Accounting: The Language of Business (Part 93)

I got fired from a job years ago. It was an accounting job. They were basically trying to cut corners, so they employed a bunch of temps to do proper accounting. And it just caused absolute bedlam and I did get fired.

Nish Kumar

Bonds Payable and Investments in Bonds (Part D)

by

Charles Lamson

Investment in Bonds

Throughout the last several posts, we have discussed bonds and the related transactions of the issuing corporation (the debtor). However, these transactions also affect investors. In this section, we discuss the accounting for bonds from the point of view of investors.

Accounting for Bond Investments---Purchase, Interest, and Amortization

Bonds may be purchased either directly from the issuing corporation or through an organized bond exchange. Bond exchanges publish daily bond quotations. These quotations normally include the bond interest rate, maturity date, volume of sales, and the high, low, and closing prices for each corporation's bonds traded during the day. Prices for bonds are quoted as a percentage of the face amount. Thus, the price of a $1,000 bond quoted at 99.5 would be $995, while the price of a bond quoted at 104.25 would be $1,042.50.

As with other assets, the cost of a bond investment includes all costs related to the purchase. For example, for bonds purchased through an exchange, the amount paid as a broker's commission should be included as part of the cost of the investment.

When bonds are purchased between interest dates, the buyer normally pays the seller the interest accrued from the last interest payment date to the date of purchase. The amount of the interest paid is normally debited to Interest Revenue, since it is an offset against the amount that will be received at the next interest date.

To illustrate, assume that an investor purchases a $1,000 bond at 102 plus a brokerage fee of $5.30 and accrued interest of $10.20. The investor records the transaction as follows:

The cost of the bond is recorded in a single investment account. The face amount of the bond and the premium (or discount) are normally not recorded in separate accounts. This is different from the accounting for bonds payable. Separate premium and discount accounts are usually not used by investors, because they usually do not hold the bond Investments until the bonds mature.

When bonds held as long-term investments are purchased at a price other than the face amount, the premium or discount should be amortized over the remaining life of the bonds. The amortization of premiums and discounts affects the investment and interest accounts as shown below.

 The amount of the amortization can be determined by using either the straight line or interest methods. Unlike bonds payable, the amortization of premiums and discounts on bond investments is usually recorded at the end of the period, rather than when interest is received.

To illustrate the accounting for bond investments, assume that on July 1, 2022, Crenshaw Inc. purchases $50,000 of 8% bonds of Deitz Corporation, due in 8 3/4 years. Crenshaw Inc. purchases the bonds directly from Deitz Corporation to yield an effective interest rate of 11%. The purchase price is $41,706 plus interest of $1,000 ($50,000 X 8% * 3/12) accrued from April 1, 2022, the date of the last semiannual interest payment. Journal entries in the accounts of Crenshaw Inc. at the time of purchase and for the remainder of the fiscal period ending December 31, 2022 are as follows: 

Accounting for Bond Investments---Sale

Many long-term investments in bonds are sold before their maturity date. When this occurs, the seller receives the sales price (less commissions and other selling costs) plus any accrued interest since the last interest payment date. Before recording the cash proceeds, the seller should amortize any discount on premium for the current period up to the day of sale. Any gain or loss on the sale is then recorded when the cash proceeds are recorded. Such gains and losses are normally reported in the Other Income section of the income statement.

To illustrate, assume that the Deitz Corporation bonds in the preceding example are sold for $47,350 plus accrued interest on June 30, 2029. The carrying amount of the bonds (cost-plus amortized discount) as of January 1, 2029 (78 months after their purchase) is $47,868 [$41,706 + $6 + ($79 per month * 78 months)].The entries to amortize the discount for the current year and to record the sale of the bonds are as follows: 

*WARREN, REEVE, & FESS, 2005, ACCOUNTING, 21ST ED., PP. 614-616*

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