Bonds Payable
Issued at par, discount, or premium.
Why This Matters
This is the module where accounting students either breakthrough or bail out.
Bonds aren't hard — but they require layering several concepts: face value, market interest rates, present value, discount amortization, premium amortization. Stack them on top of each other without a solid foundation and it becomes a blur.
Here's the truth:
Bonds are just long-term loans with a twist. A company borrows money, pays interest periodically, and repays the principal at the end. What makes bonds different is that the interest rate printed on the bond (the "stated rate") often doesn't match what the market is currently paying (the "market rate"). That gap creates discounts and premiums.Master bonds payable, and you'll understand one of the most sophisticated instruments in corporate finance. You'll also understand why a bond that pays 6% interest can sell for more or less than its face value.
What Is a Bond?
A bond is a formal debt instrument issued by a company to raise capital from multiple investors simultaneously.
When a company issues a bond:
- It borrows money from bondholders
- It promises to pay periodic interest (coupon payments) at the stated rate
- It promises to repay the face value (par value) at the maturity date
CORPORATE BOND
Coupon payments: $60/year
(or $30 every 6 months)
The Three Scenarios
The stated rate (printed on the bond) vs. the market rate (what investors currently demand) determines whether the bond sells at, below, or above face value.
PAR
Sells at face value
DISCOUNT
Sells below face value
PREMIUM
Sells above face value
Why Does This Happen?
Imagine you're buying a bond that pays 6% interest. But today, the market is paying 8% on similar bonds. Would you pay $1,000 for a bond that only pays you 6%? No — you'd demand a lower price to compensate for the below-market interest. You'd pay less than $1,000 — a discount.
Now flip it: if the bond pays 8% and the market is only paying 6%, investors would compete to buy that bond, driving the price above $1,000 — a premium.
Issued at Par
The simplest case. Stated rate = market rate.
1. Issue (Jan 1)
2. Semi-Annual Interest
3. Maturity (10 Yrs)
At par, it's clean: borrow $100k, pay $3k every 6 months, repay $100k.
Issued at a Discount
Stated rate (6%) < market rate (8%). Investors pay less than face value.
The Setup
- Face value: $100,000
- Stated rate: 6%
- Market rate: 8%
- Issue price: $86,410
The difference is the bond discount:
$100,000 - $86,410 = $13,590
This is a contra-liability account.
Entry 1: Issue at Discount
Balance Sheet Presentation:
Discount Amortization
The discount must be spread (amortized) over the life of the bond. The investor paid $86,410 but gets $100,000 at maturity. That extra $13,590 is additional interest compensation.
Entry 2: Semi-Annual Interest + Amortization
Key Insight: Cash paid is only $3,000. But actual interest expense is $3,679.50 because the discount amortization makes the effective cost higher.
| Period | Beg. Carrying Value | Interest Expense | Cash Paid | Amortization | End Carrying Value |
|---|---|---|---|---|---|
| 1 | $86,410.00 | $3,679.50 | $3,000 | $679.50 | $87,089.50 |
| 2 | $87,089.50 | $3,679.50 | $3,000 | $679.50 | $87,769.00 |
| ... | ... | ... | ... | ... | ... |
| 20 | $99,320.50 | $3,679.50 | $3,000 | $679.50 | $100,000.00 |
Carrying value INCREASES toward $100k.
Issued at a Premium
Stated rate (8%) > market rate (6%). Investors pay more than face value.
The Setup
- Face value: $100,000
- Stated rate: 8%
- Market rate: 6%
- Issue price: $114,877
The difference is the bond premium:
$114,877 - $100,000 = $14,877
This is an adjunct-liability account.
Entry 1: Issue at Premium
Balance Sheet Presentation:
Premium Amortization
The premium is also amortized, but it reduces interest expense. The company received more cash ($114,877) than it'll repay ($100,000). That extra $14,877 offsets future interest payments.
Entry 2: Semi-Annual Interest + Amortization
Key Insight: Cash paid is $4,000. But actual interest expense is only $3,256.15 because the premium amortization reduces the effective cost.
| Period | Beg. Carrying Value | Interest Expense | Cash Paid | Amortization | End Carrying Value |
|---|---|---|---|---|---|
| 1 | $114,877.00 | $3,256.15 | $4,000 | $743.85 | $114,133.15 |
| 2 | $114,133.15 | $3,256.15 | $4,000 | $743.85 | $113,389.30 |
| ... | ... | ... | ... | ... | ... |
| 20 | $100,743.85 | $3,256.15 | $4,000 | $743.85 | $100,000.00 |
Carrying value DECREASES toward $100k.
The Big Picture
| Metric | AT PAR | DISCOUNT | PREMIUM |
|---|---|---|---|
| Face Value | $100,000 | $100,000 | $100,000 |
| Stated Rate | 6% | 6% | 8% |
| Market Rate | 6% | 8% | 6% |
| Issue Price | $100,000 | $86,410 | $114,877 |
| SEMI-ANNUAL METRICS | |||
| Cash Paid | $3,000 | $3,000 | $4,000 |
| Interest Expense | $3,000 | $3,679.50 | $3,256.15 |
| Carrying Value Direction | Flat ─→ | Rising ↑ (to $100k) | Falling ↓ (to $100k) |
Carrying Value to Maturity
Bond Retirement Before Maturity
Companies sometimes call (retire) bonds before the maturity date — if they can refinance at lower rates.
Retiring Above Carrying Value (LOSS)
Call bonds when carrying value = $96k, pay $98k
Retiring Below Carrying Value (GAIN)
Call bonds when carrying value = $103k, pay $101k
Common Mistakes
Mistake 1: Rates vs. Price Direction
"Market rate goes UP, so bond price goes UP"
They move in OPPOSITE directions. Market rate ↑ → Bond price ↓
If market offers better rates, your old bond is less attractive.
Mistake 2: Forgetting Interest Exp ≠ Cash Paid
Recording only cash paid as interest exp.
Interest Exp 3,000
Cash 3,000
True cost includes amortization.
Interest Exp 3,679
Discount 679
Cash 3,000
Key Takeaway
When stated < market, bonds issue at a discount — below face value — and the discount is amortized to additional interest expense each period. When stated > market, bonds issue at a premium — above face value — and the premium is amortized to reduce interest expense each period.
In all three cases, the carrying value converges to exactly face value at maturity.
Test Your Understanding
See if you've got the basics down. Click each option and check your answer.
Question 1: A company issues bonds with a 5% stated rate when the market rate is 7%. The bonds will sell:
Question 2: A $200,000 bond is issued at 95 (i.e., 95% of face value). What is the bond discount?
Question 3: A $100,000 bond issued at a discount of $8,000, with a 10-year term and semi-annual payments. Using straight-line amortization, what is the discount amortized each period?
Question 4: A bond is issued at a premium. What happens to the carrying value of the bond over its life?
Question 5: When recording semi-annual interest on a DISCOUNT bond, the journal entry includes:
Ready to Practice?
You now understand one of the most complex topics in financial accounting. The Practice Lab challenges you to issue bonds, build amortization schedules, and watch carrying value converge.
Try the Practice LabWhat's Next?
You've completed the Long-Term Liabilities unit! Next, we flip to the other side of the balance sheet: Stockholders' Equity.