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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