Bonds Issued at Par with Accrued Interest
If a corporation has prepared a bond with a date of January 1, 2016 but delays issuing the bond until February 1, the investors buying the bonds on February 1 will have to pay the issuing corporation one month of accrued interest. (The delay may have been caused by a turbulent financial market or some other situation.)
Let's illustrate this scenario with a corporation preparing to issue a 9% $100,000 bond dated January 1, 2016. The bond will mature in 5 years and requires interest payments on June 30 and December 31 of each year until December 31, 2020. The bond is issued on February 1 at its par value plus accrued interest.
Since the bond was sold to investors at par, the issuing corporation will receive 100% of the bond's face value plus one month of accrued interest. The accrued interest amounts to $750 ($100,000 x 9% x 1/12). In total the issuing corporation will receive $100,750. The journal entry for this transaction is:
Note that the total amount received is debited to the Cash account and the bond's face amount is credited to Bonds Payable. The $750 received by the corporation for the accrued interest is credited to Interest Payable. The corporation is receiving the $750 because the corporation is required to pay the bondholders $4,500 ($100,000 x 9% x 6/12) on June 30. The difference between the $4,500 paid on June 30 and the $750 received on February 1, 2016 is $3,750—equal to five months of interest for the months of February through June: $100,000 x 9% x 5/12.
Journal Entries for Interest Expense - Annual Financial Statements
If a corporation that is planning to issue a bond dated January 1, 2016 delays issuing the bond until February 1, the corporation will not have interest expense during January. Assuming the corporation has an accounting year that ends on December 31, it will have eleven months of interest expense during the year 2016. During each of the subsequent years 2017, 2018, 2019, and 2020 the corporation will have twelve months of interest expense equal to $9,000 ($100,000 x 9% x 12/12).
If the corporation issues only annual financial statements, its journal entries for its interest payments during the year 2016 will be:
Note that the total amount of interest expense in 2016 will be $8,250 ($3,750 recorded on June 30 + $4,500 recorded on December 31). This amount of interest expense for February 1 through December 31, 2016 is confirmed by the following calculation: $100,000 x 9% x 11/12 = $8,250.
In the year 2017, the journal entries will be:
In the year 2017, the interest expense will be $9,000 ($4,500 + $4,500 = $9,000; or $100,000 x 9% = $9,000) because the bond will be outstanding for a full year. The entries will be similar for the years 2018, 2019, and 2020.
Journal Entries for Interest Expense - Monthly Financial Statements
If monthly financial statements are issued by the corporation, the following journal entries are needed in the year 2016 (including the entry when the bonds were issued on February 1, 2016):
Note that in 2016 the corporation's entries included 11 monthly adjusting entries to accrue $750 of interest expense plus the June 30 and December 31 entries to record the semiannual interest payments. As a result of these journal entries, each monthly income statement will report one month of interest expense and the balance sheet will report a current liability for the amount of interest incurred by the corporation but not yet paid to the bondholders.
In each of the years 2017 through 2020 there will be 12 monthly entries of $750 each plus the June 30 and December 31 entries for the $4,500 interest payments.