Issued at discount

If the effective interest rate is above the stated interest rate, then the bond is issued at a discount.

This means the selling price will be lower than the face value!

The annuity payments (defined with "stated interest") will cover less than the "effective interest" that the bond accrues year-after-year.

This makes the Bonds Payable rise each time we make an annuity payment, since our annuities aren't covering all the interest.

The selling price being less than face value enables the bond liability to grow until it reaches the face value at maturity!

Face Amount$100
Stated Annual Interest Rate10%
Terms3
Interest PaidAnnually
Effective Interest Rate12%

Selling Price

PV of Bond = $100 x 0.71178
PV of Bond = $71.18

Annuity = $100 x 10%
Annuity = $10

PV of Annuities = $10 x 2.40183
PV of Annuities = $24.02

Selling Price = PV of Bond + PV of Annuities
Selling Price = $71.18 + $24.02
Selling Price = $95.20

Interest Payments

TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1??????????????????
TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1$95.2012%????????????
TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1$95.2012%$95.20 x 12% = $11.42?????????
TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1$95.2012%$95.20 x 12% = $11.42$10??????
TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1$95.2012%$95.20 x 12% = $11.42$10$11.42 - $10 = +$1.42???
TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1$95.2012%$95.20 x 12% = $11.42$10$11.42 - $10 = +$1.42$95.20 + $1.42 = $96.62
TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1$95.2012%$95.20 x 12% = $11.42$10$11.42 - $10 = +$1.42$95.20 + $1.42 = $96.62
TransactionDebitCredit
??????
     Cash$10
     ??????

Credit to Cash because we're paying the $10 annuities each term with cash, and assets (Cash) have a normal debit balance.

TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1$95.2012%$95.20 x 12% = $11.42$10$11.42 - $10 = +$1.42$95.20 + $1.42 = $96.62
TransactionDebitCredit
Interest Expense$11.42
     Cash$10
     ??????

Debit to Interest Expense because interest on our bond is a cost of running business, and expenses (Interest Expense) have a normal debit balance.

TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1$95.2012%$95.20 x 12% = $11.42$10$11.42 - $10 = +$1.42$95.20 + $1.42 = $96.62
TransactionDebitCredit
Interest Expense$11.42
     Cash$10
     Bonds Payable$1.42

Credit to Bonds Payable because since our annuity didn't cover the entire interest expense, we now add $1.42 to our bond liability, and liabilities (Bonds Payable) have a normal credit balance.

Maturity

TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1$95.2012%$95.20 x 12% = $11.42$10$11.42 - $10 = +$1.42$95.20 + $1.42 = $96.62
2$96.6212%$96.62 x 12% = $11.59$10$11.59 - $10 = +$1.59$96.62 + $1.59 = $98.21
TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1$95.2012%$95.20 x 12% = $11.42$10$11.42 - $10 = +$1.42$95.20 + $1.42 = $96.62
2$96.6212%$96.62 x 12% = $11.59$10$11.59 - $10 = +$1.59$96.62 + $1.59 = $98.21
3$98.2112%$98.21 x 12% = $11.79$10$11.79 - $10 = +$1.79$98.21 + $1.79 = $100
TermBonds Payable (beg.)Effective Interest RateInterest ExpenseAnnuity+/- Bonds PayableBonds Payable (end)
1$95.2012%$95.20 x 12% = $11.42$10$11.42 - $10 = +$1.42$95.20 + $1.42 = $96.62
2$96.6212%$96.62 x 12% = $11.59$10$11.59 - $10 = +$1.59$96.62 + $1.59 = $98.21
3$98.2112%$98.21 x 12% = $11.79$10$11.79 - $10 = +$1.79$98.21 + $1.79 = $100
TransactionDebitCredit
Bonds Payable$100
     ??????

Debit to Bonds Payable because after amortization, we're paying off the face value of the bond, and liabilities (Bonds Payable) have a normal credit balance.

TransactionDebitCredit
Bonds Payable$100
     Cash$100

Credit to Cash because we're using $100 in cash to pay off the face amount of the bond, and assets (Cash) have a normal debit balance.

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