Bonds Payable

What are Bonds Payable?

Bonds payable are long term liabilities and represent amounts owed by a business to a third party. A business will issue bonds payable if it wants to obtain funding from long term investors by way of loans.

The bond payable will stipulate the interest rate and the term to be used, known as the maturity date. At the maturity date the investor will receive repayment of the principal amount invested and interest. Bonds are transferable, and an investor can sell their bond before the maturity date.

In operation, bonds payable are similar to notes payable. A note payable is issued when there is a small loan required from a single lender. A bond payable is issued if the need is for a larger loan requiring multiple investors. In this case, the loan is split into units called bonds, and for each bond a bond payable (note payable) is issued to the investor.

So issuing bonds payable is a way of raising larger amounts of finance from multiple investors.

Types of Bonds Payable

There are numerous different types of bond with different characteristics, a few of these are listed below:

  • Secured bond payable – Secured on specific assets of the business.
  • Registered bonds payable – Registered to a particular owner
  • Bearer bonds – The owner is the bearer (person who has) the bond.
  • Sinking fund bonds payable – Regular amounts have to be transferred into an account (sinking fund) to repay the bond at maturity.
  • Serial bonds payable – Issued in groups with differing maturity dates.
  • Convertible bonds payable – Allow the owner to exchange them in return for shares in a business.
  • Callable bond payable – Can be called in by the business and bought back before the maturity date.
  • Debenture bonds payable – Not secured on specific assets of the business.

What are Bonds in Accounting?

To a business, a bond payable represents a series of regular interest payments together with a final principal repayment at the maturity date. To an investor, the bond is a series of interest receipts followed by the return of the principal at the maturity date.

An investor should be prepared to pay the present value of the cash flows for the bond (the bond price).

The present value is given by the present value of the principal repayment plus the present value of the regular annuity created by the interest payments.

The amount the investor should be prepared to pay is then given by the following bonds payable formula:

Present value = Principal / (1+i)n + Interest x ((1-1/(1+i)n)/i)

Where i = market interest rate, and n = number of periods.

Bonds Payable Issued at Par

Suppose for example, the business issued 100,000, 5 year, 10% bonds, with interest payable every 6 months. The total face value (par value) of the bonds payable is 100,000. The interest payable every 6 months for 5 years is 100,000 x 10% x 6 / 12 = 5,000

If the market rate was also 10%, then the investors,using the formula above, would be prepared to pay the present value of the cash flows:

i = 10%/2 every 6 months
n = 2 x 5 =10 6 month periods
Bond price = Principal / (1+i)n + Interest x ((1-1/(1+i)n)/i)
Bond price = 100,000 / (1 + 10%/2)10 + 5,000 x ((1 - 1 / (1 + 10%/2)10) / (10%/2))
Bond price = 100,000

The investors are prepared to pay the face value 100,000 as the bond rate is the same as the market rate.

The bonds payable would be issued at their face (par) value of 100,000, and the journal entry to record this would be as follows.

Bonds Payable Journal Entry – Issued at par value
Account Debit Credit
Cash 100,000
Bonds payable 100,000
Total 100,000 100,000

Every 6 months the interest on the bonds payable is paid and the following journal is recorded:

Bonds Payable – Pay the interest
Account Debit Credit
Interest expense 5,000
Cash 5,000
Total 5,000 5,000

Finally, at the end of the 5 year term (the maturity date) the bonds payable have to be paid and the following journal completes the transaction.

Bonds Payable – Payment at the end of the term
Account Debit Credit
Bonds payable 100,000
Cash 100,000
Total 100,000 100,000

Premium on Bonds Payable

If the market rate was lower than the bond rate, say 8%, then the investors again should be prepared to pay the present value of the cash flows:

i = 8%/2 every 6 months
n = 2 x 5 =10 (6 month periods)
Bond price = Principal / (1+i)n + Interest x ((1-1/(1+i)n)/i)
Bond price = 100,000 / (1 + 8%/2)10 + 5,000 x ((1 - 1 / (1 + 8%/2)10) / (8%/2))
Bond price = 108,111

The investors are prepared to pay 108,111, more than the face value (a premium) as the bond rate is higher than the market rate.

The bonds payable would be issued at a premium value of 108,111, and the journal entry to record this would be as follows.

Bonds Payable – Issued at a premium
Account Debit Credit
Cash 108,111
Bonds payable 100,000
Premium on bonds payable 8,111
Total 108,111 108,111

Every 6 months the interest on the bonds payable is paid and the following journal is recorded:

Bonds Payable – Pay the interest
Account Debit Credit
Interest expense 5,000
Cash 5,000
Total 5,000 5,000

In addition, every 6 months the premium on the bonds payable is amortized over the life of the bond, and a credit for this is taken to the interest expense account.

In this example, the useful life is 10 periods and the amortization is 8,111 / 10 = 811 per period.

Bonds Payable – Amortize the premium
Account Debit Credit
Interest expense 811
Premium on bonds payable 811
Total 811 811

The last two journals could be combined to show a net interest expense of 5,000 – 811 = 4,189.

The explanation for this is that the business must pay back 100,000 plus the interest for 10 periods of 50,000, a total of 150,000, but because the bonds were issued at a premium the net cost to them is 150,000 – 108,111 = 41,889 or 4,189 per period.

At the end of the 5 years the entire premium will have been taken to the profit and loss account and the premium on the bonds payable account will be zero.

Finally, at the end of the 5 year term (the maturity date) the bonds payable have to be paid and the following journal completes the transaction.

Bonds Payable – Payment at the end of the term
Account Debit Credit
Bonds payable 100,000
Cash 100,000
Total 100,000 100,000

Discount on Bonds Payable

If the market rate was higher than the bond rate, say 12%, then the investors should be prepared to pay the present value of the cash flows:

i = 12%/2 every 6 months
n = 2 x 5 =10 (6 month periods)
Bond price = Principal / (1+i)n + Interest x ((1-1/(1+i)n)/i)
Bond price = 100,000 / (1 + 12%/2)10 + 5,000 x ((1 - 1 / (1 + 12%/2)10) / (12%/2))
Bond price = 92,640

The investors are prepared to pay 92,640, less than the face value (a discount) as the bond rate is lower than the market rate.

The bonds payable would be issued at a discount value of 92,640, and the journal entry to record this would be as follows.

Bonds Payable – Issued at a discount
Account Debit Credit
Cash 92,640
Bonds payable 100,000
Discount on bonds payable 7,360
Total 92,640 92,640

In addition, every 6 months the interest on the bonds payable is paid and the following journal is recorded:

Bonds Payable – Pay the interest
Account Debit Credit
Interest expense 5,000
Cash 5,000
Total 5,000 5,000

Every 6 months the discount on the bonds payable is amortized over the life of the bond and a debit taken to the interest expense account.

In this example the useful life is 10 periods and the amortization is 7,360 / 10 = 736 per period.

Bonds Payable – Amortize the discount
Account Debit Credit
Interest expense 736
Discount on bonds payable 736
Total 736 736

The last two journals could be combined to show a total interest expense of 5,000 + 736 = 5,736.

The explanation for this is that the business must pay back 100,000 plus the interest for 10 periods of 50,000 a total of 150,000, but because the bonds were issued at a discount the net cost to them is 150,000 – 92,640 = 57,360 or 5,736 per period.

At the end of the 5 years the entire discount will have been charged to the profit and loss account and the discount on the bonds payable account will be zero.

Finally, at the end of the 5 year term (the maturity date) the bonds payable have to be paid and the following journal completes the transaction.

Bonds Payable – Payment at the end of the term
Account Debit Credit
Bonds payable 100,000
Cash 100,000
Total 100,000 100,000

Bonds Payable on Balance Sheet

Bonds payable have terms exceeding one year and are classified as long term liabilities in the balance sheet. The portion of the bonds payable which fall due within 12 months of the balance sheet date are be classified as current liabilities.

Bonds Payable May 25th, 2017Team

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