At this stage, the bond issuer would pay the maturity value of the bond to the owner of the bond, whether that is the original owner or a secondary investor. For risk-adverse investors, bonds can be an attractive way to receive an anticipated return and safeguard capital. For issuers, bonds can be a way to provide operating cash flow, fund capital investments, and finance debt. The stated interest rate of a bond payable is the annual interest rate that is printed on the face of the bond and stated in the related legal document known as the bond indenture.

• Initially it is the difference between the cash received and the maturity value of the bond.
• They did this because giving a discount but still paying only 5% interest on the face value is mathematically the same as receiving the face value but paying 7% interest.
• This tax-exempt status of municipal bonds allows the entity to attract investors and fund projects more easily.
• If interest was promised semiannually, entries are made twice a year.

Investor 2 purchases the bond after a decline in interest rates for $1,100. The same will occur if interest rates drop, pushing the price of the bond higher in the secondary market. LO
13.1On April 1 a company sells a 5-year, $60,000 bond with a 7% stated interest rate. If interest is paid quarterly, the company makes interest payments of ________. For many investors, it may seem like the current environment is an aberration. Instead, bond watchers say the rate landscape we’d known since the 2008 financial crisis was the true anomaly.

Interest Rates Have Been Abnormally Low

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The interest payments are calculated based on the coupon rate of the bond, which is the annual interest rate paid on the bond. The coupon rate is set when the bond is issued and does not change during the life of the bond. In return for buying the issuer’s bonds, they agree to pay you regular interest payments, called coupons.

To record this action, the company would debit Bonds Payable and credit Cash. Remember that the bond payable retirement debit entry will always be the face amount of the bonds since, when the bond matures, any discount or premium will have been completely amortized. It looks like the issuer will have to pay back $104,460, but this is not quite true. If the bonds were to be paid off today, the full $104,460 would have to be paid back. But as time passes, the Premium account is amortized until it is zero.

However, there are some drawbacks to bond interest payments as well. Current yield is expressed as an annual percentage, which is affected by the price the buyer pays for it. When the interest rate environment declines, prices on the bond at hand generally rise. Regardless of the direction of interest rates and their impact on the price of the bond, the coupon rate and the dollar amount of interest paid by the bond will remain the same.

The $19 difference between the $469 interest expense and the $450 cash payment is the amount of the discount amortized. The entry on December 31 to record the interest payment using the effective interest method of amortizing interest is shown on the following page. The interest expense is calculated by taking the Carrying Value ($91,800) multiplied by the market interest rate (7%). The amount of the cash payment in this example is calculated by taking the face value of the bond ($100,000) and multiplying it by the stated rate (5%). Since the market rate and the stated rate are different, we need to account for the difference between the amount of interest expense and the cash paid to bondholders. The amount of the discount amortization is simply the difference between the interest expense and the cash payment.

• Bondholders will receive $30 in interest payments each year, generally paid on a semiannual basis.
• When you buy a company’s stock, you’re purchasing ownership in that company.
• Since they promised to pay 5% while similar bonds earn 4%, the company received more cash up front.
• The coupon rate is stated as an annual percentage rate based on the bond’s par, or face value.

Investors will receive coupon payments throughout the term of the bond and then receive the bond’s par value at its maturity date, which can be anywhere from a few months to 30 years away. A bond’s coupon rate tells an investor the dollar amount of interest they can expect to receive each year for as long as they hold the bond. This can help in planning your cash flow over the period until the bond matures.

Straight-line method

The stated interest rate is the interest rate listed on a bond coupon. Thus, if the issuer pays $60 on a bond with a face value of $1,000, then the stated interest rate is 6%. An investor can adjust the effective interest rate received by paying more or less than the face value when buying a bond. The concept can also be applied to the rate paid on a variety of savings instruments issued by a bank. The annual interest paid divided by bond par value equals the coupon rate. As an example, let’s say the XYZ corporation issues a 20-year bond with a par value of $1,000 and a 3% coupon rate.

Tax and accounting regions

“We’re in a more normal period of interest rates,” explains Kristy Akullian, iShares senior investment strategist at BlackRock. “The last 15 years were the exception rather than the norm.” She notes that over the past 60 years, 10-year Treasury yields have averaged about 5.9%. At the end of 5 years, the company will retire the bonds by paying the amount owed.

Stated interest rate definition

The coupon rate of a bond or other fixed income security is the interest rate paid out on the bond. LO
13.1On July 1, a company sells 8-year $250,000 bonds with a stated interest rate of 6%. If interest payments are paid annually, each interest payment will be ________. Akullian says current yield levels mean investors can benefit by adapting their portfolios to the new regime. For example, a $1,000 bond can sell for $950 or $1,050, but either way, $1,000 is what the coupon rate will be calculated from and what you’ll receive when the bond matures. If the coupon rate is 4%, you’ll receive $40 in annual coupon payments.

What is bond amortization?

For example, a bond might be callable by the issuing company, in which the company may pay a call premium paid to the current owner of the bond. Also, a bond might be called while there is still a premium or discount on the bond, and that can complicate the retirement process. Situations like these will be addressed in later accounting courses. As we go through the journal entries, it is important to understand that we are analyzing the accounting transactions from the perspective of the issuer of the bond. For example, on the issue date of a bond, the borrower receives cash while the lender pays cash. When a company issues bonds to generate cash, bonds payable are recorded and listed as a liability on the company’s balance sheet.

What It Means for Individual Investors

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While interest payments can be helpful in some situations, there are also a few drawbacks to consider. One of the biggest disadvantages is that interest payments can add up over time, especially if you have a large balance. This can make it difficult to pay off your debt, and you may end up paying more in interest than you originally borrowed. Let’s say Investor 1 purchases the bond for $900 in the secondary market but still receives the same $30 in interest.