different from those resulting with the effective-interest technique. Note that under either method, the interest expense and the
carrying value of the bonds stays the same. Note that under either method, the interest expense and the carrying value of the bonds stays the same. Bonds also allow investors to earn a higher return on their investment while being less risky than other investments. Dividend stocks are an attractive option as they can generate a steady income stream, plus potential capital gains.
The same as discount bonds, the total interest shall need to divide by the total number of periods until the maturity date of the bonds in order to recognize the interest expense equally for each period. As mentioned above, the journal entry for bond issuance varies depends on whether the bond is issued at par, at discount, or a premium. In the below section, we cover the journal entry for each type of issuance. The bond premium is the amount a company pays in excess of the face value of the bond, and this amount is also entered into the bonds payable account.
When bonds are issued at par, the coupon rate offered on the bond and the market interest rate will be the same. 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.
Note that the company received less for the bonds than face value but is paying interest on the $100,000. For the first interest payment, the interest expense is $469 ($9,377 carrying value × 10% market interest rate × 6/ 12 semiannual interest). The semiannual interest paid to bondholders on Dec. 31 is $450 ($10,000 maturity amount of bond × 9% coupon interest rate × 6/ 12 for semiannual payment). The $19 difference between the $469 interest expense and the $450 cash payment is the amount of the discount amortized. The entry on December 31 to record the interest payment using the effective interest method of amortizing interest is shown on the following page. The amount of the premium amortization is simply the difference between the interest expense and the cash payment.
Notice that under both methods of amortization, the book value at the time the bonds were issued ($96,149) moves toward the bond’s maturity value of $100,000. The reason is that the bond discount of $3,851 is being reduced to $0 as the bond discount is amortized to interest expense. Let’s assume that just prior to selling the bond on January 1, the market interest rate for this bond drops to 8%. Rather than changing the bond’s stated interest rate to 8%, the corporation proceeds to issue the 9% bond on January 1, 2022. Since this 9% bond will be sold when the market interest rate is 8%, the corporation will receive more than the bond’s face value.
Study the following illustration, and observe that the Premium on Bonds Payable is established at $8,530, then reduced by $853 every interest date, bringing the final balance to zero at maturity. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. Beyond FASB’s preferred method of interest
amortization discussed here, there is another method, the
straight-line method.
The 8% market rate of interest equates to a semiannual rate of 4%, the 6% market rate scenario equates to a 3% semiannual rate, and the 10% rate is 5% per semiannual period. One of the entries that you will prepare involves the upcoming bond interest payment that will be paid on January 15 of the next year. Your supervisor asks you if you will consider dating the journal entry on January 1 instead of December 31 of the current year. Assess the implications of the various stakeholders and explain what your answer will be. (Figure)If there is neither a premium nor discount present, the journal entry to record bond interest payments is _______. At some point, a company will need to record bond
retirement, when the company pays the obligation.
No transaction occurs on that date but adjustment is necessary when preparing the Year One statements to report both the expense and the liability for these two months. Many of these are promises made by the debtor to help ensure that money will be available to make required payments. For example, the debtor might agree to limit dividend payments until the liability is extinguished, keep its current ratio above a minimum standard, or limit the amount costs and benefits of other debts that it will incur. In order to illustrate how the bonds issued and sold at par is recorded, let’s go through the example below. These benefits include increased financial stability, the ability to raise long-term capital without diluting existing shareholdings, and protection from interest rate fluctuations. Moreover, corporate bonds offer flexibility in raising debt capital, allowing companies to prioritize their debts over others.
(Figure)Assume you are a newly hired accountant for a local manufacturing firm. Bondholders receive the stated rate times the principle, so they would receive $6,000. (Figure)Gingko Inc. issued bonds with a face value of $100,000, a rate of 7%, and a 10-yearterm for $103,000. From this information, we know that the market rate of interest was ________. (Figure)O’Shea Inc. issued bonds at a face value of $100,000, a rate of 6%, and a 5-year term for $98,000.