Recording Interest Collection and Year-End Updating Entries
Let us discuss the current short-term bond investment of Jewel Corporation, to help clarify the accounting for bond transactions:
The interest dates of the $1,000,000 investment are January 1 and July 1. On July 1, the company will receive cash of $60,000 which represents interest income for three months, April 1 to July 1, that is computed as follows: $1,000,000 multiplied by .12 multiplied by 3 months/12 months. On December 31, the interest receivable from the month of July 1 to December 31 is $24,000 computed as: $400,000 multiplied by .12 or 12% multiplied by 6 months/over 12 months. $400,000 is assumed to be the remaining amount of bonds at the end of the period.
For the noncurrent bond investment, the semiannual interest is $60,000 and is received on October 1. The accrued interest at the end of December is $30,000 ($1,000,000 multiplied by .12 or 12% multiplied by three months (October 1 to December 31).
Unlike the current bond investment, another important end-of-year entry for noncurrent bonds is the amortization for either bond premium or discount. When does a discount or premium occur in a long-term investment? It happens when the face value of the bonds is different from its acquisition price. If the face value of the bonds is greater than the acquisition price, there is a discount; and if the acquisition price is bigger than the face value, there is a premium.
Philosophy on the Amortization
The reason for amortization of bond premium or discount is to bring the investment balance to its fair value on the date of maturity. The bondholder is a creditor and will collect on the date of maturity an amount equal only to the face value of the bonds, no more and no less.
The bond premium is a loss on the part of the bondholder because the bondholder paid more than what can be collected on the date of maturity. Such loss is not recognized outright but allocated over the life of the bonds; it will be offset against the interest income to be derived from the bond investment.
On the other hand, bond discount is a gain on the part of the bondholder because the bondholder paid less than what can be collected on the date of maturity. Such is not recognized outright but allocated over the life of the bonds to be added to the interest derived from the bond investment.
To continue with the noncurrent bond investment, the discount on the investment is $60,000 or the cost of $940,000 deducted from its fair value of $1,000,000.
The annual amortization is $12,000, which resulted from dividing the total discount of $60,000 over 5 years. The actual discount to be amortized is $9,000 computed as $12,000 a year/12 multiplied by 9 months.
Please continue to Page 4 for more on Accounting for Bond Transactions