Accounting For a Bond

Follow us on LinkedIn

A bond is a debt instrument issued by entities to obtain a loan. It comes with a fixed income, usually based on a fixed interest rate. Usually, companies use bonds to raise debt finance. However, other entities, such as government organizations may also issue bonds to gather funds. Overall, a bond is one of the most commonly used and widely available methods for entities to raise debt finance that doesn’t require them to refer to loans providing financial institutions.

There are many different types of bonds classified based on the issuer, the maturity, interest rate, and risks associated with the bond. The bonds that come with the lowest risk are government-issued bonds known as treasury bills. However, these bonds are usually short-term. Similarly, bonds issued by cities or local governments are known as Municipal bonds. They are riskier as compared to treasury bills. Likewise, corporate bonds are bonds issued by companies or corporations. These come with the highest risk as compared to the others.

Add your business to our business directory https://harbourfronts.com/directory/ Add your business. Also check out other businesses in the directory

The risk associated with a bond also dictates the returns on it. Riskier bonds come with higher returns to compensate for the bondholder. It means government-issued bonds come with the lowest interest rates but greater safety. On the other hand, bonds issued by companies come with the highest interest rates due to the higher risks.

Accounting for a bond

There are several transactions, related to a bond, that occur starting from its date of issue to its maturity. First of all, when an entity issues a bond, it will record a liability in its accounts. The value of the bond depends on its face amount, which is the amount the entity pays back for it on maturity. Therefore, the accounting treatment at the issuance date will be as follows.

Dr Cash

Cr Bonds payable

Sometimes, the company may also sell the bond at a lower price than its face value. In that case, the entity still has to pay back the full amount of face value on maturity. However, it receives lower cash as compared to the bond’s face value. Therefore, the company must record the difference as a discount, which is an expense. The accounting treatment is as follows.

Dr Cash

Dr Discount on bonds payable

Cr Bonds payable

If the entity receives more cash than the face value, it records the difference as other income. It is also known as a premium on bond. The accounting treatment will be as follows.

Dr Cash

Cr Premium on bonds payable

Cr Bonds payable

When the entity pays interest on a bond, it will record the interest as an expense. The accounting treatment for interest on a bond will be as follows.

Dr Interest Expense

Cr Cash/Interest payable

Finally, once the entity repays the bond, it will reverse the liability related to the bond. As mentioned above, the entity repays the lender the face value of the bond. Therefore, the accounting treatment will be as below.

Dr Bonds payable

Cr Cash

Valuing a bond

A fixed-rate bond is valued using the discounted cash flow method. The valuation of a bond with embedded derivatives is more complex. It requires a short-rate model such as the Hull-White method. The valuation steps are as follows,

  • Calibrate the short-rate model using market data
  • Build an interest-rate tree
  • Price the bond

Conclusion

A bond is a debt instrument that entities issue to raise finance. There are different types of bonds categorized based on issuer, risks, interest rates, etc. The accounting for a bond consists of recording it when issued initially. Furthermore, it also consists of recording interest payments associated with bonds. Finally, it also involves writing off the bond when the entity repays the face value of the bond.

Further questions

What's your question? Ask it in the discussion forum

Have an answer to the questions below? Post it here or in the forum

LATEST NEWSThe South Park stock market jinx could be coming for high-flying weight-loss stocks
The South Park stock market jinx could be coming for high-flying weight-loss stocks

An analysis found that a stock underperformed the S&P 500 by a median of 7% in the year after being featured in the animated comedy.

Stay up-to-date with the latest news - click here
LATEST NEWSEarnings call: CollPlant reports Q1 2024 results and corporate updates
Earnings call: CollPlant reports Q1 2024 results and corporate updates
Stay up-to-date with the latest news - click here
LATEST NEWSEarnings call: Covalon turns profitable with strong Q2 performance
Earnings call: Covalon turns profitable with strong Q2 performance
Stay up-to-date with the latest news - click here
LATEST NEWSUS health insurer shares fall after UnitedHealth flags Medicaid enrollment issues
US health insurer shares fall after UnitedHealth flags Medicaid enrollment issues
Stay up-to-date with the latest news - click here
LATEST NEWSBESREMi ® (Ropeginterferon alfa-2B) Shows Greatest Benefit Among Cytoreductive Therapies in Lowering Symptomatic Burden of Polycythemia Vera (PV): Real-World Analysis Published at ASCO
BESREMi ® (Ropeginterferon alfa-2B) Shows Greatest Benefit Among Cytoreductive Therapies in Lowering Symptomatic Burden of Polycythemia Vera (PV): Real-World Analysis Published at ASCO
Stay up-to-date with the latest news - click here

Leave a Reply