Chapter 20
Corporations and Bonds
Payable
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Learning Objective 1
Journalizing the recording of bonds as
well as interest payments
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LO-1
Bond
An interest-bearing note payable issued
by a corporation to a large group of
lenders
 Usually long-term
 Usually issued in $1,000 denominations

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LO-1
Bond Certificate

Piece of paper held by bondholder
showing evidence of bond issued by
corporation
◦ Face value - (principal) - amount a
corporation must repay a lender at maturity
◦ Contract rate - (stated interest rate) – the
annual interest rate, based on face value,
usually paid semiannually
◦ Dates of interest payment - printed on
certificate
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Bond Indenture

Contract that spells out the provisions of
the contract between the corporation
and the bondholder
◦ Written by corporation
◦ Usually monitored by trustee
◦ Trustee represents bondholders
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Types of Bonds
Secured - pledges specific assets as
security to meet terms of bond
agreement
 Debenture - Unsecured bond issued
only on the general credit of a
corporation.

◦ Higher risk than secured

Serial - issued in a series, each one
having a different maturity date
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Types of Bonds
Registered - bondholders of record are
registered with corporation; interest
checks are sent directly to them
 Callable - has provision that it can be
called in by a corporation after a certain
date
 Convertible - bondholders have option
of converting bonds into stock at a
specified rate

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Stock vs. Bonds




Stockholders
Owners
Paid upon
liquidation after
creditors’ claims
Dividends paid if
declared
Dividends - not tax
deductible
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



Bondholders
Creditors
Have claims on assets
before stockholders
Interest paid in
accordance with
contract
Interest - tax
deductible
LO-1
Issuing Bonds

When a corporation issues bonds, it
must:
◦
◦
◦
◦
Receive approval from the board of directors
Receive approval from the S.E.C.
Print bonds
Advertise bond issue
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LO-1
Issue Bonds At Par:
Exercise 20-2
Bonds Payable
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LO-1
Bonds Sold Between Interest Dates
Bond issuers only pay interest every 6
months
 When buyer purchases bond between 6
month interest dates, buyer pays purchase
price plus accrued interest since last
payment date
 On next payment, buyer receives full
interest for 6-month period

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Learning Objective 2
Amortizing bond discounts and bond
premiums by the straight-line method and
by the interest method
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LO-2
Bond Issued at a Discount or
Premium
When contract rate is different from
market rate of interest
 Discount – market rate is higher than
contract rate
 Premium – market rate is lower than
contract rate

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Rates
Contract Rate - Rate of interest stated
on bond certificate and bond indenture
Market Rate - Current rate of interest at
which bonds are being sold
Effective Rate - Real or actual rate of
interest to the borrowing corporation
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Bonds Issued at a Discount or
Premium

Carrying value – Face amount of bonds
less bond discount or plus bond premium

Amortization – allocating a portion of
the discount or premium to interest
expense each interest period
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Bonds Issued at a Discount
Cash received is less than face amount of
bond
 New account – Discount on Bonds
Payable

◦ Contra-liability account
◦ Debit balance
◦ Amortization of discount increases interest
expense
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Bonds Issued at a Premium
Cash received is greater than face amount
of bond
 New account – Premium on Bonds
Payable

◦ Liability account
◦ Credit balance
◦ Amortization of premium reduces interest
expense
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LO-2
Straight-line Method of Amortizing

Transfers an equal amount of bond
discount or premium to interest expense
each interest period
◦ Interest expense is the same
◦ Amount of interest paid to bondholders is the
same
◦ Amortized discount or premium is the same
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Bonds Issued at a Discount Exercise 20-3
(a) and (b)
Amortization of Discount =
$6,000 / 20 interest periods = $300
Interest Expense =
$15,000 + 300 = $15,300
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Cash Paid for Interest =
$300,000 x 10%/2 = $15,000
LO-1,2
Carrying Value of Bond
On May 1, 20XX
Bonds Payable
Less: Discount on Bonds Payable
Carrying Value
$300,000
6,000
$294,000
On November 1, 20XX
Bonds Payable
Less: Discount on Bonds Payable
Carrying Value
$300,000
5,700
$294,300
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LO-1,2
Bonds Issued at a Premium Exercise 20-4
of Premium =
(a) and (b) Amortization
$6,000 / 20 interest periods = $300
Cash Paid for Interest =
$300,000 x 10%/2 = $15,000
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Interest Expense =
$15,000 - 300 = $14,700
LO-1,2
Carrying Value of Bond
On May 1, 20XX
Bonds Payable
Plus: Premium on Bonds Payable
Carrying Value
$300,000
6,000
$306,000
On November 1, 20XX
Bonds Payable
Plus: Premium on Bonds Payable
Carrying Value
$300,000
5,700
$305,700
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LO-1,2
Interest Method of Amortizing
Discount or Premium
Interest expense is a constant percentage of the
carrying value
 Interest expense of carrying value =

Carrying value at beginning x Market interest rate
Interest expense to bondholders =
Face value x Contract interest rate
 Difference between expense and cash =
amount of discount or premium to amortize
 Discount amount is not constant.

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LO-2
Interest Method - Exercise 20-5
Interest Expense =
$90,000 x 12%/2 = $5,400
Cash Paid for Interest =
$100,000 x 10%/2 = $5,000
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Amortization of Discount =
$5,400 – 5,000 = $400
LO-1,2
Carrying Value of Bond
On July 1, 20XX
Bonds Payable
Less: Discount on Bonds Payable
Carrying Value
$100,000
10,000
$90,000
On December 31, 20XX
Bonds Payable
Less: Discount on Bonds Payable
Carrying Value
$100,000
9,600
$90,400
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LO-1,2
Interest Method - Exercise 20-5
June 30: Interest Expense =
$89,400 x (12% / 2) = $5,364
Cash Paid for Interest =
$100,000 x (10% / 2) = $5,000
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Amortization of Discount =
$5,424 – 5,000 = $424
LO-1,2
Learning Objective 3
Journalizing year-end adjusting entries for
bonds
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LO-3
Problem 20B-4
$104,408 x (10% / 2)
$6,000-5,220.40
$104,408 - 779.60
103,628.40
$100,000 x (12% / 2)
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LO1,2,3
Problem 20B-4
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LO1,2,3
Problem 20B-4
Period
Carrying
Value, Beg.
Int.
Paid
Interest
Expense
Prem
to be
Amort
Carrying
Value, End
9/1/X8
104,408
6,000
5,220.40
779.60
103,628.40
3/1/X9
103,628.40
6,000
5,181.42
818.58
102,809.82
9/1/X9
102,809.82
6,000
5,140.49
859.51
101,950.31
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LO1,2,3
Problem 20B-4
Period
Carrying
Value,
Beg.
Int.
Paid
Interest
Expense
Prem Carrying
to be Value, End
Amort
9/1/X8
104,408
6,000
5,220.40 779.60 103,628.40
3/1/X9
103,628.40
6,000
5,181.42 818.58 102,809.82
9/1/X9
102,809.82
6,000
5,140.49 859.51 101,950.31
Dec. 31
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LO1,2,3
Learning Objective 4
Journalizing entries related to retirement
of bonds and to sinking funds
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LO-4
Retirement of Bonds Before
Maturity Date
Amortization of discount or premium must be
brought up-to-date.
 Remove premium or discount as well as bond
liability account.
 Compare carrying value of bond with cash paid
to determine gain or loss.
 Gain or loss is recognized as an extraordinary
item on the income statement.

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LO-4
Bond Sinking Fund

Fund that accumulates cash to pay off
bonds when they are retired
◦ Asset account
◦ Debit balance

Sinking Fund Interest Earned – used to
record earnings on sinking fund balance
◦ Other revenue account
◦ Credit balance
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LO-4
Exercise 20-6
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LO-4
End of Chapter 20
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