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

2024
Views:

454

Pages:

3
Author:

stud_ice13

Bond Discounts and Premiums Key Terms: • • Contract Rate (Coupon Rate): The stated interest rate on the bond, used to calculate periodic cash payments to bondholders. Market Rate: The interest rate prevailing in the market at the time of bond issuance, reflecting the risk and return expectations of investors. Pricing Bonds at Discount or Premium: 1. At Par: If the contract rate equals the market rate, the bond sells at par value. 2. At a Discount: If the contract rate is lower than the market rate, the bond sells for less than par value. 3. At a Premium: If the contract rate is higher than the market rate, the bond sells for more than par value. Example of Issuing Bonds at a Discount Suppose a company issues $7,000, 8% bonds on December 31, 2021, maturing in 2 years with semiannual interest payments. The market rate is 10%, resulting in a selling price of 96.46% of par value or $6,752. The discount on the bond is the difference between par value ($7,000) and the issue price ($6,752), which is $248. Amortization Table Using the Straight-Line Method Step 1: Calculate the Interest Payment and Amortization Interest Payment: Par Value×Contract Rate×12 Par Value×Contract Rate×21 =7,000×8%×12=280 Total Discount: Par Value−Issue Price=7,000−6,752=248 Amortization of Discount: Divide the discount by the number of periods (4 periods for a 2-year bond with semiannual payments). Amortization per Period=2484=62 5. Step 2: Amortization Table 1. 2. 3. 4. Date Interest Payment 12/31/2021 06/30/2022 $280 12/31/2022 $280 06/30/2023 $280 12/31/2023 $280 Discount Amortization $62 $62 $62 $62 Total Interest Expense $342 $342 $342 $342 Carrying Value $6,752 $6,814 $6,876 $6,938 $7,000 Journal Entries (a) Issuance of Bonds on December 31, 2021 To record the issuance at a discount: plaintext Cash 6,752 Discount on Bonds Payable 248 Bonds Payable 7,000 (b) Interest Payments and Discount Amortization (Straight-Line Method) For each semiannual period, record interest expense and amortization of the discount: First Payment - June 30, 2022 plaintext Interest Expense 342 Discount on Bonds Payable Cash 62 280 Second Payment - December 31, 2022 plaintext Interest Expense 342 Discount on Bonds Payable Cash 62 280 Third Payment - June 30, 2023 plaintext Interest Expense 342 Discount on Bonds Payable Cash Fourth Payment - December 31, 2023 plaintext Interest Expense 342 62 280 Discount on Bonds Payable Cash 62 280 (c) Maturity of the Bonds on December 31, 2023 To record repayment of the par value: plaintext Bonds Payable Cash 7,000 7,000 Summary of Bond Discount Amortization • • Each period, the discount on bonds payable is reduced by $62, which increases the bond’s carrying value. By the bond's maturity, the carrying value equals the par value, reflecting full repayment. This straight-line approach is commonly used for simplicity and is allowed under GAAP when results are similar to effective interest amortization.