Bonds Payable
Bonds payable are a type of long term debt issued by businesses and governments for immediate cash needs. Unlike stocks, bonds have a fixed maturity date at some point in the future, with interest paid out on a frequent basis as per a formalized agreement. For businesses, issuing bonds is considered advantageous over stock because it does not indicate ownership in a company, preserving current company stock ownership. Bond interest can also be deducted on income taxes, unlike stock dividends. Finally, bonds are less expensive than stocks.
Download Our Free Brochure →However, bonds are still vulnerable to market changes such as fluctuations in market interest rates and the financial standing of the business which issued the bonds. If a bond’s interest rate is higher than the market interest rate, the bond has a positive value. If a bond’s interest rate is lower than the market interest rate, the bond has a negative value. The true market value and interest rate of a bond is calculated using present value calculations. These calculations deduct the market interest rates of a bond by the principal and interest rates established for the bond, or what it will be worth in the future.
Bond interest typically occurs on a semiannual or six month basis. Interest payments are calculated by multiplying the face amount of a bond by the established annual interest rate and multiplying that amount by 1/2.
If a business issues bonds, this information must be incorporated into monthly financial statements. Though interest is paid twice a year, it accrues interest on a daily basis and must be accounted for on monthly income statements. Incurred interest expense is debited and interest payable is credited. The interest expense is calculated as a daily fraction, or 1/365 of the interest expense which will be paid for that year. Interest expenses are tallied on a regular basis due to bondholders often buying and selling previously issued bonds. When buying or selling, the accrued interest and value of the bond must be considered. When interest is paid, interest expense is debited the interest amount and cash is credited the interest amount.
If a bond is given a starting date at a certain point, but is sold at a later date, the buyer must pay for the bond as well as whatever interest accrued during that time. Bonds which have a value higher than the market rate are known as premium bonds. Premiums on a bond must be reported on financial statements as a debit. For the sake of amortization, a premium bond is reduced over the course of its life and recorded in increments on income statements as a debit. At the end of an accounting year, a bond’s premium and interest are accumulated in an interest expense account.
Bonds which are sold at an interest lower than the market rate are known as discount bonds. The discrepancy between the interest rate of the bond issued and of the higher market value is debited on financial statements and is a contra liability account. For the sake of amortization, a discount bond is reduced over the course of its life and recorded in increments on income statements as a credit. At the end of an accounting year, the discount on a bond and any accumulated interest is compiled in an interest expense account. As the discount becomes accounted for, the book value of the bond will correspondingly increase.
