Issuance of Bonds Payable at Premium

When the stated interest rate on a bond is higher than the prevailing market price a company is able to sell its bonds for more than their par value. Investors consider the bond to be worth more than its par because it is offering a rate of return that is higher than the market rate of return.

Example

Company P has printed 100,000 bonds of face value of $100 each, carrying a stated interest rate of 10% and maturing in five year. When the company is ready to sell the bonds on 1 January 2013 the market rate is 8%. Since the stated interest rate is higher than the market interest rate the bonds will be issued at a premium to the par value which means the price will be higher than the par value.

The price would be $108 calculated as follows:

Price of Bond = 10% × $100 × 1 − (1 + 8%)-5+$100= $108
8%(1 + 8%)5

Accounting treatment for issuance of bonds at premium

Company P will record this issue of bonds at a price higher than their par value using the following journal entry:

Cash108,000
Bonds Payable100,000
Premium on Bonds Payable8,000

The premium on bonds payable is added to the face value of bonds payable on the balance sheet and increases the carrying amount of the bonds.

Interest expense on bonds issued at premium

The interest expense recognized on bonds issued at premium to par is the difference between the interest paid or payable of $10,000 based on the stated interest rate of 10% (calculated as the product of 10% and the face value of $100,000) and the annual amortization of premium on bonds payable. If the premium is amortized based on a straight line method the premium of $8,000 would be written off over the 5 years of the bonds payable. Amortization of bond premium for the year would be $1,600. Company P would record the annual interest expense as follows:

Interest Expense8,400
Amortization of Premium1,600
Interest Payable/Cash10,000

The amortization of premium on bonds reduces the carrying amount of bonds such that at the maturity the carrying amount of bonds payable approaches their face value.

Retirement of bonds issued at premium

At maturity the carrying amount of bonds payable issued at premium approaches their face value and the bond is redeemed by paying back the principal to bondholders. Company P would record the event as follows:

Bonds Payable100,000
Cash100,000

Written by Obaidullah Jan, ACA, CFA <--- Hire me on Upwork