Thursday, November 8, 2012

Bonds Payable

http://ccba.jsu.edu/accounting/BONDSPAYABLE.HTML

A. Bond Prices

Bonds pay a stated rate of interest that may be different from the market rate of interest when the bonds are issued.
Bond prices are usually quoted as a percentage of the face amount (i.e., the amount which must be repaid when the bonds mature). For example, a bond price of 96 indicates that a bond is selling at 96% of its face value (a discount), while a bond price of 103 indicates that the bond is selling at 103% of its face amount (a premium). The actual bond price is found by determining the present value of the cash flows for the face value and interest payments, discounted at the market rate of interest. The following examples have already determined the bond prices.

B. Bond Sold at Face Value (Market rate = Stated Bond Rate)

Bonds sell at 100% if the market rate equals the stated rate at the time the bonds are issued.
     Example:
     On January 1, 2005 ABC issues $100,000 of 10%, 2 year bonds.  The
     bonds pay interest annually each December 31.  The bonds are issued
     at a price of 100.

     > Jan 1, 2005 - Date of Issuance

                                                  Debit      Credit
                                                 -------    --------
          Cash                                   100,000
             Bonds Payable                                  100,000

     > Dec 31, 2005 - Interest Payment

          Interest Expense                        10,000
             Cash                                            10,000

     > Dec 31, 2006 - Interest Payment and Maturity of Bonds

          Interest Expense                        10,000
             Cash                                            10,000

          Bonds Payable                          100,000
             Cash                                           100,000

C. Bond Sold at a Discount (Market rate > Stated Bond Rate)

Bonds sell at less than 100% if the market rate is greater than the stated rate at the time the bonds are issued.
     Example:
     On January 1, 2005 ABC issues $100,000 of 10%, 2 year bonds.  The
     bonds pay interest annually each December 31.  The bonds are issued
     at a price of 95.  Assume straight-line amortization of the discount.

     > Jan 1, 2005 - Date of Issuance

                                                  Debit      Credit
                                                 -------    --------
          Cash (100,000 x 95%)                    95,000
          Discount on Bonds Payable                5,000
             Bonds Payable                                  100,000

     > Dec 31, 2005 - Interest Payment

          Interest Expense                        12,500
             Discount on Bonds Payable                        2,500
             Cash                                            10,000

     > Dec 31, 2006 - Interest Payment and Maturity of Bonds

          Interest Expense                        12,500
             Discount on Bonds Payable                        2,500
             Cash                                            10,000

          Bonds Payable                          100,000
             Cash                                           100,000

     Note: The purpose of the discount is to force the interest expense
           to the higher market rate.  The $5,000 discount is actually
           additional interest paid upon the issuance of the bonds.
           The borrower only gets $95,000 but must pay back a face value
           of $100,000.

D. Bond Sold at a Premium (Market rate < Stated Bond Rate)

Bonds sell at more than 100% if the stated bond rate is greater than the market rate at the time the bonds are issued.
     Example:
     On January 1, 2005 ABC issues $100,000 of 10%, 2 year bonds.  The
     bonds pay interest annually each December 31.  The bonds are issued
     at a price of 105.  Assume straight-line amortization of the premium.

     > Jan 1, 2005 - Date of Issuance

                                                  Debit      Credit
                                                 -------    --------
          Cash (100,000 x 105%)                  105,000
             Premium on Bonds Payable                         5,000
             Bonds Payable                                  100,000

     > Dec 31, 2005 - Interest Payment

          Interest Expense                         7,500
          Premium on Bonds Payable                 2,500
             Cash                                            10,000

     > Dec 31, 2006 - Interest Payment and Maturity of Bonds

          Interest Expense                         7,500
          Premium on Bonds Payable                 2,500
             Cash                                            10,000

          Bonds Payable                          100,000
             Cash                                           100,000

     Note: The purpose of the premium is to force the interest expense
           to the lower market rate.  The $5,000 premium is actually
           a reduction of interest granted upon the issuance of the bonds.
           The borrower gets $105,000 but must only pay back a face value
           of $100,000.

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