How to Record an Accrued Bond Interest Expense on a Balance Sheet

A company records accrued bond interest expense on its balance sheet when it issues bonds to raise funds. The bonds may be issued at face value (the actual price of the bonds), at a discount (less than the face value) or at a premium (more than the face value). Recording the bond liability and the total associated accrued interest is handled differently in each of these situations.

Difficulty: Moderate

Instructions

1. Assume that company A sells 5-year bonds to an investor in the the amount of $100,000 at 10 percent interest. At the end of each year over the 5-year life of the bonds, company A will pay $10,000 (10 percent) to the investor. Record the bond in the Long Term Liability section of the balance sheet, because its maturity date is longer than one year. Debit Cash ($100,000) when the investor buys the bonds and credit Bonds Payable ($100,000). To record the accrued interest (a current liability because it is due within 1 year), debit Interest Expense ($10,000) and credit Accrued Interest Payable $10,000) in the Current Liability section of the balance sheet. When the interest is paid at the end of the year, debit Accrued Interest Payable ($10,000) and credit Cash ($10,000). Repeat the entries for accrued interest payable at the beginning of each subsequent year and the interest payment at the end of each subsequent year until the bonds' maturity date.

2. Consider the additional entries required if the the same bonds are sold at a 2 percent discount. This means the $100,000 bonds are actually sold to the investor for $98,000 ($100,000-$2,000). At the maturity date, the company will redeem the bonds for the full face value of $100,000. To record the sale of the bonds, debit Cash ($98,000) and credit Bonds Payable ($98,000) in the Long-Term Liability section of the balance sheet. To record the discount on the bonds, debit Bond Interest Expense ($2,000) and credit Bond Discount ($2,000) in the Long-Term Liability section of the balance sheet. This discount is additional interest expense and is allocated (amortized) over the life of the bond (5 years) at 1/5 of the total discount ($400) each year. To amortize the discount at the end of each year, debit Bond Discount ($400) and credit Bonds Payable ($400). At the bonds' maturity date, the Bonds Payable account will be $100,000, the amount due to the investor when company A redeems the bonds, and the Bond Discount account will be zero. Record the $10,000 annual interest as you did in Step 1.

3. Make different, additional entries if company A sells the same bonds at a 2 percent premium. This means the investor pays more than the $100,000 face value of the bonds. A 2 percent premium means the investor pays $102,000 for the bonds ($100,000 + $2,000 premium). To record the sale, debit Cash ($102,000) and credit Bonds Payable ($102,000). At the end of each year, 1/5 of the premium ($400) is deducted (amortized) from the Bonds Payable account. Debit Bonds Payable ($400) and credit Bond Interest Expense ($400). When the 5-year bonds mature, the Bonds Payable account will have a balance of $100,000, the amount due the investor when company A redeems the bonds. The premium is a reduction of interest expense. The $10,000 annual interest is recorded in the same way as in Step 1.