How is the issuance of bonds at a premium or discount recorded and how is that premium/discount amortized?
Bond Accounting
Bonds issued at premium (price > face value) or discount (price < face value) require amortization of the premium/discount over the bond life using the effective interest method.
How is the issuance of bonds at a premium or discount recorded and how is that premium/discount amortized?
Summary: Bonds issued at premium (price > face value) or discount (price < face value) require amortization of the premium/discount over the bond life using the effective interest method.
Recording Issuance:
At Par (Face Value):
- Dr Cash $1,000,000
- Cr Bonds Payable $1,000,000
At Discount:
- Dr Cash $957,876
- Dr Discount on Bonds Payable $42,124
- Cr Bonds Payable $1,000,000
At Premium:
- Dr Cash $1,044,518
- Cr Premium on Bonds Payable $44,518
- Cr Bonds Payable $1,000,000
Amortization Methods:
1. Effective Interest Method (Required by GAAP):
Interest Expense = Carrying Value × Market Rate
Cash Paid = Face Value × Coupon Rate
Amortization = Difference between Interest Expense and Cash Paid
Discount Amortization Example (5% bonds, 6% market rate):
| Period | Interest Expense (6%) | Cash Paid (5%) | Discount Amortized | Carrying Value |
|---|---|---|---|---|
| 1 | $57,473 | $50,000 | $7,473 | $965,349 |
| 2 | $57,921 | $50,000 | $7,921 | $973,270 |
| 5 | $59,434 | $50,000 | $9,434 | $1,000,000 |
Premium Amortization Example (5% bonds, 4% market rate):
| Period | Interest Expense (4%) | Cash Paid (5%) | Premium Amortized | Carrying Value |
|---|---|---|---|---|
| 1 | $41,781 | $50,000 | $8,219 | $1,036,299 |
| 2 | $41,452 | $50,000 | $8,548 | $1,027,751 |
| 5 | $40,385 | $50,000 | $9,615 | $1,000,000 |
Key Points:
- Premium: When coupon rate > market rate
- Discount: When coupon rate < market rate
- Effective interest method matches expense with period
- Carrying value approaches face value at maturity
- Balance sheet: Bonds payable ± premium/discount