Bonds Issued at a Premium

Definition

The term bonds issued at a premium refers to newly issued debt that is sold at a price in excess of its par value.   When a bond is issued at a premium, the company will typically choose to amortize the premium paid over the term of the bond using a straight line method.

Bonds can sell at a discount or premium to par value due to administrative delays in getting the offering to market.

Explanation

Issuing long-term bonds represents an important source of financing for many companies.  When a corporation prepares to issue bonds to investors, they determine an acceptable coupon rate, which reflects both the prevailing rate of interest and the creditworthiness of the company.

The process of issuing bonds to the public takes a considerable amount of time.  Approval is needed from the Securities and Exchange Commission, a prospectus must be written, and underwriting of the securities might be arranged.  This delay, along with changes in variables such as prevailing interest rates or the creditworthiness of the issuing company, can result in the bonds selling at a premium to their face value.  As a general rule of thumb, the price of a bond will move inversely with interest rates.

If a bond is sold at a premium, the excess amount received is referred to as a premium on bonds payable.  Companies will typically choose to use a straight line method to amortize this premium over the term of the bond.

Example

Company A issued $1,000,000 in bonds with a coupon rate of 5.0% and a term of ten years.  These bonds were well-received by the market, selling at 102, which is 102% of par value.

The journal entry to record the issuing of the bonds at a premium would be:

  Debit Credit
Cash ($1,000,000 x 1.02) $1,020,000  
Bonds Payable   $1,000,000
Premium on Bonds Payable   $20,000

Using the straight line method, Company A would amortize the premium over a period of ten years.  The journal entry for this transaction is as follows:

  Debit Credit
Premium on Bonds Payable ($20,000 / 10 years) $2,000  
Interest Expense   $2,000

As noted in the above journal entry, the premium received on a bond effectively lowers the interest expense of the issuing company.

Related Terms

liabilities, long-term liabilities, interest expense, bonds issued at a discount, debt issue costs, ability to pay, adjustment bond