Bonds Payable: Long-Term Debt Financing
A bond is a formal debt instrument through which a borrower (the issuing company) raises money from investors by promising to pay regular interest (coupon payments) and return the principal at maturity. Bonds are a major source of long-term financing for companies and governments.
Key Bond Terminology
- Face Value (Par Value) — The amount the bondholder receives at maturity (e.g., $1,000 per bond).
- Coupon Rate — The stated annual interest rate on the face value (e.g., 8%).
- Market Rate (Yield) — The rate investors demand in the market, which may differ from the coupon rate.
- Maturity Date — When the issuer repays the face value to bondholders.
- Issue Price — What investors actually pay when bonds are first sold.
Premium and Discount Bonds
- If coupon rate > market rate → Bond issued at a premium (above face value). Investors pay more for the above-market coupon.
- If coupon rate < market rate → Bond issued at a discount (below face value). Investors pay less to compensate for the below-market coupon.
- If coupon rate = market rate → Bond issued at par.
Accounting for a Bond Issued at Par
Issued $1,000,000 of 8% bonds at par, 5-year maturity:
At issuance: Dr. Cash $1,000,000; Cr. Bonds Payable $1,000,000
Semi-annual interest: Dr. Interest Expense $40,000; Cr. Cash $40,000
At maturity: Dr. Bonds Payable $1,000,000; Cr. Cash $1,000,000
Amortisation of Bond Discount/Premium
When bonds are issued at a discount or premium, the difference is amortised over the bond’s life — adjusting the carrying value toward face value and adjusting interest expense to reflect the true cost of borrowing.
The effective interest method (required under Ind AS 109) amortises based on the carrying value × market rate each period — resulting in a consistent effective interest rate over the bond’s life.
Why Bonds Matter for Business Analysis
Bonds payable appear under non-current liabilities on the balance sheet. High bond debt increases financial leverage (and risk). The interest coverage ratio (EBIT ÷ Interest Expense) reveals whether the company earns enough to comfortably service its debt. Investment-grade companies maintain coverage ratios of 3× or higher.
Lesson Summary
- Bonds are formal debt instruments with face value, coupon rate, and maturity date.
- Bonds issued at discount/premium are amortised to face value over their life.
- Interest coverage ratio (EBIT ÷ Interest) measures a company’s ability to service bond debt.
Bond Premium and Discount: How They Work
When a bond is issued, the market interest rate (yield) may differ from the bond’s stated coupon rate. This difference creates a premium or discount:
| Scenario | What Happens | Effect on Carrying Value |
|---|---|---|
| Coupon Rate = Market Rate | Bond sells at par (face value) | Constant over life |
| Coupon Rate > Market Rate | Investors pay a premium (above face value) | Premium amortised down to face value |
| Coupon Rate < Market Rate | Investors demand a discount (below face value) | Discount amortised up to face value |
Complete Bond Example: $200,000, 5-Year Bond at 6%, Issued at 96
Proceeds: $200,000 × 96% = $192,000
Discount: $200,000 − $192,000 = $8,000 (amortised over 5 years = $1,600/year using straight-line)
| Year | Interest Payment (6%) | Discount Amortised | Interest Expense | Carrying Value |
|---|---|---|---|---|
| 0 (issuance) | $192,000 | |||
| 1 | $12,000 | $1,600 | $13,600 | $193,600 |
| 2 | $12,000 | $1,600 | $13,600 | $195,200 |
| 3 | $12,000 | $1,600 | $13,600 | $196,800 |
| 4 | $12,000 | $1,600 | $13,600 | $198,400 |
| 5 | $12,000 | $1,600 | $13,600 | $200,000 |
Year 1 Journal Entries
| Date | Account | Debit | Credit |
|---|---|---|---|
| Jan 1 (issue) | Cash | $192,000 | |
| Discount on Bonds Payable | $8,000 | ||
| Bonds Payable | $200,000 | ||
| Dec 31 (interest) | Interest Expense | $13,600 | |
| Discount on Bonds Payable | $1,600 | ||
| Cash | $12,000 |
Bonds offer larger capital amounts, no collateral requirement, and fixed terms. Banks offer flexibility and faster execution. Most large corporations use a mix — shorter-term bank credit lines for liquidity and bonds for long-term capital projects.
Bonds Payable Practice Worksheet — Download, print, and complete to reinforce this lesson.