What is the Carrying Value of Bond?
Carrying value of a bond is also known as book value or carrying amount of bond and it is nothing but the sum total of the face value and unamortized premiums (if any) less unamortized discounts (if any) of a bond and this amount is usually projected on the issuing company’s balance sheet.
It’s known that bond pricesBond PricesThe bond pricing formula calculates the present value of the probable future cash flows, which include coupon payments and the par value, which is the redemption amount at maturity. The yield to maturity (YTM) refers to the rate of interest used to discount future cash flows. are volatile since they fluctuate daily. As the price is not constant, it causes the bond to be traded at a premium or discount according to the difference between the market rate of interest and stated bond interest on the date of issuance. These premiums or discounts are amortized over the life of the bond, thereby making the value of the bond equal to the face value on maturity.
How to Calculate the Carrying Value of Bond?
The effective interest methodThe Effective Interest MethodEffective interest method is used for allocating interest expense over the life of financial instruments with the help of standard rate and the market rate of a financial instrument with the aim of reaching to the par value of instrument which is sold either at discount or premium by accumulating and amortizing interest expenditure to carrying value of the financial instrument on systematic and consistent basis respectively. is one of the most common ways for amortizing premiums and discounts and perhaps one of the easiest methods for computation of carrying value.
For simplicity, let’s assume a firm issue 3 year bond with a face value of $100,000 has an annual coupon rate of 8%. The investors view the firm as with considerable risk and are willing to purchase the bond only if it offers a higher yield of 10%.
Since the YTM (yield to maturityYield To MaturityYield to Maturity refers to the expected returns an investor anticipates after keeping the bond intact till the maturity date. In other words, a bond's expected returns after making all the payments on time throughout the life of a bond.) of 10% is higher than the coupon rate (8%), the bond shall be sold at a discount. Thus, its carrying value shall be less than its face value of $100,000.
Let us consider another below example with a Bond Amortization schedule for a bond Par value of $600,000 for improved understanding:
|Number of Payments||Payment Date||Amount of Payment [A]||Bond Interest Expense [B]||Discount Amortized [C]||Unamortized Discount [D]||CarryingValue of Bond [E]|
|0||Jan 1, 2013||2,03,408.03||3,96,591.97|
|1||Jan 1, 2013||36,000||47,591.04||-11,591.04||1,91,816.99||4,08,183.01|
|2||Jan 1, 2014||36,000||48,981.96||-12,981.96||1,78,835.03||4,21,164.97|
|3||Jan 1, 2014||36,000||50,539.80||-14,539.80||1,64,295.24||4,35,704.76|
|4||Jan 1, 2015||36,000||52,284.57||-16,284.57||1,48,010.67||4,51,989.33|
|5||Jan 1, 2015||36,000||54,238.72||-18,238.72||1,29,771.95||4,70,228.05|
|6||Jan 1, 2016||36,000||56,427.37||-20,427.37||1,09,344.58||4,90,655.42|
|7||Jan 1, 2016||36,000||58,878.65||-22,979.65||86,465.93||5,13,534.07|
|8||Jan 1, 2017||36,000||61,624.09||-25,624.09||60,841.84||5,39,158.16|
|9||Jan 1, 2017||36,000||64,698.98||-28.698.98||32,142.86||5,67,857.14|
|10||Jan 1, 2018||36,000||68,142.86||-32,142.86||0||6,00,000.00|
Below is the basis of calculations:
- A = $600,000 * 0.06
- B= E * 0.12
- C = A – B
- D = Prior payment unamortized discount minus current discount amortized
- E = Prior carrying balance minus current discount amortized
Whenever there is an issuance of a bond, a premium or discount account is created, which consists of the difference between the face value of the bond and the cash collected through the sale of the bond. While recording them in the financial statementsThe Financial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels., the bond premium or discount is netted with bonds payable for computing the carrying value of the bond.
The carrying value/book value of a bond is the actual amount of money an issuer owes the bondholder at a given point in time. This is the par value of the bond less any remaining discounts or including any remaining premiums.
Recording Carrying Value of Bond on Financial Statements
The carrying value or book value of bonds payable includes the following amounts, all of which are found in bond-related liability accounts:
- The face value of the bonds is a credit balance in the account Bonds payableBonds PayableBonds payable are the company's long-term debt with the promise to pay the interest due and principal at the specified time as decided between the parties. A bond payable account is credited in the books of accounts with the corresponding debit to the cash account on the issue date.
- The related unamortized discount is a debit balance in the contra-liability account as ‘Discount on Bonds PayableDiscount On Bonds PayableDiscount on bonds payable is the markdown value of a bond's coupon rate or selling price compared to its market interest rate or fair value. Such bonds trade at a lower price than their face value..’
- The related unamortized premium is a credit balanceA Credit BalanceCredit Balance is the capital amount that a company owes to its customers & it is reflected on the right side of the General Ledger Account. Usually, Liability accounts, Revenue accounts, Equity Accounts, Contra-Expense & Contra-Asset accounts tend to have the credit balance. in the adjunct liability account as ‘Premium on Bonds Payable.’
- The unamortized bond costs associated are a debit balanceDebit BalanceIn a General Ledger, when the total credit entries are less than the total number of debit entries, it refers to a debit balance. A debit balance is a net amount often calculated as debit minus credit in the General Ledger after recording every transaction. in the contra-liability account.
One should note that the discount, premium, and issue costs are amortized properly up to the moment when the book value of the bonds is needed.
- The carrying value of bonds upon maturity will be equivalent to the par value (amount on which the issuer pays interest and is required to be repaid at the end of the term. For bonds sold at a discountBonds Sold At A DiscountA discount bond is one that is issued for less than its face value. It also refers to bonds whose coupon rates are lower than the market interest rate and thus trade for less than their face value in the secondary market., the carrying value will increase and equal their par value on maturity.
- On the other hand, for bonds sold at a premium, the carrying valueCarrying ValueCarrying value is the book value of assets in a company's balance sheet, computed as the original cost less accumulated depreciation/impairments. It is calculated for intangible assets as the actual cost less amortization expense/impairments. will fall and equal the par value on maturity.
Certain structure bonds can have a redemption amount different from the face value and can also be linked to the performance of assets such as FOREX, commodity index, etc. This may result in the investor receiving more or less than its original value on maturity.
This has been a guide to the Carrying Value of Bond. Here we discuss how to amortize premiums/discounts and calculate the Carrying Value of Bond and also how to record it on financial statements. You can learn more from the following articles –