The names BOND...
No, not James Bond.
Now sit back, relax, grab a popcorn and let's get started.
To fully grasp the concept of Bonds Payable, you need to be COMPLETELY CLEAR on what a bond is.
Put simply, a Bond is a type of Loan.
In life, you might be used to people borrowing money from Credit institutions and Banks.
But, a Bond works in Reverse!
With a Bond, Institutions such a Corporations and Governments borrow money from people.
Why do these Institutions need your money you ask?
Because, just like us, Governments and Corporations have expenses too...and big ones.
Governments need money to build roads, bridges, other infrastructure and so on...
Corporations need money to purchase Plant and Equipment, for Research and development and so on...
And, one of the ways they raise funds for these projects is by borrowing money from normal folk - the public - like you and me.
Now, because the money these Institutions need is usually a lot.
The money is borrowed in bite-sized pieces from MANY willing individuals (Typically, thousands).
Individuals are willing to lend the money NOW because they will have the right to earn INTEREST on the money they have given for years into the future.
The Contract that holds this deal in place is called a BOND.
(Well, If you wanna get really technical about it - the exact agreement is called a BOND INDENTURE).
The interest rate that the Institution will pay on the Bond is called the COUPON RATE.
The Interest is usually paid back in a series of payments over several years (usually, semi-annually) and is called the Yield or a Coupon payment.
The Institution borrowing the money and issuing the bond is usually called the BOND ISSUER.
The Investors giving the money are called the BONDHOLDERs.
Now, the Bond world can get quite complex with its own lingo and fancy terms like Face Value, Yield to Maturity, Coupon Yields amongst many others (Not for the faint of heart!)
For our purposes, i.e., to understand Bonds Payable and get your feet wet in the Bond world, the above info is enough.
Now, when an Institution wants to sell Bonds and raise money - They assign what is called a PAR VALUE to each Bond (Also called Face Value).
The Par value of most bonds is usually a $1,000.
Based on what the market thinks that Bonds are worth - Bonds are issued at
Amongst other factors, such as if how risky the institution wanting to borrow the money is, the primary deciding factor on whether a bond is sold at Premium, Discount or Par is the Coupon Rate on the Bond and the prevailing interest rate on already available bonds in the market.
Let me explain.
If the Coupon Rate on the New Bond is 6% and prevailing Market Rates are approx 4% - Potential Buyers of the Bond would be willing to pay more for this bond and it is gonna sell at a Premium.
On the flip side, if the coupon rate on the Bonds is 4% and the prevailing market rates are 6% - the bond will likely sell at a discount.
When a company issues the Bond - there are two sides to the coin.
You have the company, which is now the BOND ISSUER and has borrowed the money.
And you have Investors - The ones who have bought the Bonds - The BOND HOLDERS.
Since the company now OWES this money to the Investors, they have created a LIABILITY on their books.
The amount of this Liability will now be found in Company Balance Sheet and is called BONDS PAYABLE.
Bonds payable with terms exceeding one year are classified as long-term liabilities and the portion of the bonds payable which fall due within 12 months of the balance sheet date are be classified as current liabilities.
Overall, to a business, bonds payable represents a series of regular interest payments together with a final principal repayment at the maturity date.
Since Bonds are sold at Par when the Coupon Rate and the Market Rates are the same, the journal entry would be
Cash A/c Debit A Dollars
Bonds Payable A/c Credit A Dollars
For Semi-annual interest payments, the journal entry would be recorded as
Interest Expense Debit Y Dollars
Cash A/c Credit Y Dollars
Where matters get a bit complex is that Bonds are sold at a premium or a discount.
If the coupon rate on the bond is higher than the market interest rate, the bonds are issued at a price higher than the face value, i.e., at a premium.
The Journal Entry for this would be
Cash A/c Dr. A + B Dollars
Bonds Payable A/c Cr. A Dollars Bond Premium A/c Cr. B Dollars
The premium on bonds payable is a contra account that increases its value and is added to bonds payable in the long‐term liability section of the balance sheet.
Similarly, if the coupon rate is lower than the market interest rate, the bonds are issued at a discount i.e., Bonds sold at a discount result in a company receiving less cash than the face value of the bonds.
The Journal Entry for this would be
Cash A/c Debit B Dollars
Discount on Bonds Payable A/c Debit A - B Dollars Bonds Payable A/c Credit A Dollars
Upon maturity of the Bond, the principal repayment is recorded as follows:
Bonds Payable A/c Debit A Dollars
Cash A/c Credit A Dollars
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