Issuing bonds: A bond arises from a contract known as a bond indenture and represents a promise to pay:
1) A sum of money at a designated maturity rate.
2) Periodic interest at a specified rate on the maturity amount (face value).




Cash (proceeds) ****
Discount or Premium (plug) *** or ***
Interest payable (Between Interest Dates) ***
Bonds Payable (Face Amount) ***




Proceeds: The interest rate written in terms of the bond indenture is known as the stated , coupon , or nominal rate ; is expressed as percentage of the face value called par value , principle amount , or maturity value of the bond.


Present value approach :
Present value of principle (lump sum) at yield rate.
+ Present value of interest (ordinary Annuity) at yield rate.


Sales price approach:

Sales price given as percentage of face amount
Multiplied by face to give proceeds amount


Interest: Bonds issued between Interests dates can be calculated as follows:
Face amount of bonds
*
Stated rate


*
Portion of the year since previous Interest date


*
= Interest rate
To illustrate the computation of the present value of a bond issue, consider service master which issues $ 100,000 in bonds due in 5 years with 9 % interest payable annually at year end. The market rate for such bonds is 11%. The following time diagram depicts both the interest and the principle
Cash flows:














Present value of the principle
$100,000 * 59345 $ 59,345.00
Present value of the interest payments:
$ 9,000 * 3, 69590 33,263.10
$92,608 present value (selling price) of the bonds




By paying 92,608. 10 at the date of issue, the investors will realize an effective rate yield 11% over the 5- year term of the bonds


Bonds issue at par on interest date: To illustrate , if 10- year term bonds with a bar value of $800,000 , dated January 1, 2001, and bearing interest at an annual rate of 10% payable semiannually on January 1 and July 1, are issued on January 1 at par , the entry on books of the issuing corporation would be :


Cash 800,000
Bonds payable 800,000


The entry to record the first semiannual interest payment of 40,000
($ 800,000* .10 * 1/2) on July 1, 2001, would be as follows;


Bond Interest Expense 40,000
Cash 40,000


The entry to record accrued interest payment at December 31, 2001 ( year – end ) would be as follows :


Bond Interest Expense 40,000
Bond Interest Payable 40,000


Bonds issued at Discount or premium on interest date:


If the $800,000 of bonds illustrated above were issued on January 1, 2001, at 97 (meaning 97% of par), the issuance would be recorded as follows:


Cash ($800,000 * .97) 776,000
Discount on bonds payable 24,000
Bonds Payable 800,000



Bond interest:
Effective Interest Method: under this method :
1) Bond interest expense is computed first by multiplying the carrying value of the bonds.

2) The bond discount or premium amortization is then determined by computing, comparing the bond interest to be paid.

Bond interest expense
Carrying value
Of at beginning of period * Effective
Interest rat

Subtract from it
Bond interest paid
Face Amount stated
Of bonds * interest rat

Equals:

Amortization
Amount




Interest expense Interest payable
Carrying value
* yield rate ( market rate)
* portion of year since
previous interest date
= interest expense Face amount
* stated rat ( contract rat)
* portion of year since
previous interest date
= interest payable
The Difference between Interest payable and Interest Expense Equals Amortization of discount or premium









Bonds issued at a discount:


Maturity value of bonds payable $ 100,000
Present value of $ 100,000 due in 5 years at 10% interest payable $61,391
) Semiannually fv ( pvf 10.5 % ) ( $ 100,000 * .61,391

Present value of $ 4,000 interest payable semiannually for 5 years at
10% annually R ( pvf-OA 10,5% ); ($ 4,000 * 7.72173 ) 30,887


Proceeds from sale of bonds 92,278


Discount on bonds payable $ 7,722








Schedule of bonds Discount Amortization
Effective Interest Method – Semiannual Interest Payments
5- year , 8 % Bonds sold to yield 10%
Interest Discount carrying amount Date cash
paid Expense Amortization of bonds
1/1/01 $ 92,278
7/1/01 $4,000 $4,614 $ 614 92,892
1/1/02 4,000 4,645 645 93,537
7/1/02 4,000 4,677 677 94,214
1/1/03 4,000 4,711 711 94,925
7/1/03 4,000 4,746 746 95,671
1/1/04 4,000 4,783 783 94,454
7/1/04 4,000 4,823 823 97,277
1/1/05 4,000 4,864 864 98,141
7/1/05 4,000 4,907 907 99,048
1/1/06 4,000 4,952 952 100,000
$ 40,000 $ 47,722 $7,722


$4,000= $ 100,000* .08 *6/12 $ 614=$4,614- $ 4,000
$ 4,614=$92,278 * .01* 6/12 $ 92,892=$92,278+ $614





The entry to record the issuance of Evermaster Corporation's bonds at a discount on January 1, 2001, is:

Cash 92,278
7,722 Discount on bonds payable
Bonds payable 100,000


The journal entry to record the first interest payment on July 1, 2001, and amortization of the discount is:


Bond interest expense 4,614
Discount on bonds payable 614
Cash 4,000


The journal entry to record the interest expense accrued at December31, 2001 and amortization of the discount is:

Bond interest expense 4,614
Bond interest payable 4,000
Discount on bonds payable 645




Bonds issued at premium: if the market were willing to accept an effective rate of 6% on the bond issue illustrated above, they have paid $ 108,530 or a premium of $ 8,530,
Computed as follows :

Maturity value of bonds payable $ 100,000
Present value of $ 100,000 due in 5 years
74,409 at 6%, interest payable semiannually (100,000*.74409)
present value of $4,000 interest payable semiannually for
5 years at 6%annually (4,000 *8.53020) 34,121
proceeds from sale of bonds 108,530
$8,530 s payable premium on bond


Note: $4000 = $ 100,000 * .08 *6/12 $744 = 4,000 – 3,256
$ 3,256 = $ 108,530 * .06 * 6/12 $ 107,786= $108,530 -$744




The entry to record the issuance of Evermaster bonds at a premium on January 1,
2001, is:


Cash 108,530
Premium on bonds payable 8,530
Bonds payable 100,000


The journal entry to record the first interest payment on July 1,2001 and amortization of the premium is :
Bond interest expense 3,256
Premium on bonds payable 744
Cash 4,000

















Straight – Line Method: under this method the amount amortized each year is a constant amount. For example using the:
Bond discount of $ 24000, the amount amortized to interest expense each year for 10 years is $ 2,400 ($ 24, 00/10), it can be recorded as follows:

Bond interest 2,400
Discount n bonds payable 2,400




Premium on bonds: if the 10 years bonds of a bar value of $ 800,000 are dated and sold on January 1, 2001, at 103, the following entry is made to record issuance:

Cash (800,000* 1.03) 824,000
Premium on bonds 24,000
Bonds 800,000


At the end of 2001 and for each year the bonds are outstanding, the entry to amortize the premium on a straight line method basis is:

Premium on bonds payable 2400
Bond interest expense 2400


Bond interest expense is increased by amortization of a discount and decreased by amortization of premium.

amortization Interest payable
Premium or discount
/ months in bonds term =
= amortization per month
interest dated
*
months since last interest date
= amortization Face Amount
*
stated amount
*
portion of year since
previous interest date
= interest payable



Interest expense = interest payable + amortization
-
+ Amortization of discount
- Amortization of premium












Accruing interest:


Interest expense ***
Bond premium or discount (amortization) ***
Cash or interest payable ***


Let's illustrate an example based on the schedule of bond discount amortization compensations, so if we report financial statements at the end of February 2001, in this case, the premium is prorated by the appropriate number of months to arrive at the proper interest expense as follows:


Interest accrual ($4,000* 2/5) $ 1,085.33
Premium amortized ( $744* 2/6) (248.00)
$ 1,0,85.33 Interest expense ( jan.- feb)




The journal entry to record this accrual is as follows:

Bond interest expense 1,085.33
Premium on bonds payable 248.00
Bond interest payable 1,333.33






Bond issue costs: it involves engraving and printing costs, legal and accounting fees, commissions, promotion costs, and other similar charges.


Recorded as asset:

- deferred charge
- Amortization (straight line) over term of bonds
- Not considered part of carrying value




Bond retirement:

Journal entry


Bond payable (face a amount) ****
Bond premium or discount (balance) ****
Extraordinary gain or loss (plug) ***
Bond issue costs (balance) ***
Cash (amount paid) ***