Bonds Payable

A. Approaches of recording the issuance of bonds

There are two different approaches of recording the issuance of bonds- Memorandum
Approach and Journal Entry Method Approach. In the first mentioned approach, no entry is
made upon the authorization of the entity to issue bonds, and authorized bonds payable
account is not maintained. A memorandum entry is a short message entered into the
general journal and also entered into a general ledger account. It is not a complete journal
entry because it does not contain debit and credit amounts. On the other hand, with Journal
entry Method a journal is made to record the authorized bonds payable, unlike the former
approach at least two accounts are always impacted, with a debit entry being recorded against
one account and a credit entry against the other account.

B. Issuance of bonds at a premium or at a discount

A premium bond is a bond trading above its face value or in other words; it costs more than
the face amount on the bond. A bond might trade at a premium because its interest rate is
higher than current rates in the market. The premium is not reported as an outright gain, and is
amortized over the life of the bonds and credited to interest expense.

A bond issued at a discount has its market price below the face value. The bond discount is
the difference by which a bond's market price is lower than its face value. Bonds are sold at a
discount when the market interest rate exceeds the coupon rate of the bond. When the
interest rate increases past the coupon rate, bondholders now hold a bond with lower interest
payments. The same with the premium, it is not treated as an outright loss and is amortized as
loss over the life of the bonds and charged to interest expense.

C. Methods of amortizing discount or premium on bonds payable

1. Straight line method

This method provides for an equal amortization of bond premium or discount. The
procedure is simply dividing the amount of bond premium or discount by the life of the
bonds to arrive at the periodic amortization.
2. Bonds outstanding method
This method is applicable to serial bonds or those with a series of maturity dates. As the
name implies, this approach gives recognition to the diminishing balance of the bonds.
This is based on a theory that interest expense shall decrease every year by reason of
the decreasing principal bond liability.

3. Effective interest method

It is also known as the scientific method or interest method. Under this method, the
effective interest expense is determined by multiplying the effective rate by the carrying
amount of the bonds. The carrying amount changes every year as the amount of
premium or discount is amortized periodically, it is then compared with the nominal
interest and the difference is the premium or discount amortization.