Bond Valuation
A business must record a liability in its records when it issues a series of bonds. The value of the liability the business will record must equal the amount of money or goods it receives when it issues the bond. Whether the amount the business will receive equals its face value depends on the difference between the bond's contract rate and the market rate of interest at the time the bond is issued .
Balance Sheet
A bond issued by a company is recorded as a liability on its balance sheet.
The bond's contract rate is another term for the bond's coupon rate. It is what the issuing company uses to calculate what it must pay in interest on the bond. The market rate is what other bonds that have a similar risk pay in interest.
Regardless of what the contract and market rates are, the business must always report a bond payable liability equal to the face value of the bonds issued. If the market rate is greater than the coupon rate, the bonds will probably be sold for an amount less than the bonds' face value and the business will have to report a "bond discount. " The value of the bond discount will be the difference between what the bonds' face value and what the business received when it sold the bonds. If the market rate is less than the coupon rate, the bonds will probably be sold for an amount greater than the bonds' value. The business will then need to record a "bond premium" for the difference between the amount of cash the business received and the bonds' face value.
Calculating the Premium and Discount
If the market and coupon rates differ, the issuing company must calculate the present value of the bond to determine what price to charge when it sells the security on the open market. The present value of a bond is composed of two components; the principal and the interest payments. The discount rate for both the principal and interest payment components is the market rate when the bond was issued.