A bond is a debt instrument that companies use to collect funds from creditors. This instrument does not require companies to apply for loans from financial institutions. Instead, companies can issue them of their own will and collect funds from any entity. While this entity may include financial institutions, it can also consist of individuals, companies, and other parties.
Bonds allow companies to accumulate debt finance. In exchange for that finance, companies must pay compensation to the bondholder. On top of that, bonds also come at face value. It is the amount the issuer must repay the holder at the bond’s maturity. However, it does not represent the finance received when a company issues its bonds.
Bonds come with various features. These features may also differ from one type of bond to another. However, almost every bond comes with coupon rates and expenses. Usually, it is a fixed rate, although it can also be floating. For the issuer, payments based on that rate constitute bond interest expense. Therefore, they must account for it accordingly.
Before discussing how to record bond interest expense journal entries, it is crucial to understand it first.
What is Bond Interest Expense?
Bond interest expense refers to the interest incurred on any bonds issued to holders. When companies collect funds through these instruments, they promise to pay holders at specific times. Usually, they also come with fixed coupon rates that dictate the interest holders receive on those bonds. On top of that, the face value of the bond plays a role in how much that amount is.
Bonds interest expense is a financial expense for companies. Since it relates to debt finance, companies record it under that category. This expense appears on the income statement after operating profits. In accounting, bond interest expense is a prevalent finance expense for companies that issue bonds. This expense differs based on various factors, as stated above.
The calculation for bond interest expense is straightforward in most cases. Companies promise to pay interest on these instruments after specific periods. Once that time arrives, companies can calculate the bond interest expenses using the formula below.
Bond interest expense = Face value of the bond x Coupon rate
The bond interest expense formula helps companies calculate the interest payment they must make to holders. Based on this formula, they can also account for that expense. However, this process may involve two stages.
What is the accounting treatment of Bond Interest Expenses?
The accounting treatment of bond interest expense is straightforward. However, the process may involve several stages. Before defining those stages, it is crucial to understand how companies record the bond interest expense. Usually, this process occurs on an accrual basis based on the concept. This concept requires companies to recognize the expense when it incurs rather than when companies pay for it.
Therefore, companies must record a bond interest expense as soon as it occurs. In other words, when the holder becomes eligible to receive the interest payment, the company must book it. The accruals concept applies to bond interest expenses like others. Usually, companies define the dates at which this interest expense becomes payable to holders. However, it is not the same date when they make payments.
In the first stage of recording bond interest expense, companies create a liability to pay in the future. This liability may fall under one of many names. Usually, companies term it accrued interest. However, it may also appear under interest payable or other similar names. On the other hand, companies also record an expense, which they calculate on the bond.
Before recording the bond interest expense, it is crucial to calculate it. As stated above, this expense depends on the face value of the bond. On top of that, it also relates to the coupon rate on the bond. Once companies calculate it, they can create the expense in their books. This expense appears on the income statement. Usually, companies include it as a part of their financial expenses.
On the other hand, companies also create a liability for the bond interest expense. This liability will appear on the balance sheet until its subsequent payment. At this stage, the recording of the bond interest expense ends. When companies pay for that expense, they can remove the liability. This transaction will not affect the interest expense recorded initially. However, it is still a part of the process.
How to record Bond Interest Expense journal entries?
Recording a bond interest expense journal entry is straightforward. When a company calculates this expense, it must recognize it as a payable amount. In this stage, companies can debit the bond interest expense account. Some companies may also use a financial expenses account or other similar names to accumulate those expenses.
On the other hand, it also involves creating a liability, which is the credit side of the double-entry. Companies can use the accrued expenses or interest payable accounts. Either way, the accounting treatment for the bond interest expense will be similar. Companies can use the following journal entry to record the bond interest expense.
|Bond interest expense||XXXX|
When companies pay the bondholder the accrued amount, they must remove the liability created before. In this case, the debit entry to the transaction will be the accrued expense account. On the other hand, it will also require the source of payment. Usually, it includes the cash or bank account for companies. Therefore, the journal entry will look as follows.
|Cash or bank||XXXX|
However, the above journal entry does not impact the bond interest expense account. In some cases, this transaction may occur in a different accounting period than that expense gets debited.
However, it is still crucial to the overall process of dealing with bond interest expense transactions. This journal entry concludes the cycle. Usually, it repeats until the final interest payment on the bond until its maturity.
A company, ABC Co., issues 1,000 bonds at a $100 face value. The company promises bondholders a coupon rate of 10% after every six months for five years. Therefore, the company must pay $10,000 (1,000 bonds x $100 x 10%) bond interest expense after that period. However, ABC Co. does not finalize the payment until the month after that period.
When ABC Co. becomes eligible to pay the interest accrued on the bonds, it must record the expense. At that stage, the company will use the following journal entries.
|Bond interest expense||$10,000|
After a month, ABC Co. pays its bondholders the accrued amount. The company uses its bank account to finalize that payment. Therefore, ABC Co. records that transaction as follows.
This process will repeat until the bonds reach their maturity after five years. Since the payments occur after six months, ABC Co. will use these entries twice each year for that period. Once the company repays its bondholders the face value of the bond, it will not account for bond interest expense anymore.
Bond interest is the expense companies incur after issuing bonds. Usually, they use these bonds to fund projects. Based on the face value of the bond and its coupon rate, they can calculate the bond interest expense. They must record this expense in two stages. The journal entries for the bond interest expense will fall in those stages.