Journal Entry of Bond issue

Assume a bond whose par value is $100,000 and whose contract rate is 10% payable annually is issued by the Greenfield Corporation. If the market rate is also 10%, the selling price will be the par value of $100,000. Assuming the date of issue is January 1, 19X1, interest is payable every December 31 and the life of the bond is 4 years, the journal entries will be as follows:

Jan. 1, 19X1 

 

Cash                     100,000
Bonds Payable                 100,000

Dec. 31, 19X1 

 

Interest Expense             10,000
Cash                                          10,000
(This entry will be repeated every December 31 through 19X4).

Jan. 1, 19X5 

 

On this date, Greenfield Corporation will pay back the principal and make the following entry:

Bonds Payable         100,000
Cash                                     100,000

It often happens that after a corporation prints up a bond, the market rate changes. If the market rate goes up nobody will be willing to buy this bond since it pays a lower rate than the market. What should the corporation do? It can simply tear up the bond and print a new one with the higher rate. However, printing takes time and costs money. A better idea would be to sell the bond at a discount—below par. At maturity time, however, the corporation must pay back the full par because it is so stated in the indenture (a helpful rule to remember is: The corporation must always pay exactly what the bond says). Thus the extra  payback received by the buyer at maturity compensates him or her for the low interest rate in the  bond. Indeed it may be considered additional interest.