Bonds payable journal entries, step by step

When a business needs to borrow a large amount for many years, it can issue bonds instead of taking out one big loan. Investors buy the bonds, the business gets their cash, and in return it promises to pay interest regularly and repay the face value at the end. This page explains the vocabulary, records bonds issued at par, at a discount and at a premium, walks through the first interest payment with straight-line amortization, and covers the mistakes our exercises catch.

The words you need

• Face value (also par value or principal) is the amount the business will repay when the bonds mature. It is printed on the bond.
• Stated rate (also coupon rate or contract rate) is the annual interest rate printed on the bond. Cash interest is always face value × stated rate, whatever price the bonds sold for.
• Term is how long until the bonds mature, for example 10 years.
• Interest periods: many bonds pay interest every six months, so a 10-year bond has 20 interest periods and each payment is half a year's interest.
• Price is quoted as a percentage of face value. "At 100" means 100% of face value; "at 96" means 96%; "at 105" means 105%.

The price depends on how the stated rate compares with the rate investors want at the time of sale, often called the market rate. If the two match, the bonds sell at face value. If investors want more than the stated rate, they pay less than face value, and the shortfall makes up the difference. If the stated rate is more generous than they need, they pay more.

Three ways bonds can be issued

In every case, Bonds Payable is recorded at face value, because that is what the business will repay. The difference between cash and face value goes to a separate account that sits next to Bonds Payable on the balance sheet.

Worked example 1: bonds issued at par

Harbor Bakery issued $200,000.00 of 20-year, 7% bonds that pay interest every six months, at 100 (par), for cash.

At par, cash received equals face value: $200,000.00 × 100 ÷ 100 = $200,000.00. The business has more cash and owes the bondholders, which is a long-term liability:

Each six-monthly interest payment on these bonds will be $200,000.00 × 7% ÷ 2 = $7,000.00 (my calculation), recorded as a debit to Interest Expense and a credit to Cash. With no discount or premium there is nothing to amortize, so interest expense equals the cash paid.

Worked example 2: bonds issued at a discount

Harbor Bakery issued $750,000.00 of 8-year, 4% bonds that pay interest every six months, at 96, for cash.

Cash received = $750,000.00 × 96 ÷ 100 = $720,000.00

Discount = $750,000.00 − $720,000.00 = $30,000.00

Discount on Bonds Payable is a contra liability: it has a debit balance and is subtracted from Bonds Payable on the balance sheet. Right after issue, the bonds' carrying value is $750,000.00 − $30,000.00 = $720,000.00, which is exactly the cash borrowed.

Think of the discount as extra interest. The business received $720,000.00 but will repay $750,000.00, so the $30,000.00 difference is an additional cost of borrowing. It is spread over the bonds' life as part of interest expense.

Worked example 3: bonds issued at a premium

Pine Street Dental issued $100,000.00 of 10-year, 8% bonds that pay interest every six months, at 105, for cash.

Cash received = $100,000.00 × 105 ÷ 100 = $105,000.00

Premium = $105,000.00 − $100,000.00 = $5,000.00

Premium on Bonds Payable is an adjunct liability: it has a credit balance and is added to Bonds Payable, giving a carrying value of $105,000.00. The premium works in the opposite way from a discount. The business received more than it will repay, so the premium reduces the cost of borrowing over the bonds' life.

Amortizing the discount or premium

A discount or premium does not stay on the books forever. By the maturity date, the carrying value must equal face value, because that is what gets repaid. Each interest period, part of the discount or premium is moved into interest expense. This is called amortization.

The exercises use the straight-line method: the same amount is amortized every period.

Amortization per period = discount or premium ÷ number of interest periods

Another approach, the effective-interest method, works out interest expense from the carrying value and the market rate, so the amortization changes a little each period. It is the method generally preferred when the difference is significant, but this page and its exercises stay with straight-line.

The interest entry then has three parts:

• Cash paid = face value × stated rate ÷ 2 for six-monthly payments. This never depends on the issue price.
• Discount: interest expense = cash paid + amortization. Credit Discount on Bonds Payable.
• Premium: interest expense = cash paid − amortization. Debit Premium on Bonds Payable.

Worked example 4: first interest payment on a discount

Northside Print Shop issued $50,000.00 of 5-year, 7% bonds that pay interest every six months, at 98, so it recorded a $1,000.00 discount. It amortizes the discount by the straight-line method.

Cash paid = $50,000.00 × 7% ÷ 2 = $1,750.00

Periods = 5 years × 2 = 10

Amortization = $1,000.00 ÷ 10 = $100.00

Interest expense = $1,750.00 + $100.00 = $1,850.00

After this payment the discount balance is $900.00, and the carrying value has risen from $49,000.00 to $49,100.00. After ten payments the discount will be gone and the carrying value will be $50,000.00.

Worked example 5: first interest payment on a premium

Copperleaf Studio issued $300,000.00 of 10-year, 5% bonds that pay interest every six months, at 102, so it recorded a $6,000.00 premium. It amortizes the premium by the straight-line method.

Cash paid = $300,000.00 × 5% ÷ 2 = $7,500.00

Amortization = $6,000.00 ÷ 20 = $300.00

Interest expense = $7,500.00 − $300.00 = $7,200.00

Common mistakes and how to avoid them

Each mistake below is one that our exercises catch and explain.

Crediting Notes Payable

Bonds and notes are both borrowing, but bonds have their own liability account. Crediting Notes Payable for Harbor Bakery's $200,000.00 would mix the bonds in with bank loans. Credit Bonds Payable.

Crediting revenue

Receiving $200,000.00 can look like income, but it comes with a debt of $200,000.00. Borrowing never creates revenue. Credit Bonds Payable.

Recording Bonds Payable at the cash received

Crediting Bonds Payable for $720,000.00 in the discount example, or $105,000.00 in the premium example, misstates what the business will repay. Bonds Payable always shows face value. Put the difference in Discount on Bonds Payable (debit) or Premium on Bonds Payable (credit).

Expensing the discount at issue

Debiting the $30,000.00 discount to Interest Expense on the day the bonds are issued charges eight years of extra interest to one period. Record it in Discount on Bonds Payable and amortize it over the bonds' life.

Recording the premium as revenue

The $5,000.00 premium is not income. It is extra money received now that the business effectively gives back through lower interest expense later. Credit Premium on Bonds Payable.

Recording only the cash interest

Debiting Interest Expense for $1,750.00 and crediting Cash leaves the discount untouched, so by maturity the bonds would still be carried below face value. The same happens with a premium: recording $7,500.00 of expense ignores the $300.00 that should lower it. Amortize part of the discount or premium every period.

Paying a full year's interest

A 7% stated rate is an annual rate. With six-monthly payments, each payment is half of that: $50,000.00 × 7% ÷ 2 = $1,750.00, not $3,500.00.

Adding a premium to interest expense

A premium works the other way from a discount. Recording $7,800.00 of interest expense and crediting the premium would make it grow instead of shrink. Debit Premium on Bonds Payable and subtract the amortization from the cash interest.

A quick routine for any bonds question

1. At issue: cash = face value × price ÷ 100. Credit Bonds Payable for face value. Debit a discount or credit a premium for the difference.
2. For each interest payment: cash = face value × stated rate ÷ 2 (for six-monthly payments).
3. Number of periods = years × 2. Straight-line amortization = discount or premium ÷ periods.
4. Discount: interest expense = cash + amortization, credit the discount. Premium: interest expense = cash − amortization, debit the premium.
5. Check that the entry balances and that the carrying value moves toward face value.

Bonds are one way to finance long-term assets. A smaller loan from a single lender is more often an installment note; the installment note journal entry page shows how those payments are split.