Bonds Payable is the promissory note which the company uses to raise funds from the investor. Company sells bonds to the investors and promise to pay the annual interest plus principal on the maturity date. It is the long term debt which issues by the company, government, and other entities. It must be classified as long-term liability unless it going to mature within a year.
In simple words, bonds are the contracts between lender and borrower, the amount of contract depends on the face value. However, the lender can receive the principal before the maturity date by selling contract to the capital market. The borrower will pay back the principal to whoever holds the contract on maturity date.
Bonds Payable usually equal to Bonds carry amount unless there is discounted or premium. Bonds Payable equal to bonds par value.
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.
This amount must be amortized over the life of bonds, it is the balancing figure between interest expense and interest paid to investors (Please see the example below). At the maturity date, bonds carry amount must be equal to bonds par value.
Bonds issue at par value mean that the issuer sell bonds to investors at par value. The money receive equal to bonds par value.
The issuer needs to recognize the financial liability when publishing bonds into the capital market and cash is received. The company has the obligation to pay interest and principal at the specific date. Bonds will be issued at par value when the coupon rate equal to market rate, there is no discount or premium on bond.
On 01 Jan 202X, Company A issue 6% bond at par value of $ 100,000. The bonds will be matured in 3 years. As the market rate is also 6%, so company can issue bonds at par value.
You may wonder why don’t we discount cash flow bonds value which will be paid at the end of 3 rd year. When the coupon rate equal to the effective interest rate, the present value of bond value and annual interest is equal to the par value.
Bonds Issue at discounted means that company sell bonds at a price which lower than par value. The company receive cash less than bond par value. Due to the market rate and coupon rate, company may issue the bonds with discount to the investor. Company will discount to attract investors when the coupon rate is lower than the market rate.
The discounted price is the total present value of total cash flow discounted at the market rate. The difference between cash receive and par value is recorded as discounted on bonds payable. This balance must be amortized over the term of bonds. The unamortized amount will be net off with bonds payable to present in the balance sheet.
On 01 Jan 202X, Company B issue 6%, bond with a par value of $ 100,000. The bond will be mature in 3 years and market rate is 8%. When the coupon rate is less than the effective interest rate, company must discount the bond to attract investors. How to calculate the bonds discounted price?
Bond price is the present value of future cash flow discount at market interest rate.
When coupon rate is lower than market rate, company must calculate the market price of bonds. They will use the present value of future cash flow with market rate to calculate the bond selling price. In order to attract investors, company needs to sell bond at $ 94,846 only.
The discount on Bonds Payable will be net off with Bonds Payble to show in the balance sheet. So it means company B only record 94,846 ($ 100,000 – $ 5,151) on the balance sheet.
Bonds issued at premium means the company sell bond at a price that is higher than par value. The company receives cash more than the bond par value. It happens as the bond coupon rate is higher than market rate, so investors will pay premium to enjoy higher return.
Company C issue 9%, 3 years bond when the market rate is only 8%, par value is $ 100,000. When the coupon rate is higher than effective interest rate, the company can sell bonds at a higher price. The company received cash of 105,154 which more than the bonds par value.
The price is arriving from the present value of all cash flow as following:
Bond price is calculated by total the present value of interest and bond principal.
The balance of premium on bonds payable will be included in bonds payable. So on the balance sheet, carry value is $ 102,577 which is the present value of cash flow.
At the end of the third year, premium bonds payable will be zero and the carrying amount of bonds payable will be $ 100,000. So the journal entry is debit bonds payable and credit cash paid to investors.
The company may decide to buyback bonds before the maturity date. 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.
Company will pay a premium if they decide to buyback as the investor will lose some part of their interest income. It will happen when the market rate is declining, company can access the fund with a lower interest rate, so they can retire the bond early to save interest expense.
As the company decides to buyback bonds before maturity, so the carrying amount is different from par value. It can be higher or lower than par value depend on each bond. We need to calculate the carrying amount and compare it with the purchase price to calculate gain or lose.
Continue from three examples above, assume all companies buyback the bonds at the end of second year. Here is the data which takes from three examples above. The purchase price is given below: