What Is Bonds Payable?
Bonds Payable are the long-term debt issued by the company with the promise to pay the interest due and principal at the specified time as decided between the parties and is the liability; the payable bond account is credited in the books of accounts of the company with the corresponding debit to cash account on the date of issue of the bonds.
Bonds Payable word can be broken into two parts – bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period. and payable. As you can understand, bonds are debt. And payable means you are yet to pay that amount. So bonds payable stands for debt that’s not being paid.
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Bonds Payable Explained
The situation of bonds payable arises when a company issues bonds to the prospective investors in the financial market to raise funds to meet the business expenditures. In this case the company becomes the borrower and the investors become the lender. Since there is a borrower-lender relationship, it naturally creates a liability for the issuer in the balance sheet, in this form of debt.
A company issues IOU (“I owe you.” An IOU is a signed document acknowledging a debt. The investors buy this issued IOU instead of cash. In simple terms, the company is borrowing money from the investors by issuing them a legal document that states that the investors would get paid the full amount with interest in due time.
Two things that we need to pay heed to in the case of bonds payable –
- First, once the company issues bonds to the investors, the company needs to calculate bonds payable and pay the interest to the bond-holders semi-annually (or every six months). The interest rate would be decided beforehand, and the company needs to pay the pre-determined amount as the interest charges.
- Second, the company also needs to ensure that it pays off the full amount at maturity.
Normally bonds fall under the category of non-current liability and may be issued at a discount, a premium or at par. A non -current liability will be for long term and will mature after a year. According to the indenture of the bond, which is a document which states clearly the terms and conditions like face value, interest rate the issuer will have to pay the bondholder, any special terms and conditions or covenants supporting the bondholder.
Thus, it is a liability where the issuer is obliged to pay back the bondholder the interest along with the principal amount on the maturity date.
How To Calculate?
The calculation of bond payable amount is based on the carrying value or the book value of the bond. This carrying value is calculated as the face value plus the unamortized premium or minus the unamortized discount. Due to volatility of interest rates, the bonds are not normally sold or issued at the face value. They are issued either at a premium or at a discount, which are amortised over the lifetime of the bond.
In order to calculate bonds payable, it is important to know the par value, the interest rate and maturity date of the bond.
Thus, in case the bond is issued at a premium, the carrying amount will be face value plus premium(unamortised). In case it is issued at a discount, varying amount will be face value minus discount (unamortised). In case the bond is issued at par, then the carrying value or book value will be same as the face value of the bond since there is no discount or premium.
This carrying amount of bonds payable on balance sheet is what the issuer will get from the investor when the bond is issued. On maturity, due to amortization of premium/discount, the carrying value will become same as face value on the debt instrument.
Bonds Payable Video Explanation
Specifically, bonds payable is a long-term debt that has remained outstanding.
As we note from above, Durect Corp had Bonds payables in its current liabilityCurrent LiabilityCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc. and long-term liability sections.
The entire transaction of bonds payable on balance sheet is recorded affecting different accounts in balance sheet of the company. Now let us look at the procedure to record the transaction in books of accounts.
Firstly in the Bonds Payable account, the face value is recorded as credit balance. Next, for recording the premium, the Bonds Payable Premium account is credited. Thus, the entry will be as follows:
Cash A/c debit
To Bonds Payable A/c
To Bonds Payable Premium A/c.
In case of discount, the Bonds Payable Discount account is debited.
Cash A/c debit
Bonds Payable Discount A/c debit
To Bonds Payable A/c
Regarding the amortization of premium/discount, the entry will be as follows:
Interest A/c Debit
To Discount A/c
To Cash A/c
Interest A/c Debit
Premium A/c Debit
To cash A/c
Thus, the above are the entries passed in books of accounts in the company for bonds payable accounting that affect many accounts at the same time.
Below is an example of Nike’s Bond of $1 bn and $500 million issued in 2016.
We note the following about Nike’s Bond.
- Par value – The amount of money paid to the bondholders at maturity. A bond is issued in the denomination of $1000. It generally represents the amount of money borrowed by the bond issuer.
- Coupon – Coupon payments represent the periodic interest payments from the bond issuer to the bondholder during bonds payable accounting. The annual coupon payment is calculated by multiplying the coupon rateCoupon RateThe coupon rate is the ROI (rate of interest) paid on the bond's face value by the bond's issuers. It determines the repayment amount made by GIS (guaranteed income security). Coupon Rate = Annualized Interest Payment / Par Value of Bond * 100% by the bond’s face value. As we note above, Nike’s bond pays interest semiannually; generally, one-half of the annual coupon is paid to the bondholders every six months.
- Coupon rate – The coupon rate, which is generally fixed, determines the periodic coupon or interest payments. It is expressed as a percentage of the bond’s face value. It also represents the interest cost of the bond to the issuer. The coupon rate is 2.375% in the case of a $1 billion offer.
- Maturity – Maturity represents the date on which the bond matures, i.e., the date on which the face value is repaid. The last coupon payment is also paid on the maturity date. The maturity date is 11/1/2026.
Bonds Payable Vs Notes Payable
Both the above are two types of debt instruments available for investing in financial market, through which companies raise funds for financing operations. But there are some differences between them, as follows.
- The former is for long term whereas the latter is for short term.
- The long term bonds payable helps in raising a heavy amount for the issuer compared to the latter which raises a lesser amount of fund.
- Since the former is for larger amount of money, it is secured by collateral or backed by company assets or covenants that provide some protection to the bondholder in case the issuer is not able to repay the amount. But this is not the case for notes payable, since the investment amount is less.
- Since the former is for long term, the maturity period is usually more than one year, whereas for the notes payable, it is less than one year.
- The financing size for the long term bonds payable is more, which means it is used to major projects, expansion, growth and long-term needs. But the latter is for meeting the short-term working capital needs.
- The bonds payable usually has less rates due to their long-term nature compared to notes, which has higher interest rates.
- Both are subject to certain rules and regulation. But since the former involves larger fund requirement, the rules are more stringent as compared to the notes.
Therefore, the above are some important differences between these two types of debt instruments and both are widely used by investors in the financial market.
This article has been a guide to what is Bonds payable. We explain it with example, how to calculate along with journal entry & differences with notes payable. You may also have read through the following recommended articles –