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Currently, generally accepted accounting principles require use of the effective interest method of amortization unless the results under the two methods are not significantly different.
To calculate the additional interest expense to be recognized when recording the semiannual interest payments, divide the total discount by the number of interest payments. The entry to pay interest on December 31, 20X1 would be: The carrying value will continue to increase as the discount balance decreases with amortization.
When the bond matures, the discount will be zero and the bond's carrying value will be the same as its principal amount. The discount amortized for the last payment may be slightly different based on rounding. At maturity, the entry to record the principal payment is shown in the General Journal entry that follows Table 1. The effective interest method of amortizing the discount to interest expense calculates the interest expense using the carrying value of the bonds and the market rate of interest at the time the bonds were issued.
When the bond matures, the premium account's balance will be zero and the bond's carrying value will be the same as the bond's principal amount. The other thing that needs to be kept in mind is the coupon. You may also have read through the following recommended articles —. Below, we look at how you can determine whether a company is issuing new debt to fund operating needs. The face value of a zero-coupon bond is paid to the investor after a specified period of time but no other cash payment is made.
The semiannual interest paid to bondholders on Dec. The entry on December 31 to record the interest payment using the effective interest method of amortizing interest is shown on the following page. As the discount is amortized, the discount on bonds payable account's balance decreases and the carrying value of the bond increases. The amount of discount amortized for the last payment is equal to the balance in the discount on bonds payable account.
See Table 2 for interest expense and carrying values over the life of the bond calculated using the effective interest method of amortization. On July 1, Lighting Process, Inc.
After the Entry,the bonds would be included in the long-term liability section of the balance sheet as follows: The premium account balance represents the difference excess between the cash received and the principal amount of the bonds. Unlike the discount that results in additional interest expense when it is amortized, the amortization of premium decreases interest expense. This method divides the total premium by the number of interest payments to determine the reduction in interest expense to be recognized semiannually.
The entry for the first interest payment would be as follows: The carrying value will continue to decrease as the premium account's balance decreases. When the bond matures, the premium account's balance will be zero and the bond's carrying value will be the same as the bond's principal amount.
The premium amortized for the last payment should be the balance in the premium on bonds payable account.
Debt issues, such as bonds , are issued by corporations to raise money for certain projects or to expand into new markets. Municipalities, states, federal, and foreign governments issue debt to finance a variety of projects such as social programs or local infrastructure projects.
In exchange for the loan, the issuer borrower must make payments to the investors the lenders in the form of interest payments. The interest rate is often called the coupon rate , and coupon payments are made using a predetermined schedule and rate. When the debt issue matures, the issuer repays the face value of the asset to the investors.
Face value, or par value, differs across the various types of debt issues. In terms of maturities of a debt issue, short-term bills typically have maturities between one and five years; medium term notes mature between five and ten years; and long term bonds generally have maturities longer than 10 years. Issuing debt is a corporate action which a company's board of directors must approve.
If debt issuance is the best course of action for raising capital, and the firm has sufficient cash flows to make regular interest payments on the issue, the board would draft a proposal which will be sent to investment bankers and underwriters. Corporate debt issues are commonly issued through the underwriting process in which one or more securities firms or banks purchase the issue in its entirety from the issuer and form a syndicate which is tasked with marketing and reselling the issue to interested investors.
The interest rate set on the bonds is based on the credit rating of the company and the demand from investors. The underwriters impose a fee on the issuer in return for their services. The process for government debt issues is different since these are typically issued in an auction format.
In the United States, for example, investors can purchase bonds directly from the government through its dedicated website, TreasuryDirect. A broker is not needed, and all transactions, including interest payments, are handled electronically. Debt issued by the government are considered to be the safest investments, given that the issue is backed by the full faith and credit of the US government.
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