Amortization of Issued Bonds

CFA Level I FRA
#1

Hi,

Just doing some reading on issued bonds and wanted to know if there is an amortization expense going through the income statement as coupon payments are made. From my understanding we have:

Cr Cash

Dr Interest expense (goes through income statement)

Dr Amortization expense

If the amortization expense goes directly to the balance sheet (which I think it must in order to reduce the liability) then aren’t total expenses understated?

Any help is appreciated, thanks.

#2

Suppose that you issue a 10-year, 6% coupon, annual pay, $1,000 par bond when interest rates are at 5%; you issue that bond at $1,077.22. There are two approaches to the journal entry for the issuance:

  • Dr Cash, $1,077.22
  • Cr Bonds payable, $1,077.22

or

  • Dr Cash, $1,077.22
  • Cr Bonds payable, $1,000.00
  • Cr Bond premium, $77.22

The first year’s interest expense will be $53.86 (= $1,077.22 × 5%), the coupon payment will be $60.00, and the amortization of the premium will be $6.14 (= $60.00 – $53.86). Again, there are two approaches to the journal entry when the coupon is recorded (corresponding to the two methods of recording the issuance, above):

  • Dr Interest expense, $53.86
  • Dr Bonds payable, $6.14
  • Cr Cash, $60.00

or

  • Dr Interest expense, $53.86
  • Dr Bond premium, $6.14
  • Cr Cash, $60.00

I wrote an article on amortization that may be of some help: http://financialexamhelp123.com/amortization-tables/. It doesn’t have the journal entries, but it explains how the amortization works.

#3

Yeah that seems to work fine for bonds with coupons but what about zero-coupon bonds? You cannot credit cash (as there is no coupon payment) but you still have to recognize the amortization - and the amortization (if we were to use the journals above) would not have any associated debit amount.

i.e. Suppose we have a 10 year $1,000,000 face value bond with no coupon that was issued when the market interest rate was 5%. The liability would initally be recognised at $613,913. In terms of journal entries we have:

Dr Cash $613,913

Cr Bond Payable $613,913

At the end of the first year, however, we must recognise the amortization of the bond of $613,913*5% = $30,696.

Cr Bond Amortization $30,696

Dr ?

As a result, I’m inclined to think that the amortization expense must be recognised in the income statement as it looks like the most likely place where the debit would go. But I’m really not sure…

Thanks,

#4

Anyone?

#5

Read my previous answer; you can work it out if you think about it. All the information is there.

#6

Cr Bonds Payable

Dr Interest Expense

Right?

#7

Bingo!

#8

hey s2k,

if you took the L1 exam this June, what do you think you would score?

i say 95%

#9

MPS + 1

#10

doubt it