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On July 1, Lighting Process, Inc. issues $10,000 ten‐year bonds, with a coupon rate of interest of 12% and semiannual interest payments payable on June 30 and December 31, when the market interest rate is 10%. The entry to record the issuance of the bonds increases (debits) cash for the $11,246 received, increases (credits) bonds payable for the $10,000 maturity amount, and increases (credits) premium on bonds payable for $1,246. Premium on bonds payable is a contra account to bonds payable that increases its value and is added to bonds payable in the long‐term liability section of the balance sheet. Lighting Process, Inc. issues $10,000 ten‐year bonds, with a coupon interest rate of 9% and semiannual interest payments payable on June 30 and Dec. 31, issued on July 1 when the market interest rate is 10%. The entry to record the issuance of the bonds increases (debits) cash for the $9,377 received, increases (debits) discount on bonds payable for $623, and increases (credits) bonds payable for the $10,000 maturity amount.
Company XYZ, a tech firm, issues $1,000,000 in 5-year bonds with a face value (par value) of $1,000 each. However, due to prevailing market interest rates being higher than the coupon rate they can offer, they issue these bonds at a discount. The coupon rate is set at 4%, but investors require a 6% yield on similar bonds in the market. The difference between the amount received and the face or maturity amount is recorded in the corporation’s general ledger contra liability account Discount on Bonds Payable.
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It ensures compliance with accounting standards, provides transparency in financial reporting, and helps stakeholders make informed investment and lending decisions. Such discounts occur when the interest rate stated on a bond is below the market rate of interest and the investors consequently earn a higher effective interest rate than the stated interest rate. This $31,470 must be expensed over the life of the bond; uniformly spreading the $31,470 over 10 six-month periods produces periodic interest expense of $3,147 (not to be confused with the actual periodic cash payment of $4,000). Rational investors would not pay any more than the present value of these two future cash flows, discounted at the desired yield rate. This pivotal shift changed the simple promissory note into an agency for the expansion of the monetary supply itself. As these receipts were increasingly used in the money circulation system, depositors began to ask for multiple receipts to be made out in smaller, fixed denominations for use as money.
Discount on Bonds Payable is a contra liability account with a debit balance, which is contrary to the normal credit balance of its parent Bonds Payable liability account. Computing long-term bond prices involves finding present values using compound interest. Buyers and sellers negotiate a price that yields the going rate of interest for bonds of a particular risk class.
When a bond is issued at a premium, the carrying value is higher than the face value of the bond. When a bond is issued at a discount, the carrying value is less than the face value of the bond. When a bond is issued at par, the carrying value is equal to the face value of the bond. As the company decides to buyback bonds before maturity, so the carrying amount is different from par value. We need to calculate the carrying amount and compare it with the purchase price to calculate gain or lose. Company will pay a premium if they decide to buyback as the investor will lose some part of their interest income.
For the first interest payment, the interest expense is $469 ($9,377 carrying value × 10% market interest rate × 6/ 12 semiannual interest). The semiannual interest paid to bondholders on Dec. 31 is $450 ($10,000 maturity amount of bond × 9% coupon interest rate × 6/ 12 for semiannual payment). The $19 difference between the $469 interest expense and the $450 cash payment is the amount of the discount amortized. The entry on December 31 to record the interest payment using the effective interest method of amortizing interest is shown on the following page.
Discount on Bonds Payable serves as a liability on the issuer’s balance sheet and represents a future obligation to repay the bondholders. It is an important accounting measure that reflects the cost of borrowing for the issuer and is crucial for accurately assessing the company’s financial health. Proper accounting for this discount ensures that the issuer’s financial statements reflect the true cost of the debt and provide transparency for investors and creditors. When the bonds issue at premium or discount, there will be a different balance between par value and cash received. The difference is premium/discount on bonds payable, which will impact the bonds carrying value presented in the balance sheet.
Generally, a central bank or treasury is solely responsible within a state or currency union for the issue of banknotes. However, this is not always the case, and historically the paper currency of countries was often handled entirely by private banks. Thus, many different banks or institutions may have issued banknotes in a given country. Even bonds are issued at a premium or discounted, we need to calculate the carrying value and compare with the cash payment to calculate the gain or lose.
This entry records $5,000 received for the accrued interest as a debit to Cash and a credit to Bond Interest Payable. Accountants have devised a more precise approach to account for bond issues called the effective-interest method. Be aware that the more theoretically correct effective-interest method is actually the required method, except in those cases where the straight-line results do not differ materially. Effective-interest techniques are introduced in a following section of this chapter. Over the life of the bonds, the initial debit balance in Discount on Bonds Payable will decrease as it is amortized to Bond Interest Expense.
The very highest quality bonds are called “investment grade” and include debt issued by the U.S. government and very stable companies, like many utilities. Bonds that are not considered investment grade, but are not in default, are called “high yield” or “junk” bonds. These bonds have a higher risk of default in the future and investors demand a higher coupon payment to compensate them for that risk. A senior note is a type of bond that takes precedence over other debts in the event that the company declares bankruptcy and is forced into liquidation.
At maturity, the General Journal entry to record the principal repayment is shown in the entry that follows Table 4 . The investors want to earn a higher effective interest rate on these bonds, so they only pay understanding progressive tax $950,000 for the bonds. The $50,000 amount is recorded in a Discount on Bonds Payable contra liability account. Over time, the balance in this account is reduced as more of it is recognized as interest expense.
Discount on bonds payable is a contra account to bonds payable that decreases the value of the bonds and is subtracted from the bonds payable in the long‐term liability section of the balance sheet. Initially it is the difference between the cash received and the maturity value of the bond. The central government soon observed the economic advantages of printing paper money, issuing a monopoly right of several of the deposit shops to the issuance of these certificates of deposit. By the early 12th century, the amount of banknotes issued in a single year amounted to an annual rate of 26 million strings of cash coins.
