SCUBA TECH Accounting Help

will make the following adjusting to amortize the bond discount: Interest Expense 500′ Discount on Bonds Payable 500 Recognized one year’s amortization of discount on 40-year bonds payable ($20,000 original discount x %0). The net liability for bonds payable 453 454 Liabilities Notice that amortization of the discount increases SCUBA TECH’s annual interest expense.

It does not, however, require any immediate cash outlay. The interest expense represented by the discount will not be paid until the.bonds mature. As the discount is amortized, the carrying amount of the bonds (face or maturity value less the discount) increases. Accounting for Bond Premium If bonds are issued at a premium (a price above par), the borrower would again record the liability at the amount borrowed.

The amounts in excess of par value would be credited to a special account entitled Premium on Bonds Payable. In the balance sheet. bond ‘.premium is added to the face value of the bonds to determine the net liability. As this premium is amortized, the carrying value of the liability gradually declines toward the maturity value.

Amortization of bond premium is recorded by debiting Premium on Bonds Payable and crediting Interest Expense. Therefore, amortization of a premium reduces the annual interest expense to an amount less than the annual cash payments made to bond holders Bond Discount and Premium in Perspective From a conceptual point of view, investors might pay a premium price to purchase bonds· that pay an above-market rate of interest. If the bonds pay a below-market rate, investors will buy them only at a discount. ‘ But these concepts seldom come into play when bonds are issued. Most bonds are issued at the market rate of interest.

Corporate bonds almost never are issued at a premium. BOI.dsoften are issued at a small discount, but this discount represents only the underwriter’s profit margin, not inv.estors’ response to a below-market interest ‘rate? The annual effects of amortizing bond discount or premium are diluted further because these amounts are amortized over the entire life of the bond issue-usually 20 years or more. In summary, bond discounts and premiums seldom have a material effect on a company’s annual interest expense or its financial position.’ For this reason. we defer further discussion of this topic to more advanced accounting courses.

Notice that the Long-term liability i~increasing very gradually at an average rate of $500 per year increase + 40-year life of the bond issue). When bonds arc issued, the unount of any discount is debited to an account entitled Discount Oil BondsSCUBA TECH will record the issuance of these bonds as follows:

Cash 980,000 Discount on Bonds Payable  20,000 Bonds Payable 1,000,000 Issued $1,000.000 face value 40-year bonds to an underwriter at a price of 98. SCUBA TEqrs liability at the date of issuance will appear as follows: Long-term liabilities:

Bonds Payable Less: Discount on Bonds Payable 20,000 $980,000 The debit balance account Discount on Bonds Payable is a contra-liability account. In the balance sheet, it is shown as a reduction in the amount of the long-term liability.

Thus the net liability originally is equal to the amount borrowed: Amortization of the Discount Over the 40-year life of the bond issue, adjusting entries are made to gradually transfer the balance in the Discount account into interest expense. Thus the balance in the Discount account gradually declines, and the carrying value of  the bonds face value less the unamortized discount-rises toward the bonds’ maturity value. Assuming the bonds pay interest annually on December 31 each year, SCUBA TECH will make the following adjusting enu» to amortize the bond discount: Interest

Expense 500 Discount on Bonds Payable 500 Recognized one year’s amortization of discount on 40-year bonds .payable ($20,000 original.

The net liability for bonds payable 45 ,454 Liabilities Notice that amortization of the discount increases SCUBA TECH’s annual interest expense. It does not, however, require any immediate cash outlay. The interest expense represented by the discount will not be paid until the.bonds mature. As the discount is amortized, the carrying amount of the bonds (face or maturity value less the discount) increases. Accounting for Bond Premium If bonds are issued at a premium (a price above par), the borrower would again record the liability at the amount borrowed.

The amount in excess of par value would be credited to a special account entitled Premium on Bonds Payable. In the balance sheet. bond ‘.premium is added to the face value of the bonds to determine the net liability. As this premium is amortized, the carrying value of the liability gradually declines toward the maturity value. Amortization of bond premium is recorded by debiting Premium on Bonds Payable and crediting Interest Expense.

Therefore, amortization of a premium reduces the annual interest expense to an amount less than the annual cash payments made to bond holders Bond Discount and Premium in Perspective From a conceptual point of view, investors might pay a premium price to purchase bonds· that pay an above-market rate of interest. If the bonds pay a below-market rate, investors will buy them only at a discount. But these concepts seldom come into play when bonds are issued. Most bonds are issued at the market rate of interest.

Corporate bonds almost never are issued at a premium.  BOI.dsoften are issued at a small discount, but this discount represents only the underwriter’s profit margin, not inv.estors’ response to a below-market interest ‘rate? The annual effects of amortizing bond discount or premium are diluted further because these amounts are amortized over the entire life of the bond issue-usually 20 years or more. In summary, bond discounts and premiums seldom have a material effect on a company’s annual interest expense or its financial position. For this reason. we defer further discussion of this topic to more advanced accounting courses.

2Professor Bill Schwartz of Virginia Commonwealth University cond~cted’a study of 685 bond issues in a given year. None of these bonds was issued at a premium, and over 95% were issued either at par or at a discount of less than 2% of face value.

3Some companies issue zero-coupon bonds. which pay no interest but are issued at huge .dlscounrs. In these situations, amortization of the discount is material and may comprise much of the company’s total interest expense. Zero-coupon bonds are a specialized form of financing that will be discussed in later accounting courses and courses in corporate finance

Posted on November 21, 2015 in Liabilities

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