Various Types of Bonds and Their Characteristics
Bonds can be classified into secured bonds, unsecured bonds, convertible bonds, and Callable bonds. Secured bonds refer to bonds attached to the issuer’s asset ( Kieso, Weygandt & Kell, 2018 ). The assets are treated as the bond’s collateral such as a mortgage involving a real estate or bond security. Unsecured bonds also referred to as debenture bonds, are bonds issued against the borrower’s general credit. Covetable bonds refer to bonds that can be converted to common stock. Callable bonds are those that can be bought back at stated dollar before maturity by the issuing company.
Discussion and Examples of Bonds Being Issued at Par, At a Discount, and a Premium
The classification of a bond into discount or premium bond depends on its tradition potion I relation to its par value. The par value is the original fixed value for a bond at the start ( Boyd et al. 2014 ). A bond issued at a premium refers to a bond, in the secondary market, trading higher than its par value while a discount bond trades at values lower than the par value in the secondary market. For example, a bond’s initial price is $1000; the bond will sell at par value if it is sold at the fixed amount. The bond will be sold at premium and discount values if it is sold at a value higher or lower than the $1000 par value, respectively.
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Two Methods to Amortize the Bond Premium And Discount
The two primary methods to amortize bond premium and discount are the s traight-line method and effective interest rate method ( Warren, Reeve & Duchac, 2016; Joyner, 2018 ). According to the straight-line method, the amount of premium each year remains constant by dividing the amount above the par value by the amount of time. However, the effective rate differs in each period. The effective interest rate method has a constant rate but a different amount for each period.
Example Journal Entries for the Two Different Amortization Methods
Straight-line bond amortization journal entry for a premium bond
McGraw. Inc. issued 7% 3-year bonds. The bond is payable with a par value of 130,000 and semi-annual payments in return for cash of 132,204 representing a market rate of 6%
Premiums on bond payable = 132,204-130,000= 2204
| Account | Debit | Credit |
| cash | 132,204 | |
| Bonds payable | 130,000 | |
| Premiums on bonds payable | 2204 | |
| total | 132,204 | 132,204 |
Effective Interest Rate Method
J & J, Inc. issues a $500,000 bond payable in semi-annual payments for ten years. The stated bond rate is 6%, while the market rate is 12%, both semiannual.
Payment amount = $30,000 (500,000 x 0.06).
Table 1 amortization schedule for calculating bond interest expense for the first payment
Bond Amortization Schedule |
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|
1 |
2 |
3 |
4 |
5 |
||
Number of payments |
Payment date |
Amount |
Interest Expense |
Amortization |
Discount Unamortized |
Bond Carrying Value |
|
0 |
1/1/2013 |
169,506.69 | 330,493.31 | |||
Journal entry
Bond Payable Discount Payment |
||||
| January 1 | ||||
| Bond Interest Expense | 39,659.20 | |||
| -Bond Discount | 9,659.20 | |||
| -Cash | 30,000.00 | |||
| To record the semi-annual bond payment and amortize the discount | ||||
References
Boyd, K. et al. (2014). Accounting All-in-one for Dummies. John Wiley & Sons.
Joyner, D. T. (2018). How to Record Journal Entries Correctly for Bonds Issued at a Discount or a Premium? Hint: Follow the Money. American Journal of Business Education, 11 (4), 71-86.
Kieso, D. E., Weygandt, J. J., & Kell, W. G. (2018). Accounting Principles . John Wiley & Sons.
Warren, C., Reeve, J. M., & Duchac, J. (2016). Corporate Financial Accounting . Cengage learning
