Market and contract rates of interest are likely to differ. The market rate fluctuates from day to day, responding to factors such as the interest rate the Federal Reserve Board charges banks to borrow from it government actions to finance the national debt and the supply of, and demand for, money. Firms state this rate in the bond indenture, print it on the face of each bond, and use it to determine the amount of cash paid each interest period. The contract rate of interestis also called the stated, coupon, or nominal rate is the rate used to pay interest. The higher the risk category, the higher the minimum rate of interest that investors accept. The effective interest rate (also called the yield) is the minimum rate of interest that investors accept on bonds of a particular risk category. A difference between face value and issue price exists whenever the market rate of interest for similar bonds differs from the contract rate of interest on the bonds. The amount a bond sells for below face value is a discount.

The amount a bond sells for above face value is a premium. The price of a bond issue often differs from its face value. This video will explain the basic concepts and then weВ will review examples: We may be forced to issue the bond at a discount or premium. But, certain circumstances prevent the bond from being issued at the face amount. It would be nice if bonds were always issued at the par or face value of the bonds. The firm would report theВ $2,000 Bond Interest Payable as a current liability on the December 31 balance sheet for each year. Since the 6-month period ending October 31 occurs within the same fiscal year, the bond interest entry would be:Д®ach year Valley would make similar entries for the semiannual payments and the year-end accrued interest.

To record payment of 6 months bond interest. We will credit cash since we areВ paying cash to the bondholders.Д«ond Interest Expense ($100,000 x 12% x 4 months / 12 months)Д¬ash ($100,000 x 12% x 6 months / 12 months) TheВ April 30 entry in the nextВ year would include the accrued amount from December of last year and interest expense for Jan to April of this year. To record accrued interest for November and December payable in April. Interest Payable (or Bond Interest Payable) That entry would be:Д«ond Interest Expense ($100,000 x 12% x 2 months / 12 months) Valley must make an adjusting entry on December 31 to accrue interest earnedВ for November and December but not paid until April 30 of the next year. For example, assume the Valley bonds were datedВ October 31, issued on that same date, and pay interest each April 30 and October 31. At the end of ninth year, Valley would reclassify the bonds as a current liability because they will be paid within the next year. The income statement for each of the 10 years would show Bond Interest Expense ofВ $12,000 ($ 6,000В x 2 payments per year) the balance sheet at the end of each of the years 1 to 8В would report bonds payable ofВ $100,000 in long-term liabilities. Note that Valley does not need any interest adjusting entries because the interest payment date falls on the last day of the accounting period. To record final semiannual interest and bond repayment. OnВ December 31 (10 years later), the maturity date, the entry would includeВ the last interest payment and the amount of the bond: On each June 30 and December 31 for 10 years, beginning 2010 June 30 (ending 2020 June 30), the entry would be ( Remember, calculate interest as Principal x Interest x Frequency of the Year):Д«ond Interest Expense ($100,000 x 12% x 6 months / 12 months) OnВ December 31, the date of issuance, the entry is: The entries for the 10 years are as follows:

Valley made the required interest and principal payments when due. The bonds are datedВ December 31, call for semiannual interest payments on June 30 and December 31, and mature in 10 years on December 31.

The following examples illustrate the accounting for bonds issued at face value on an interest date and issued at face value between interest dates.Д«onds issued at face value on an interest date Valley CompanyвЂ™s accounting year ends on December 31. If interest dates fall on other than balance sheet dates, the company must accrue interest in the proper periods. When a company issues bonds, it incurs a long-term liability on which periodic interest payments must be made, usually twice a year.

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