Preparing to Close Out a Business’s Journals
How Business Investors Look Beyond Financial Reports
Building Blocks of a Bookkeeping System

How to Account for Discounted Bonds

A bond discount is relevant when a bond issues at less than face value. How do you account for the transaction in the following example? The figure shows how to calculate the discount on bonds payable.

  • A company issues a $100,000 bond due in four years paying 7 percent interest annually at year end. So that’s $7,000 interest expense per year ($100,000 x .07).

  • Market rate for similar bonds is 11 percent. You have to use two tables to figure this one out. Use the present value of 1 table for the bond face value factor (.65873) and the present value of an annuity for the interest payment factor (3.10245).

  • The present value of the bond is $65,873 ($100,000 x .65873). The present value of the interest payments is $21,717 ($7,000 x 3.10245).

    image0.jpg

The journal entry to record this transaction is to debit cash for $87,590 and debit discount on bonds payable for $12,410. The credit is to bonds payable for $100,000 ($87,590 + $12,410).

Now, what about the interest expense and amortization of the bond discount? Going back to the facts, this bond pays $7,000 ($100,000 x .07) interest annually at year end. So that’s $7,000 interest expense per year. And remember, the effective interest rate is 11 percent.

Here is the schedule of bond discount amortization for this issuance.

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The journal entry to record Year 1 is to debit interest expense for $9,635. The credits go to discount on bonds payable for $2,635 and cash for $7,000.

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