The excess amount by which bonds are issued over their face value is known as premium on bonds payable. This is recorded as a liability on the issuer’s books and is amortized to interest expense throughout the bonds’ remaining life. This amortization has the net effect of lowering the amount of interest expenditure associated with the bonds.
When the market interest rate is lower than the bond’s stated interest rate, a premium is paid. Investors are willing to pay more for the bond in this situation, resulting in a premium. They will pay a higher interest rate in order to achieve an effective interest rate that is comparable to the market rate.
What type of account is the bond premium payable?
A liability account with a credit balance for bonds payable that were issued at a price higher than their face or maturity value. The premium on payable bonds is deducted from interest expenditure over the bonds’ term, resulting in a reduction in interest expense. See Explanation of Bonds Payable for further information.
Premium on bonds payable quizlet is what type of account?
A bond issued at a price higher than its face (par) value is known as a premium, whereas a bond issued at a price lower than its face (par) value is known as a discount. The credit balance on Premium on Bonds Payable is positive, while the debit amount on Discount on Bonds Payable is negative.
What is a premium on bonds payable account, and what is its normal balance?
The premium paid on the bonds payable account will be amortized during the life of the bond. It has a credit balance by default. The carrying amount is calculated after deducting the premium on the bonds payable account.
How do you keep track of bond premiums?
When a company prepares to issue or sell a bond to investors, it may assume that the proper interest rate will be 9%. The bond will sell for its face value if investors are ready to accept the 9% interest rate. If the market interest rate at the time the bond is issued is less than 9%, the corporation will receive more than the bond’s face value. The premium on bonds due, bond premium, or premium is the amount received for the bond that is in excess of the bond’s face amount (excluding accumulated interest).
Let’s pretend that a firm issued a $100,000 bond in early December 2019 with a stated interest rate of 9%. (9 percent per year). The bond was issued on January 1, 2020, and it will mature on December 31, 2024. The bond’s interest is paid twice a year, on June 30 and December 31. This means the corporation will be compelled to pay $4,500 in interest every six months ($100,000 x 9% x 6/12).
Let’s pretend that the market interest rate for this bond decreases to 8% right before it is sold on January 1st. Instead of altering the bond’s stated interest rate to 8%, the firm decides to issue a 9% bond on January 1, 2020. The corporation will receive more than the bond’s face value because this 9% bond will be sold when the market interest rate is 8%.
Assume that this 9% bond, issued in an 8% market, will sell for $104,100 + $0 in interest. On January 1, 2020, the corporation’s journal entry to reflect the bond’s issuance will be:
Premium on Bonds Payable is a liability account that will always appear alongside Bonds Payable on the balance sheet. To put it another way, if the bonds are a long-term obligation, both Bonds Payable and Premium on Bonds Payable will be long-term liabilities on the balance sheet. The book value, also known as the carrying value of the bonds, is the sum of these two accounts. This bond’s book value is $104,100 as of January 1, 2020 ($100,000 credit balance in Bonds Payable + $4,100 credit balance in Premium on Bonds Payable).
Premium on Bonds Payable with Straight-Line Amortization
The balance in the account Premium on Bonds Payable must be lowered to zero over the life of the bond. The bond premium of $4,100 in our case must be decreased to $0 over the bond’s 5-year term. The bond’s book value will drop from $104,100 on January 1, 2020 to $100,000 when the bonds mature on December 31, 2024 if the bond premium is reduced to zero. Amortization is the process of reducing the bond premium in a rational and systematic manner.
The corporation got a bond premium of $4,100 since its interest payments to bondholders will be higher than the amount demanded by market interest rates. As a result, the account Interest Expense will be used to amortize the bond premium. During the life of the bond, there must be a credit to Interest Expense and a debit to Premium on Bonds Payable at each accounting period. The straight-line method of amortization will be demonstrated in this section. (We’ll show you how to use the effective interest rate method in Part 10.)
Straight-Line Amortization of Bond Premium on Annual Financial Statements
The amortization of the bond premium can be recorded once a year if a firm only produces yearly financial statements and its accounting year ends on December 31. The annual straight-line amortization of the bond premium for a 9% $100,000 bond issued for $104,100 and due in 5 years will be $820 ($4,100 divided by 5 years).
When a company only publishes annual financial statements, however, the amortization of the bond premium is frequently recognized when the company makes semiannual interest payments. On June 30 and December 31, the journal entries will be as follows:
The net sum of $8,180 comes from the interest payments and bond amortization ($4,500 of interest paid on June 30 + $4,500 of interest paid on December 31 minus $410 of amortization on June 30 and minus $410 of amortization on December 31). This $8,180 will be reported in the Interest Expense account for the year 2020, as shown in the T-account below:
Under the straight-line technique of amortization, the balance in the account Premium on Bonds Payable will decline over the 5-year life of the bonds as shown in the T-account below.
The following table illustrates how the bond’s book value will decline from $104,100 to $100,000 at maturity:
Straight-Line Amortization of Bond Premium on Monthly Financial Statements
If monthly financial statements are published, the bond premium will be amortized at a rate of $68.33 per month ($4,100 of bond premium divided by 60 months of bond life). The 12 monthly amortization entries, as well as the semiannual interest payments of June 30 and December 31, are listed below for the year 2020:
If all of the bonds remain outstanding, the journal entries for the years 2021 through 2024 will be comparable.
On the balance sheet, where does the premium on bonds payable go?
Premium on bonds payable is a counter account that enhances the value of bonds payable and is added to bonds payable in the long-term liabilities area of the balance sheet.
Is the premium on bonds payable taken from the balance sheet’s bonds payable?
C. A premium on bonds payable is deducted from the bonds payable amount and shown on the balance sheet with long-term liabilities. B. A premium on bonds payable is added to the bonds payable balance and presented on the balance sheet with stockholders’ equity.
AccountDebitCreditCash100,000Financial Liability-Bonds100,000AccountDebitCreditCash100,000AccountDebitCreditCash100,000AccountDebitCreditCash100,000Account
You might question why we don’t discount the value of cash flow bonds that will be paid at the end of the third year. The present value ledger record of bond value and annual interest equals the par value when the coupon rate equals the effective interest rate. A credit to cash account for the amount of interest expenditure and a credit to discount on bonds payable for the amount of amortization are also available for a discount.
When bonds are issued at a premium, is the face amount credited to the bonds payable account?
When bonds are sold at a discount, the face amount is applied to the bonds payable account. A debenture bond is a type of mortgage bond. The process of approximating interest rates is known as imputation, and the resultant interest rate is known as an imputed interest rate.
Is the discount on payable bonds a counter account?
For example, if a corporation issues $100,000 in bonds that are receivable for $97,000, the bonds will be issued at a 3% discount rate. A $97,000 debit to Cash, a $100,000 credit to Bonds Payable, and a $3,000 debit to Discount on Bonds Payable will be included in the company’s entry. Because it is a liability account with a debit balance, the Discount on Bonds Payable account is a contra account.
When a company reports a bond payable as a liability on its balance sheet, what should it do?
Because the bonds’ maturity date is more than a year away, they are reported in the long-term liabilities area of the balance sheet. Because the bond interest payable is due within the next year, it is considered as a current liability.