Bonds Payable at Premium

When the stated interest rate (coupon rate) on a bond payable is higher than the prevailing market interest rate, the bond sells at a price higher than its face value. The excess of the issue price over the face value of the bond is called bond premium.

The bond premium reflects the value of above-market coupon payments that the bond will make over its term.

In October 20X2, Company P initiated issue of 1,000 5-year $100-par bonds paying a 10% annual coupon. By the time the bonds were ready for issue on 1 January 20X3, the market rate dropped to 8%.

As the stated interest rate is higher than the market interest rate, we know that the bonds will sell at a premium. The issue price is determined by discounting the future cash flows of the bond at the market interest rate. In case of Company P’s bonds, the issue price would be $108:

Price of Bond = 10% × $100 × 1 − (1 + 8%)-5+$100= $108
8%(1 + 8%)5

Bond premium equals the excess of issuance price over the face value of the bond.

Accounting treatment for issuance of bonds at premium

Company P shall record the issuance of the bond (at premium) by the following journal entry:

Cash108,000
Bonds Payable100,000
Premium on Bonds Payable8,000

On the statement of financial position, the premium on bonds payable is added to the face value of bonds payable which increases the carrying amount of the bonds.

Calculation of interest expense, interest payment and amortization

The interest expense on bonds issued at premium equals the product of the carrying amount of the bonds payable (face value plus premium) and the market interest rate.

Interest expense = Bond carrying amount × market interest rate

In case of Company B, the first year interest expense would equal $8,640 (=$108 × 1,000 × 8%).

The interest payment is calculated as by applying the stated interest rate to the face value of the bond.

Interest payment = Bond face value × stated interest rate

In case of Company P, this equals $10,000.

The amortization of bond premium equals the excess of interest payment over the interest expense:

Bond premium amortization = Interest payment - Interest expense

In case of Company P, bond premium amortization in the first year would be $1,360 (=$10,000 - $8,640). Company P would record the first annual interest payment as follows:

Interest Expense8,640
Amortization of Premium1,360
Interest Payable/Cash10,000

The amortization of premium reduces the remaining premium on the bond thereby reducing the bond carrying amount on the statement of financial position such that at the maturity the carrying amount of bonds payable approaches their face value.

Retirement of bonds issued at premium

On maturity date, the bond premium is zero and the bond is redeemed by paying back the principal to bondholders. Company P would record the event as follows:

Bonds Payable100,000
Cash100,000

Before maturity, bonds issued at premium are redeemed at their prevailing market price, removing the face value of the bond and the associated remaining bond premium from the statement of financial position and recognizing any differential as gain or loss on bond retirement.

by Obaidullah Jan, ACA, CFA and last modified on

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