Step-by-step explanation:
When a company issues bonds, it incurs a long-term liability on which periodic interest payments must be made, usually twice a year. If interest dates fall on other than balance sheet dates, the company must accrue interest in the proper periods. The following examples illustrate the accounting for bonds issued at face value on an interest date and issued at face value between interest dates.
Bonds issued at face value on an interest date Valley Company’s accounting year ends on December 31. On 2010 December 31, Valley issued 10-year, 12 per cent bonds with a $100,000 face value, for $100,000. The bonds are dated December 31, call for semiannual interest payments on June 30 and December 31, and mature in 10 years on December 31. Valley made the required interest and principal payments when due. The entries for the 10 years are as follows:
On December 31, the date of issuance, the entry is:
DebitCredit
Dec 31Cash100,000
Bonds Payable 100,000
To record bonds issued at face value.
On each June 30 and December 31 for 10 years, beginning 2010 June 30 (ending 2020 June 30), the entry would be (Remember, calculate interest as Principal x Interest x Frequency of the Year):
DebitCredit
Jun 30Bond Interest Expense ($100,000 x 12% x 6 months / 12 months)6,000
Cash 6,000
To record semiannual interest payment.
On December 31 (10 years later), the maturity date, the entry would include the last interest payment and the amount of the bond:
DebitCredit
Dec 31Bond Interest Expense ($100,000 x 12% x 6 months / 12 months)6,000
Bonds Payable100,000
Cash 106,000
To record final semiannual interest and bond repayment.
Note that Valley does not need any interest adjusting entries because the interest payment date falls on the last day of the accounting period. The income statement for each of the 10 years would show Bond Interest Expense of $12,000 ($ 6,000 x 2 payments per year); the balance sheet at the end of each of the years 1 to 8 would report bonds payable of $100,000 in long-term liabilities. At the end of ninth year, Valley would reclassify the bonds as a current liability because they will be paid within the next year.
The real world is more complicated. For example, assume the Valley bonds were dated October 31, issued on that same date, and pay interest each April 30 and October 31. Valley must make an adjusting entry on December 31 to accrue interest earned for November and December but not paid until April 30 of the next year. That entry would be:
DebitCredit
Dec 31Bond Interest Expense ($100,000 x 12% x 2 months / 12 months)2,000
Interest Payable (or Bond Interest Payable) 2,000
To record accrued interest for November and December payable in April.
The April 30 entry in the next year would include the accrued amount from December of last year and interest expense for Jan to April of this year. We will credit cash since we are paying cash to the bondholders.
DebitCredit
Dec 31Bond Interest Expense ($100,000 x 12% x 4 months / 12 months)4,000
Interest Payable (or Bond Interest Payable)2,000
Cash ($100,000 x 12% x 6 months / 12 months) 6,000
To record payment of 6 months bond interest.
Since the 6-month period ending October 31 occurs within the same fiscal year, the bond interest entry would be:
DebitCredit
Oct 31Bond Interest Expense ($100,000 x 12% x 6 months / 12 months)6,000
Cash 6,000
To record semiannual interest payment.
Each year Valley would make similar entries for the semiannual payments and the year-end accrued interest. The firm would report the $2,000 Bond Interest Payable as a current liability on the December 31 balance sheet for each year.
It would be nice if bonds were always issued at the par or face value of the bonds. But, certain circumstances prevent the bond from being issued at the face amount. We may be forced to issue the bond at a discount or premium. This video will explain the basic concepts and then we will review examples:
