Since the corporation issuing a bond is required to pay interest,
and since the interest is paid on only two dates per year,
the interest on a bond will be accruing daily. This means for
each day that a bond is outstanding, the corporation will incur
one day of interest expense and will have a liability for the interest
it has incurred but has not paid. If the corporation has issued a 9%
$100,000 bond, then each day it will have interest expense of $24.66
($100,000 x 9% x 1/365).
If the corporation issues monthly financial statements, then each month
it needs to report $750 ($100,000 x 9% x 1/12) of interest expense.
The corporation usually does this with the following monthly
adjusting entry:
While the issuing corporation is incurring interest expense of $24.66 per day
on the 9% $100,000 bond, the bondholders will be earning interest revenue of $24.66
per day. With bondholders buying and selling their bond investments on any
given day, there needs to be a mechanism to compensate each bondholder for
the interest earned during the days a bond was held. The accepted technique is for
the buyer of a bond to pay the seller of the bond the amount of interest
that has accrued as of the date of the sale. For example, if a 9% $100,000
bond has a date of January 1, 2009 and it is sold on January 31, 2009, the
buyer of the bond is required to pay the seller of the bond one month’s
interest amounting to $750 ($100,000 x 9% x 1/12).
If a corporation issues a bond on January 1, 2009 and the
bond has a date of January 1, 2009 there will be no accrued
interest on the bond when it is issued. If the investor pays the corporation
the face amount of the bond, the bond is said to have been
issued at par or at 100—meaning 100% of the bond’s face value
plus any accrued interest. (As we will see later, it is possible
for a new bond to be issued after the date of the bond—and
therefore to have accrued interest. In addition a bond might
be sold by the issuing corporation for more or less than its face value.)
Let’s assume that on January 1, 2009 a corporation issues a 9% $100,000
bond at its face amount. The bond is dated January 1, 2009 and requires
interest payments on each June 30 and December 31 until the bond matures
at the end of 5 years. Each semiannual interest payment will be $4,500
($100,000 x 9% x 6/12). The corporation is also required to pay $100,000
of principal to the bondholders on the bond's maturity date of
December 31, 2013.
Since the bond was issued/sold for 100% of its face amount and since there
is no accrued interest to be paid by the buyer of the bond, the issuing
corporation will make the following journal entry:
The following timeline shows the future cash payments that the corporation must make to the
bondholders:
|
|
|
|
|
|
|
|
|
|
| Interest: |
$4,500 |
$4,500 |
$4,500 |
$4,500 |
|
$4,500 |
$4,500 |
|
| Principal: |
|
|
|
|
|
|
|
$100,000 |
|
|
|
|
|
|
|
..... |
|
|
|
|
←6 months→ |
←6 months→ |
←6 months→ |
←6 months→ |
|
|
|
←6 months→ |
|
| 01/01/09 |
06/30/09 |
12/31/09 |
06/30/10 |
12/31/10 |
|
6/30/13 |
12/31/13 |
|
| Period No. 0 |
1 |
2 |
3 |
4 |
|
9 |
10 |
|
|
Journal Entries for Interest Expense – Annual Financial Statements
If the corporation issuing the above bond has an accounting year ending on December 31,
the corporation will incur twelve months of interest expense in each of the years that
the bonds are outstanding. In other words, under the accrual basis of accounting,
this bond will require the issuing corporation to report Interest Expense of $9,000
($100,000 x 9%) per year.
If the corporation issues only annual financial statements, the interest expense can be
recorded at the time of its semiannual interest payments, as shown in the following journal
entries for the year 2009:
| Jun 30, 2009 |
Interest Expense |
4,500 |
|
| Dec 31, 2009 |
Interest Expense |
4,500 |
|
Journal Entries for Interest Expense – Monthly Financial Statements
If the corporation issues monthly financial statements, it must report
interest expense of $750 ($100,000 x 9% x 1/12) on each of its monthly income statements.
It must also report a current liability on its balance sheet for the amount of interest that it has
incurred but has not yet paid. This is accomplished by recording an accrual adjusting
entry at the end of each month. In addition there will be an entry on June 30 and
on December 31 for the required interest that was actually paid to the bondholders.
The 14 journal entries pertaining to the corporation’s bond interest during the
year 2009 will be:
| Jan 31, 2009 |
Interest Expense |
750 |
|
| Feb 28, 2009 |
Interest Expense |
750 |
|
| Mar 31, 2009 |
Interest Expense |
750 |
|
| Apr 30, 2009 |
Interest Expense |
750 |
|
| May 31, 2009 |
Interest Expense |
750 |
|
| Jun 30, 2009 |
Interest Expense |
750 |
|
| Jun 30, 2009 |
Interest Payable |
4,500 |
|
| Jul 31, 2009 |
Interest Expense |
750 |
|
| Aug 31, 2009 |
Interest Expense |
750 |
|
| Sep 30, 2009 |
Interest Expense |
750 |
|
| Oct 31, 2009 |
Interest Expense |
750 |
|
| Nov 30, 2009 |
Interest Expense |
750 |
|
| Dec 31, 2009 |
Interest Expense |
750 |
|
| Dec 31, 2009 |
Interest Payable |
4,500 |
|
The journal entries for the years 2010 through 2013 will have the same accounts and amounts.
|
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Part 8
Part 9
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