Chapter 2.5® - Issuing Bonds at Par (100% of Face Value) - Bonds Payable & Interest Expense Journal Entries, Issuing Bonds Between Interest Dates
In this section, we explore the journal entries for bond issuances at par. Consider JJ Corp. receives authorization to issue $900,000 of 6%, 20 year bonds. The bonds are issued on January 1st, 2009 and become due on January 1st, 2029. They pay interest semi-annually each June 30th and December 31st. If the bonds are sold at par, here are the journal entries that JJ Corp. would make in its books.
When the bond matures in 20 years, the company records the following journal entry to fulfill its repayment of the bond payable.
Issuing Bonds Between Interest Dates
Many bonds are issued on the date when interest is to be paid. This simplifies recordkeeping & administrative costs. However, when a company sells bonds at a date other than interest payment date, the purchasers of bonds are expected to pay the purchase price + any accrued interest since the prior interest payment date. This accrued interest is then repaid to bondholders by the issuing corporation on the next interest date.
For instance, consider Sears Corp has $2,000,000 of 6% bonds available for sale on January 1st, 2009. Interest is payable semi-annually on each June 30th and December 31st. If the bonds are sold at par on March 1st, 2009 (2 months after the original issue date), the issuing company collects 2 months worth of interest from the buyer at the time of sale. This amounts to ($2,000,000 x 6% x 2/12) = $20,000. The entry to record this transaction is:
When the June 30th semi-annual interest payment date arrives, Sears Corp will pay a full 6 months’ interest of ($2,000,000 x 6% x 6/12) = $60,000 to the bondholder. This payment includes the four months’ of interest earned (from March to June 30th, 2009) plus the repayment of 2 months’ interest collected when the bonds were sold ($20,000). The journal entry to record this is:
Above is a graph showing the breakdown of the $60,000 of interest payable to bondholders of which $20,000 is the collection of 2 months' interest when the bonds were sold and $40,000 is interest expense for 6 months starting from June 30th, 2009 to December 31st, 2009.
This practice of collecting and then repaying accrued interest with the
first interest payment is done to simplify recordkeeping & administration
costs for the issuing company. Imagine a company the size of Sears Corp
issuing 30 such bonds to different investors; obviously the cost of properly
maintaining records for each of these bonds will become a hassle and very
costly. If Sears Corp did not collect accrued interest from bondholders,
it would need to pay 30 different cash amounts on interest payment dates
to 30 different bond investments.