Journal Entry for Bonds Purchased at Premium

The company purchase bonds at a premium when the bond’s rate is higher than the market rate. It happens when the company pays to bonds issuer at a cost that is higher than the bonds par value.

Bonds are the financial instruments that issuers use to raise capital from investors in the market. In simple terms, the issuer borrows money from the investors by issuing bonds as proof. On the maturity date, investors can bring the bonds to claim back the principal. In addition, the holder of the bonds is entitled to receive the interest income as stated on the bonds.

It is the debt that the issuer owes to the bondholder. Each bond has a par value and interest rate. The issuer has the obligation to the interest-based on the par value and interest rate on the bonds. At the end of the bonds’ term, they have to pay back to the bondholder.

On the investor’s side, they have to pay a certain amount of cash to obtain the bonds. In exchange for that, they will receive annual interest income. The principle will be received at the end of bonds term. The investors have to record it as a long-term investment on the balance sheet. It sounds simple when the investors paid for bonds and record it as an investment. However, the problem comes when the bonds are sold at a different price from the par value.

In real practice, bonds can be sold at a price that is lower or higher than the market due to the interest rate. It is called bonds sold at a premium or discount. When the bond’s interest rate is higher than the market rate, investors are willing to pay more than the par value as the bonds will generate more return than the market. On the other hand, when the bond interest rate is lower than the market rate, the investors will not want to purchase it. Investors can put money in other securities and earn more. In this situation, the issuer will low down the bonds price to attract the purchase.

Journal Entry for Bond Purchased at Premium

When the company purchase bonds from the market, it will record the investment in bonds on the balance sheet.

Journal entry is debiting investment in bonds and credit cash.

The transaction will increase long-term investment on the balance sheet and reduce the cash balance.

The company will record investment based on the amount paid to issuer. This amount is higher than the par value as the bonds are sold at a premium. On the maturity date, the issuer will only pay the par value back to the holder. So it will be a variance between investment and cash received on the maturity date.

This variance must be credited from balance sheet by allocating over the bond hold period. It is the difference between cash received and interest income.

The journal entry is debiting cash and credit interest income, investment in bonds.

The cash received will depend on the bond’s par value multiplied by the bond’s interest rate. Interest income depends on par value and market rate. Investment in bonds is equal to the amortizing of the difference between bonds’ purchase price and par value.

At the end of bonds’ term, the investment in bonds will reduce to the par value. It will be reversed when company receives the cash from the issuer.

Journal Entry for Bond Purchased at Premium Example

ABC is an investment firm. During the year, the market interest rate is 10%. Company XYZ issues 5 years 12% interest bonds at a $ 1,000 par value. Due to the high-interest rate, XYZ is able to sell the bonds at a premium price of 1,075.82.

ABC purchase 100 bonds from XYZ for 107,582.

Please prepare journal entry for bonds purchased at a premium.

XYZ sells 5 years 12% interest bonds with a $ 1,000 par value. It means that XYZ will pay an annual interest of 12% to the bondholder and pay back the principal of $ 1,000 at the end of bond term.

As the interest rate is higher than the market, many people are looking to buy bonds and it increases the price. The issuer will be able to sell at a premium, and they have to calculate the bond price.

The bonds can be sold for $ 1,075.82 while the par value is only $ 1,000.

When ABC purchase 100 bonds for $ 107,582, they have to record investment in bond and cash payout.

Journal entry is debiting investment in bond $ 107,582 and credit cash $ 107,582.

At the end of first year, ABC receive interest revenue from XYZ amount $ 120 per bond as it is the

Cash receive = 100 bonds * 12% * 1,000 = $ 12,000

The issuer pay interest base on bond rate, but the ABC record interest income base on the market rate as they purchase bonds base on market price and carry amount.

Interest income = 100 bonds * 10% * 1,075.82 = $ 10,758

The journal entry is debiting cash of $ 12,000 credit interest income of $ 10,760, Investment on bond of $ 1,240.

The transaction will record cash receive $ 12,000 from bond issuer. It also records an interest income of $ 10,758 based on the above calculation. The different between interest receive and interest income will be the deduction of investment in bond.

ABC needs to reduce the investment in bond carry amount to the bonds par value.

In total, ABC record cash receive of $ 60,000 which aligns with the interest payment from the bond issuer. The investment in the bond will be reversed to zero when the issuer pays back the par value.