Accrued Interest

Since the corporation issuing a bond is required to pay interest, and since the interest is paid on only
two dates per year, the interest on a bond will be accruing daily. This means for each day that a
bond is outstanding, the corporation will incur one day of interest expense and will have a liability for
the interest it has incurred but has not paid. If the corporation has issued a 9% $100,000 bond, then
each day it will have interest expense of $24.66 ($100,000 x 9% x 1/365).

If the corporation issues monthly financial statements, then each month it needs to report $750
($100,000 x 9% x 1/12) of interest expense. The corporation usually does this with the following
monthly adjusting entry:

While the issuing corporation is incurring interest expense of $24.66 per day on the 9% $100,000
bond, the bondholders will be earning interest revenue of $24.66 per day. With bondholders buying
and selling their bond investments on any given day, there needs to be a mechanism to compensate
each bondholder for the interest earned during the days a bond was held. The accepted technique is
for the buyer of a bond to pay the seller of the bond the amount of interest that has accrued as of the
date of the sale. For example, if a 9% $100,000 bond has a date of January 1, 2019 and it is sold on
January 31, 2019, the buyer of the bond is required to pay the seller of the bond one month's interest
amounting to $750 ($100,000 x 9% x 1/12).

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Bonds Issued at Par with No Accrued

Interest
If a corporation issues a bond on January 1, 2019 and the bond has a date of January 1, 2019 there
will be no accrued interest on the bond when it is issued. If the investor pays the corporation the face
amount of the bond, the bond is said to have been issued at par or at 100—meaning 100% of the
bond's face value plus any accrued interest. (As we will see later, it is possible for a new bond to be
issued after the date of the bond—and therefore to have accrued interest. In addition a bond might
be sold by the issuing corporation for more or less than its face value.)
Let's assume that on January 1, 2019 a corporation issues a 9% $100,000 bond at its face amount.
The bond is dated January 1, 2019 and requires interest payments on each June 30 and December
31 until the bond matures at the end of 5 years. Each semiannual interest payment will be $4,500
($100,000 x 9% x 6/12). The corporation is also required to pay $100,000 of principal to the
bondholders on the bond's maturity date of December 31, 2023.
Since the bond was issued/sold for 100% of its face amount and since there is no accrued interest to
be paid by the buyer of the bond, the issuing corporation will make the following journal entry:

The following timeline shows the future cash payments that the corporation must make to the
bondholders:

Journal Entries for Interest Expense - Annual Financial Statements

If the corporation issuing the above bond has an accounting year ending on December 31, the
corporation will incur twelve months of interest expense in each of the years that the bonds are
outstanding. In other words, under the accrual basis of accounting, this bond will require the issuing
corporation to report Interest Expense of $9,000 ($100,000 x 9%) per year.

If the corporation issues only annual financial statements, the interest expense can be recorded at
the time of its semiannual interest payments, as shown in the following journal entries for the year
2019:

Journal Entries for Interest Expense - Monthly Financial Statements

If the corporation issues monthly financial statements, it must report interest expense of $750
($100,000 x 9% x 1/12) on each of its monthly income statements. It must also report a current
liability on its balance sheet for the amount of interest that it has incurred but has not yet paid. This is
accomplished by recording an accrual adjusting entry at the end of each month. In addition there will
be an entry on June 30 and on December 31 for the required interest that was actually paid to the
bondholders. The 14 journal entries pertaining to the corporation's bond interest during the year
2019 will be:
The journal entries for the years 2020 through 2023 will have the same accounts and amounts.