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Concept Version 10
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Bonds Issued at a Premium

When a bond is sold at a premium, the difference between the sales price and face value of the bond must be amortized over the bond's term.

Learning Objective

  • Explain how to record bonds issued at a premium


Key Points

    • When the bond is issued, the company must debit the cash by the amount that the business receives, credit a bond payable liability account by an amount equal to the face value of the bonds, and credit a bond premium account by the difference between the sale price and the bond's face value.
    • To calculate the amortization rate of the bond premium, a company generally divides the bond premium amount by the number of interest payments that will be made during the term of the bond.
    • When recording interest payments, the company credits cash by the amount paid to the bond holder, debits the bond premium account by the amortization rate, and debit interest expense for the difference between the amount paid in interest and the premium's amortization for the period.
    • When the bond reaches maturity, the company must pay the bondholder the face value of the bond, finish amortizing the premium, and pay any remaining interest obligations. When all the final journal entries are made, the bond premium and bond payable account must equal zero.

Term

  • amortize

    To wipe out (a debt, liability etc. ) gradually or in installments.


Example

    • Assume a business issues a 10-year bond that has an effective annual interest rate of 6%, with a face value of $100,000. This bond sells for $110,000. The resulting journal entry would be: Cash $110,000 Bond Payable $100,000The $10,000 premium would be divided by 10 annual interest payments. This would make the amortization rate of the bond's premium equal to $1,000 per year. The company must pay $6,000 in interest annually, so the company's annual interest expense equals $5,000. The resulting journal entry is: Bond Interest Expense $5,000 Bond Premium $1,000 Cash $6,000When the bond reaches maturity, the company must pay the bondholder the face value of the bond, finish amortizing the premium, and pay any remaining interest obligations. In this example, the final journal entries will be: Bond Interest Expense $5,000 Bond Premium $1,000 Cash $6,000 Bond Payable $100,000 Cash $100,000

Full Text

When a bond is issued at a premium, that means that the bond is sold for an amount greater than the bond's face value. This generally means that the bond's contract rate is greater than the market rate. Like with a bond that is sold at a discount, the difference between the bond's face value and sales price must be amortized over the term of the bond. However, unlike with a bond sold at a discount, the process of amortizing the premium will decrease the bond's interest expense recorded on the issuing company's financial records. The issuing company will still be required to pay the bondholder the interest payments guaranteed by the bond.

Amortization Schedule

An example of an amortization schedule of a $100,000 loan over the first two years.

Bond Issue

When the bond is issued, the company must debit the cash account by the amount that the business receives for the bond sale. A liability, titled "bond payable," must be created and credited by an amount equal to the face value of the issued bonds. The difference between the cash from the bond sale and the face value of the bond must be credited to a bond premium account.

For example, assume a business issues a 10-year bond that pays 6% interest annually, with a face value of $100,000. This bond sells for $110,000. The resulting journal entry would be:

Cash - $110,000

Bond Payable - $100,000

Bond Premium - $100,000

Interest Payments on the Bond

When the business pays interest, it must also amortize the bond premium at that time. To calculate the amortization rate of the bond premium, a company generally divides the bond premium amount by the number of interest payments that will be made during the term of the bond. Every time interest is paid, the company must credit cash for the interest amount paid to the bond holder. The company must debit the bond premium account by the amortization rate. The difference between the amount paid in interest and the premium's amortization for the period is the interest expense for that period.

Using the example from above, the $10,000 premium would be divided by 10 annual interest payments. This would make the amortization rate of the bond's premium equal to $1,000 per year. The company must pay $6,000 in interest annually, so the company's annual interest expense equals $5,000. The resulting journal entry is:

Bond Interest Expense - $5,000

Bond Premium - $1,000

Cash - $6,000

Bond Reaches Maturity

When the bond reaches maturity, the company must pay the bondholder the face value of the bond, finish amortizing the premium, and pay any remaining interest obligations. When all the final journal entries are made, the bond premium and bond payable account must equal zero.

Using the example, this is what the final journal entries must look like:

Bond Interest Expense - $5,000

Bond Premium - $1,000

Cash - $6,000

Bond Payable - $100,000

Cash - $100,000

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