13 3 Prepare Journal Entries to Reflect the Life Cycle of Bonds Principles of Accounting, Volume 1: Financial Accounting

XYZ Inc. issues several bonds with a 10-year life span, and it costs $50,000 to do so. XYZ Inc. capitalizes the costs by debiting the bond issuance costs account and credits the cash account. For the next ten years, XYZ Inc. charges $5,000 to expense by debiting the bond issuance expense account and crediting the bond issuance costs account. With either of the above two options, the company incurs costs such as legal fees, printing expenses, and possibly underwriting and registration fees. The interest expense is calculated by taking the Carrying Value ($100,000) multiplied by the market interest rate (5%).

Always consult with a certified accountant or auditor to ensure the accounting treatment meets the most recent and relevant accounting standards. At the end of 5 years, the company will retire the bonds by paying the amount owed. To record this action, the company would debit Bonds Payable and credit Cash. Remember that the bond payable retirement debit https://accounting-services.net/callable-bond-definition/ entry will always be the face amount of the bonds since, when the bond matures, any discount or premium will have been completely amortized. At some point, a company will need to record bond retirement, when the company pays the obligation. For example, earlier we demonstrated the issuance of a five-year bond, along with its first two interest payments.

Accounting for debt issuance costs

(1996), “Optimal debt structure and the number of creditors”, Journal of Political Economy, Vol. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. He is the sole author of all the materials on AccountingCoach.com.

If the amount is material, or if a greater degree of accuracy is desired, calculate the periodic amortization using the effective interest method. Because of the time lag caused by underwriting, it is not unusual for the market rate of the bond to be different from the stated interest rate. The difference in the stated rate and the market rate determine the accounting treatment of the transactions involving bonds. When the bond is issued at par, the accounting treatment is simplest. It becomes more complicated when the stated rate and the market rate differ.

How to account for bond issue costs

You must also determine the amount of time that has passed since the bond’s issuance plus how much of the premium or discount has amortized. A bond with an interest rate equal to current market rates sells at par. If current market rates are lower than an outstanding bond’s interest rate, the bond will sell at a premium. If current market rates are higher than an outstanding bond’s interest rate, the bond will sell at a discount.

In summary, the results suggest that the implications of shifts in bond demand differ greatly across firms. On the one hand, increases in bond demand can ease financing frictions for very constrained firms. On the other hand, they may bond issue costs also exacerbate free cash flow problems for mildly constrained firms. Finally, while mildly constrained firms mostly use the funding to increase their investment, unlike other firms they experience a negative stock price reaction.