University:
Grand Rapids Community College
Course:
Financial and Managerial Accounting: Information for Decisions - John J. Wild
Academic year:

2024
Views:

488

Pages:

3
Author:

stud_ice13

Understanding Premium Bonds When bonds are issued at a premium, the contract rate of interest is higher than the market rate, resulting in a sale price above par value. The premium represents the extra amount received by the issuer at issuance and will be amortized over the bond’s life, reducing the bond interest expense in each period. Example: Issuing Bonds at a Premium Suppose a company issues $7,000 par value, 8% bonds on December 31, 2021, with a market rate of 6%. These bonds have a two-year life with semiannual interest payments. The bonds sell at 103.71% of par value or $7,260. Here: • The premium is the difference between the issue price ($7,260) and par value ($7,000), which is $260. Amortization of Premium Bonds Using the Straight-Line Method Step 1: Calculate Interest Payment and Premium Amortization 1. Semiannual Interest Payment: Par Value×Contract Rate×12=7,000×8%×12=280 Total Premium: Issue Price−Par Value=7,260−7,000=260 Amortization of Premium per Period: Divide the premium by the number of periods (4 semiannual periods). Amortization per Period=2604=65 Step 2: Amortization Table Date Interest Payment 12/31/2021 06/30/2022 $280 12/31/2022 $280 06/30/2023 $280 12/31/2023 $280 Premium Amortization $65 $65 $65 $65 Journal Entries (a) Issuance of Bonds on December 31, 2021 Total Interest Expense $215 $215 $215 $215 Carrying Value $7,260 $7,195 $7,130 $7,065 $7,000 To record the issuance at a premium: plaintext Cash 7,260 Bonds Payable Premium on Bonds Payable 7,000 260 (b) Interest Payments and Premium Amortization (Straight-Line Method) Each semiannual period, record the interest payment, premium amortization, and adjusted bond interest expense: First Payment - June 30, 2022 plaintext Interest Expense 215 Premium on Bonds Payable 65 Cash 280 Second Payment - December 31, 2022 plaintext Interest Expense 215 Premium on Bonds Payable 65 Cash 280 Third Payment - June 30, 2023 plaintext Interest Expense 215 Premium on Bonds Payable 65 Cash 280 Fourth Payment - December 31, 2023 plaintext Interest Expense 215 Premium on Bonds Payable 65 Cash 280 (c) Maturity of the Bonds on December 31, 2023 To record repayment of the par value at maturity: plaintext Bonds Payable Cash 7,000 7,000 Summary of Premium Bond Amortization • • Each period, the premium on bonds payable is reduced by $65, decreasing the bond’s carrying value. By maturity, the carrying value equals the par value, as the premium is fully amortized. This process helps ensure the issuer's bond interest expense is aligned with the market rate across the bond’s life, while meeting the GAAP straight-line amortization requirements.