How to Calculate Interest Expense on Bonds Payable

by Chirantan Basu ; Updated September 26, 2017

Corporations, public-sector organizations and governments issue bonds to raise capital. Bonds pay regular interest, and the investors get the principal or par value of the bond back on maturity. The interest expense is a function of the coupon or nominal interest rate, the par value and the issuing price. Record the interest expense when you prepare the financial statements for an accounting period and record the cash interest payment.

Multiply the coupon rate by the principal to determine the annual interest payment. Corporate bonds typically pay interest semiannually. For example, the semiannual interest payment for a five-year, $1,000 par-value bond with an annual 8 percent coupon is $40 [($1,000 x 0.08) / 2 = $80 / 2 = $40].

Calculate the interest expense for bonds issued at par, meaning the issuing price equals the par value. Debit interest expense and credit cash by the interest payment, which is $40 in the example.

Compute the interest expense for bonds issued at a discount to par, meaning the issuing price is less than the par value. This occurs when the prevailing market interest rate is greater than the coupon rate. The straight-line method amortizes this discount equally over the life of the bond. Debit interest expense by the sum of the interest payment and the discount amortization, credit cash by the interest payment amount and credit discount on bonds payable by the amortization amount. The discount on bonds payable account is a contra account that reduces the value of the bonds payable account. Continuing with the example, if the bond was issued at a discount of $150, the semiannual amortization using the straight-line method is $15 [($150 / 5) / 2 = $30 / 2 = $15]. Debit interest expense by $55 ($40 + $15), credit cash by $40 and credit discount on bonds payable by $15.

Calculate the interest expense for bonds issued at a premium to par, meaning the issuing price is more than the par value. This occurs when the prevailing market interest rate is lower than the coupon rate. Debit interest expense by the difference of the interest payment and the premium amortization, credit cash by the interest payment amount and debit premium on bonds payable by the amortization amount. The premium on bonds payable account is a contra account that increases the value of the bonds payable account. Continuing with the example, if the bond was issued at a premium of $200, the semiannual amortization using the straight-line method is $20 [($200 / 5) / 2 = $40 / 2 = $20]. Therefore, debit interest expense by $20 ($40 - $20), credit cash by $40 and debit premium on bonds payable by $20.

Tips

  • Debits increase asset accounts, such as cash, and expense accounts, such as interest expense. Debits decrease revenue, liability and shareholders' equity accounts. Credits decrease asset and expense accounts, and they increase revenue, liability and shareholders' equity accounts.

About the Author

Based in Ottawa, Canada, Chirantan Basu has been writing since 1995. His work has appeared in various publications and he has performed financial editing at a Wall Street firm. Basu holds a Bachelor of Engineering from Memorial University of Newfoundland, a Master of Business Administration from the University of Ottawa and holds the Canadian Investment Manager designation from the Canadian Securities Institute.

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