Financial Accounting: Tools for

Business Decision Making

Tenth Edition

Kimmel ● Weygandt ● Mitchell

Chapter 10

Reporting and Analyzing Liabilities

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Chapter 10 Outline Part 1 – Revised Order

Learning Objectives
LO 2 Describe the major characteristics of bonds.
LO 3 Explain how to account for bond transactions.
App A Apply the straight-line method of bond amortization
 Characteristics of Bonds
• Long-term liabilities
o Obligations that are expected to be paid after one
year
• A form of interest-bearing notes payable issued by
corporations, universities, and governmental agencies
• Sold in small denominations (usually $1,000 or multiples
of $1,000)
• Usually accompanied by periodic interest payments

When a corporation issues bonds, it is borrowing money. The

person who buys the bonds, the bondholder, is investing in the
bonds.

LO 2
Types of Bonds - Secured and Unsecured
1. Secured bonds have specific
assets pledged as collateral.
2. Unsecured bonds are issued
against the general credit of the
borrower.
3. Convertible bonds can be
converted into common stock at
the option of the bondholder.
4. Callable bonds can be redeemed
(bought back) prior to maturity at
the option of the bond issuer.

LO 2
 Bond Terminology
 Bond certificate

► Issued to the investor.

► Provides name of the company issuing bonds, face value,

maturity date, and contractual (stated) interest rate.

 Face value - principal due at the maturity.

 Maturity date - date final payment is due.
 Contractual/stated interest rate – rate to determine cash interest
paid, stated as an annual rate (sometimes payments are semi-
annual).

Market/effective interest rate – rate that investors are currently

demanding & receiving on similar investments. Not listed on bond
certificate.
Bond Certificate
• Issued to
investor
• Provides key
information
about the bonds

LO 2
 Bond Trading
• Bondholders can sell their bonds at any time on national
securities exchanges
o Corporation makes no entries when bondholders trade on
exchanges because there is no effect on the corporation’s
financial statements
• Prices are quoted as a
percentage of face value
o Usually based on $1,000
o A quoted price of 97 means
that the selling price of the
bond is 97% of face value,
or $970

LO 2
 Market Information for Bonds
• Market information for Twitter bonds
o Twitter, Inc. has outstanding 3.875% (contractual
interest rate), $1,000 bonds that mature in 2027,
with a current yield return of 4.06%.
o At the close of trading, the price was 97.71% of
face value, or $977.10.
Issuer Bonds Maturity Close Yield
Twitter, Inc. 3.875% Dec. 15, 2027 97.71 4.06

LO 2
 Accounting for Bond Transactions
Bonds may be issued at
 face value,
 discount (below face value), or
 premium (above face value).
Corporations record bond transactions
 when they issue (sell) bonds
 when bond interest is accrued or paid
 when they redeem (buy back) bonds
 when bondholders convert bonds into common stock.
Corporation do not record bond transactions
 when bondholders sell their bonds to other investors

LO 3
 Issuing Bonds at Face Value
Candlestick Inc. issues $100,000 five-year, 10% bonds
dated January 1, 2025, at 100 (100%, at face value).
Interest is payable annually on January 1.

Entry by Candlestick to issue bonds on January 1, 2025

Cash 100,000 Always debit cash for current market value

Jan. 1,
2025 Bonds Payable 100,000 Always credit BP for face value

LO 3
 Accrual of Interest on Bonds
Issued at Face Value
• Interest is accrued over the term (life) of the bonds
Interest = Face value × Stated Interest Rate × Time Period
• Interest expense is reported on the income
statement
• Interest payable is classified as a current liability

LO 3
 Accruing Interest on Bonds
Issued at Face Value
Candlestick Inc. accrued annual interest on its
$100,000 five-year, 10% bonds dated January 1, 2025,
issued at 100.
Interest = $100,000 × 10% × 12/12 = $10,000
Accrue 1 yr. of interest: Jan 1st – Dec 31st

Entry by Candlestick to accrue interest on December

31, 2025
Dec. 31, The adjusting entry debits Interest Expense
Interest Expense 10,000
2025 Interest Payable 10,000 And credits Interest Payable

LO 3
 Paying Interest on Bonds
Issued at Face Value
• Interest payable is reduced when interest has been
previously accrued
On January 1, 2026, Candlestick Inc. paid the $10,000
interest it had accrued on its 100, five-year, 10%, $1,000
bonds issued at 100.

Entry by Candlestick to pay interest on January 1, 2026

Jan. 1, Interest payable 10,000 The interest payment debits Interest Payable
2026 And credits Cash
Cash 10,000

LO 3
 Bond Interest Rates
• Contractual interest rate
o Is the rate applied to the face (par) value to arrive at the
interest paid in a year
• Market interest rate
o Is the rate investors demand for loaning funds to the
corporation
o Changes daily
o Affected by the type of bond issued, the state of the
economy, current industry conditions, and the company’s
performance
When contractual and market rates differ, bonds sell below
(at a discount) or above (at a premium) face value.

LO 3
 Discount or Premium on Bonds

Bond prices vary inversely with changes in the market interest rate. As market interest
rates decline, bond prices increase. When a bond is issued, if the market interest rate
is below the contractual rate, the bond price is higher than the face value. Issuance of
bonds at an amount different from face value is common.

LO 3
Knowledge Check: Discount or Premium
Laurel Inc. issues 10-year bonds with a maturity value of
$200,000. If the bonds are issued at a premium, this
indicates that
a. the contractual interest rate exceeds the market
interest rate.
b. the market interest rate exceeds the contractual
interest rate.
c. the contractual interest rate and the market interest
rate are the same.
d. no relationship exists between the two rates.

LO 3
Knowledge Check: Discount or Premium
Laurel Inc. issues 10-year bonds with a maturity value of
$200,000. If the bonds are issued at a premium, this
indicates that
a. the contractual interest rate exceeds the market
interest rate.
b. the market interest rate exceeds the contractual
interest rate.
c. the contractual interest rate and the market interest
rate are the same.
d. no relationship exists between the two rates.

LO 3
 Issuing Bonds at a Discount
• Difference between face value and issue price is reported as
Discount on Bonds Payable (NEW ACCOUNT!)

On January 1, 2025, Candlestick Inc. issues $100,000, five-year,

10% bonds for $98,000 (98% of face value). Interest is payable
annually on January 1.

Entry to sell bonds at a discount MV always < Face when

bonds issued at < 100

Always debit cash for current market value

Jan. 1, Cash 98,000 Market Value = $100,000 x .98 = $98,000
2025 Discount on Bonds Payable 2,000 The balancing debit is the discount

Bonds Payable 100,000 Always credit B/P for face value

LO 3
 Reporting Bonds at a Discount
Discount on Bonds Payable
• Has a normal debit balance
• Is a contra account deducted
from bonds payable on the
balance sheet

Carrying

LO 3
 Effect of a Discount on
Cost of Borrowing
Issuance of bonds at a discount
• Issuing corporation must pay both
1. Face value at maturity
2. Contractual interest payments over
the term of the bonds
• Additional cost of borrowing
o Difference between the issuance price and face
value of the bonds—the discount
o Recorded as interest expense over the term of
the bonds
LO 3
 Total Cost of Borrowing
Bonds Issued at a Discount

Annual interest payments

($100,000 × 10% = $10,000; $10,000 × 5) $50,000
Add: Bond discount ($100,000 − $98,000) 2,000
Total cost of borrowing $52,000
or
Principal at maturity $100,000
Annual interest payments ($10,000 × 5) 50,000
Cash to be paid to bondholders 150,000
Less: Cash received from bondholders 98,000
Total cost of borrowing $ 52,000

LO 3
 Knowledge Check: Bond Issuance
On December 1, Somart issues $40,000 of 6-year, 5% bonds
for $38,600. Interest is payable annually on May 1.
Record the issuance of the bonds on December 1 and show
how the bonds will be reported on the balance sheet at the
date of issuance.

LO 3
 Knowledge Check: Bond Issuance
On December 1, Somart issues $40,000 of 6-year, 5% bonds
for $38,600. Interest is payable annually on May 1.
Record the issuance of the bonds on December 1 and show
how the bonds will be reported on the balance sheet at the
date of issuance.
Dec. 1 Cash 38,600
Discount on Bonds Payable 1,400
Bonds Payable 40,000
(To record sale of bonds at a discount)
Long-term liabilities
Bonds payable $40,000
Less: Discount on bonds payable 1,400 $38,600

LO 3
 Issuing Bonds at a Premium
• Difference between face value and issue price is reported as
Premium on Bonds Payable (New Account!)

On January 1, 2025, Candlestick Inc. issues $100,000, five-year,

10% bonds for $102,000 (102% of face value). Interest is
payable annually on January 1.

MV always > Face when

Entry to sell bonds at a premium bonds issued at > 100
Always debit cash for current market value
Jan. 1, Cash 102,000 Market Value = $100,000 x 1.02 = $102,000

2025 Bonds Payable 100,000 Always credit B/P for face value

Premium on Bonds Payable 2,000 The balancing credit is the premium

LO 3
 Reporting Bonds at a Premium
Premium on Bonds Payable
• Has a normal credit balance
• Is added to bonds payable
on the balance sheet

Carrying

LO 3
 Effect of a Premium on
Cost of Borrowing
Issuance of bonds at a premium
• Issuing corporation must pay both
o Contractual interest rate over the
term of the bonds
o Face value at maturity

• Reduction of the cost of borrowing

o Difference between the issuance price and face
value of the bonds—the premium
o Reduces interest expense over the bond term

LO 3
 Total Cost of Borrowing
Bonds Issued at a Premium

Annual interest payments

($100,000 × 10% = $10,000; $10,000 × 5) $50,000
Less: Bond premium ($102,000 − $10,000) 2,000
Total cost of borrowing $48,000
or
Principal at maturity $100,000
Annual interest payments ($10,000 × 5) 50,000
Cash to be paid to bondholders 150,000
Less: Cash received from bondholders 102,000
Total cost of borrowing $ 48,000

LO 3
Practice – Issuing Bonds at a Premium
 Practice – Issuing Bonds at a Premium

1. Jan. 1 Cash ($600,000 × 1.03) ........................... 618,000

Bonds Payable ............................... 600,000
Premium on Bonds Payable…….. 18,000

2. Long-term Liabilities
Bonds Payable, due 2024 .............................. $600,000
Add: Premium on Bonds Payable ............... 10,800
Carrying value $610,800

3. The bonds sold at a premium because contract interest rate (6%) was
higher than the market interest rate.
Learning Objective 5
Appendix A
Apply the Straight-Line Method of
Amortizing Bond Discount and Bond
Premium

LO 5
 Bond Discount Amortization
• The allocation of the discount to interest expense in each
period in which the bonds are outstanding
• Standard journal entry to amortize the discount:
Dr. Interest Expense
Cr. Discount on Bonds Payable
Cr. Interest Payable
o Amount of interest expense reported each period will
exceed contractual amount paid (reflects the higher cost
of borrowing associated with bonds sold at a discount)
• As discount is amortized
o Balance in Discount on Bonds Payable declines
o Carrying value of bonds increases
• Until the maturity carrying value of bonds equals their
face amount
LO 3
Straight-Line Method of Amortization:
Discount on Bonds Payable
• The balance in Discount on Bonds Payable
o decreases annually over the term of the bonds by the
same amount
o will have a zero balance at the maturity date of the
bonds
• The carrying value of the bonds will increase each period
until it equals the face value of the bonds at maturity

Carrying Discount on Bonds

Value = Bonds Payable − Payable

LO 5
 Bond Discount Amortization
• Carrying value of bonds
o Increases as amortization occurs
o Equals the bonds’ face amount at maturity

LO 3
 Straight-Line Amortization:
Bond Discount

Straight-line method of amortization

• Used to allocate bond discount to expense in each
period in which the bonds are outstanding
• Follows the expense recognition principle

Bond Number of Bond Discount

Discount ÷ Interest Periods = Amortization

LO 5
 Bond Discount Amortization
Candlestick Inc. sold $100,000, five-year, 10% bonds on
January 1, 2025, for $98,000 (discount of $2,000). Interest
is payable on January 1 of each year.
Entry to accrue interest and amortize the bond discount at
Dec. 31, 2025
Amortization: $2,000 ÷ 5 = $400
Interest payment = $100,000 × 10% = $10,000

Dec. 31 Interest Expense 10,400

This JE occurs Discount on Bonds Payable 400
on Dec. 31 of
each year for Interest Payable 10,000
the term of the
Bond
(To record bonds interest and
amortization of bond discount)

LO 5
Bond Discount Amortization Schedule
Candlestick Inc.
Bond Discount Amortization Schedule
Straight-Line Method—Annual Interest Payments
$100,000 of 10%, 5-Year Bonds

(A) (B) (C) (D) (E)

Interest to Interest Expense Discount Unamortized Bond
Interest Be Paid to Be Recorded Amortization Discount Carrying Value
Periods (10% x $100,000) (A) + (C) ($2,000 ÷ 5) (D) − (C) ($100,000 − D)
Issue date $2,000 $98,000
1 10,000 10,400 400 1,600 98,400
2 10,000 10,400 400 1,200 98,800
3 10,000 10,400 400 800 99,200
4 10,000 10,400 400 400 99,600
5 10,000 10,400 400 0 100,000
Total $50,000 $52,000 $2,000

LO 5
 Knowledge Check:
Bond Discount Amortization
Shop It sold $20,000, four-year, 5% bonds on January 1, 2025,
for $19,000. Interest is payable on January 1 of each year.
How much is annual interest expense for 2025?

How much is total interest expense over the bond term?

LO 5
Bond Discount Amortization Schedule
Shop It
Bond Discount Amortization Schedule
Straight-Line Method—Annual Interest Payments
$20,000 of 5%, 4-Year Bonds

(A) (B) (C) (D) (E)

Interest to Interest Expense Discount Unamortized Bond
Interest Be Paid to Be Recorded Amortization Discount Carrying Value
Periods (5% x $20,000) (A) + (C) ($1,000 ÷ 4) (D) − (C) ($20,000 − D)
Issue date $1,000 $19,000
1 1,000 1,250 250 750 19,250
2 1,000 1,250 250 500 19,500
3 1,000 1,250 250 250 19,750
4 1,000 1,250 250 0 20,000
Total $4,000 $5,000 $1,000

LO 5
 Knowledge Check:
Bond Discount Amortization
Shop It sold $20,000, four-year, 5% bonds on January 1, 2025,
for $19,000. Interest is payable on January 1 of each year.
How much is annual interest expense for 2025?
Annual Cash Interest Payment = $20,000 × 5% = $1,000
Annual Amortization = $1,000 ÷ 4 = $250
Annual Interest expense = $1,000 + $250 = $1,250
How much is total interest expense over the bond term?
Total cash payments = $1,000 × 4 = $4,000
Total discount = $20,000 − $19,000 = $1,000
Total interest expense = $4,000 + $1,000 = $5,000
Or Total interest expense = $1,250 x 4 = $5,000
LO 5
 Bond Premium Amortization
• The allocation of the premium to interest expense in each
period in which the bonds are outstanding
• The standard journal entry to amortize the premium:
Dr. Interest Expense
Dr. Premium on Bonds Payable
Cr. Interest Payable
o Amount of interest expense reported each period will be
less than the contractual amount paid (reflects the lower
cost of borrowing associated with bonds sold at a discount)
• As premium is amortized
o Balance in Premium on Bonds Payable declines
o Carrying value of bonds decreases
• Until maturity when the carrying value of bonds equals
their face amount
LO 3
Straight-Line Method of Amortization:
Premium on Bonds Payable
• The balance in Premium on Bonds Payable
o decreases annually over the term of the bonds by the
same amount
o Will have a zero balance at the maturity date of the bonds
• The carrying value of the bonds will decrease each period
until it equals the face value of the bonds at maturity

Carrying Premium on
= Bonds Payable +
Value Bonds Payable

LO 5
 Bond Premium Amortization
• Carrying value of bonds
o Decreases as amortization occurs
o Equals the bonds’ face amount at maturity

LO 3
 Bond Premium Amortization
Straight-line method of amortization
• Used to allocate bond premium as a reduction of
expense in each period in which the bonds are
outstanding
• Follows the expense recognition principle

Bond Number of Bond Premium

÷ Interest =
Premium Periods Amortization

LO 5
 Bond Premium Amortization
Candlestick, Inc., sold $100,000, five-year, 10% bonds on
January 1, 2025, for $102,000 (premium of $2,000).
Interest is payable on January 1 of each year.
Entry to accrue interest and amortize the bond discount at
December 31, 2025
Amortization: $2,000 ÷ 5 = $400
Interest payment = $100,000 × 10% = $10,000
Dec. 31 Interest Expense 9,600
This JE occurs Premium on Bonds Payable 400
on Dec. 31 of
each year for Interest Payable 10,000
the term of the
Bond (To record bonds interest and
amortization of bond premium)

LO 5
 Bond Premium Amortization Schedule
Candlestick Inc.
Bond Premium Amortization Schedule
Straight-Line Method—Annual Interest Payments
$100,000 of 10%, 5-Year Bonds

(A) (B) (C) (D) (E)

Interest to Interest Expense Premium Unamortized Bond
Interest Be Paid to Be Recorded Amortization Premium Carrying Value
Periods (10% x $100,000) (A) − (C) ($2,000 ÷ 5) (D) − (C) ($100,000 + D)
Issue $2,000 $102,000
date
1 10,000 9,600 400 1,600 101,600
2 10,000 9,600 400 1,200 101,200
3 10,000 9,600 400 800 100,800
4 10,000 9,600 400 400 100,400
5 10,000 9,600 400 0 100,000
Total $50,000 $48,000 $2,000

LO 5
 Knowledge Check:
Amortizing Bond Premium
Shop It sold $30,000, six-year, 4% bonds on January 1, 2025,
for $31,800. Interest is payable on January 1 of each year.
How much is annual interest expense for 2025?

How much is total interest expense over the bond term?

LO 5
 Bond Premium Amortization Schedule
Shop It
Bond Premium Amortization Schedule
Straight-Line Method—Annual Interest Payments
$30,000 of 4%, 6-Year Bonds

(A) (B) (C) (D) (E)

Interest to Interest Expense Premium Unamortized Bond
Interest Be Paid to Be Recorded Amortization Premium Carrying Value
Periods (4% x $30,000) (A) − (C) ($1,800 ÷ 6) (D) − (C) ($30,000 + D)
Issue $1,800 $31,800
date
1 1,200 900 300 1,500 31,500
2 1,200 900 300 1,200 31,200
3 1,200 900 300 900 30,900
4 1,200 900 300 600 30,600
5 1,200 900 300 300 30,300
6 1,200 900 300 0 30,000
Total $7,200 $5,400 $1,800

LO 5
 Knowledge Check:
Amortizing Bond Premium
Shop It sold $30,000, six-year, 4% bonds on January 1, 2025,
for $31,800. Interest is payable on January 1 of each year.
How much is annual interest expense for 2025?
Annual Cash Interest Payment = $30,000 × 4% = $1,200
Annual Amortization = $1,800 ÷ 6 = $300
Annual Interest Expense = $1,200 − $300 = $900
How much is total interest expense over the bond term?
Total cash payments = $1,200 × 6 = $7,200
Total premium = $1,800
Total interest expense = $7,200 − $1,800 = $5,400
Or Total interest expense = $900 x 6 = $5,400
LO 5
 Redeeming Bonds at Maturity
• At maturity carrying value of the bonds will equal the
face value of the bonds regardless if issued at a
discount or premium
Candlestick records the redemption (payback of the principle)
of its $100,000 bonds issued at $98,000 at maturity. Interest
for the last period has been separately paid and recorded.

Entry to redeem bonds at maturity

Bonds Payable 100,000 Always debit B/P for face value

Cash 100,000 And credit Cash

LO 3
 Extra Practice: Types of Bonds
Identify the type of bond(s) each statement describes.

1. A bond with a specific asset

pledged as collateral
2. Bonds that can be
exchanged for common
stock
3. Bonds issued against the
credit of the borrower
4. Bonds that the issuer can
buy back before maturity

LO 2
 Extra Practice: Types of Bonds
Identify the type of bond(s) each statement describes.

1. A bond with a specific asset Secured bond

pledged as collateral
2. Bonds that can be Convertible bonds
exchanged for common
stock
3. Bonds issued against the Unsecured bonds
credit of the borrower
4. Bonds that the issuer can Callable bonds
buy back before maturity

LO 2
Extra Practice – Issuing Bonds at a Discount
 Extra Practice – Issuing Bonds at a Discount

1. Jan. 1 Cash ($500,000 × .96) ........................... 480,000

Discount on Bonds Payable ................ 20,000
Bonds Payable ............................... 500,000

2. Long-term Liabilities
Bonds Payable, due 2029 .............................. $500,000
Less: Discount on Bonds Payable ............... 12,000 $488,000

3. Bonds sold at a discount because contract interest rate (7%) was lower
than the market interest rate.
 Extra Practice:
Recording and Reporting Bonds
On January 1, Somart issues $40,000 of 6-year, 5% bonds
for $41,200. Interest is paid annually on January 1. Record
the issuance of the bonds, and show how the bonds will be
reported on the balance sheet at the date of issuance.

LO 3
 Extra Practice:
Recording and Reporting Bonds
On January 1, Somart issues $40,000 of 6-year, 5% bonds
for $41,200. Interest is paid annually on January 1. Record
the issuance of the bonds, and show how the bonds will be
reported on the balance sheet at the date of issuance.
Jan. 1 Cash 41,200
Premium on Bonds Payable 1,200
Bonds Payable 40,000
(To record sale of bonds at a discount)
Long-term liabilities
Bonds payable $40,000
Add: Premium on bonds payable 1,200
$41,200
LO 3
 Extra Practice: Issuing Bonds

Review Question
The market interest rate:

a. is the contractual interest rate used to determine the

amount of cash interest paid by the borrower.

b. is listed in the bond indenture.

c. is the rate investors demand for loaning funds.

d. More than one of the above is true.

 Extra Practice: Issuing Bonds

Review Question
The market interest rate:

a. is the contractual interest rate used to determine the

amount of cash interest paid by the borrower.

b. is listed in the bond indenture.

c. is the rate investors demand for loaning funds.

d. More than one of the above is true.

 Extra Practice: Issuing Bonds

Review Question
Discount on Bonds Payable:

a. Has a credit balance.

b. Is a contra account.

c. Is added to bonds payable on the balance sheet.

d. Increases over the term of the bonds.

 Extra Practice: Issuing Bonds

Review Question
Discount on Bonds Payable:

a. Has a credit balance.

b. Is a contra account.

c. Is added to bonds payable on the balance sheet.

d. Increases over the term of the bonds.