I am reading the introduction to FSA in the Shweser notes and find this very confusing. “The accounting entry for bonds issued at a premium requires crediting the unamortized bond premium account. Suppose the $1 million par value bond is issued at a premium of $100,000. Cash is increased by $1,100,000 and the related liability is $1,000,000 for bonds payable (face value) and also a $100,000 liability termed unamortized bond premium.” And for a bond discount scenario they say cash is increased by the $900,000 proceeds of selling the bonds and $100,000 is shown as a reduction in liability. What I don’t understand is why a $100,000 profit is termed a liability and how selling a bond below par value can be a reduction in liability! I did read the amortization part and the company does pay a higher total interest cost when it sells the bond at a discount which should mean a higher liability and not a reduction in liability. Can anybody help me with understanding this please? Thank you.
Whoa. Issuing a bond at 110 does not mean that the difference between bond price and par is profit. The bond is issued at 110 most likely because it has a higher coupon than would be required to issue the bond at par for its seniority and credit quality or perhaps the bond is puttable or comes with a Rolex attached or whatever. That 100,000 represents a liability to the company because one way or another that bond is going to cost them that extra amount either through the extra coupon payments, the value of the put option, or the bill for the Rolexes.
But how can the discounted amount be a reduction in liability(when the bond is sold at a discount) when it costs the company even more to repay the face value plus interest? Also the total cost to the company in this particular example is less when the bond is sold for a premium than at a discount. Thank you.
The bond discount appears on the Balance Sheet as a contra liability account (debit balance unber liabilities), right?
cfaDecember Wrote: ------------------------------------------------------- > But how can the discounted amount be a reduction > in liability(when the bond is sold at a discount) > when it costs the company even more to repay the > face value plus interest? Also the total cost to > the company in this particular example is less > when the bond is sold for a premium than at a > discount. Thank you. For the same reason in reverse. The company makes up the difference in lower coupon payments.
That is correct. It is under the debit column.