Face Value Bonds - Online Tutor, Practice Problems & Exam Prep

Face value bonds are issued when the stated interest rate equals the market rate, resulting in the bond selling at its face value. For example, a $50,000 bond with a 9% interest rate pays $4,500 annually, or $2,250 semi-annually. Journal entries include debiting cash and crediting bonds payable upon issuance, and recording interest expense and cash payments at each interest date. At maturity, the principal is repaid by debiting bonds payable and crediting cash, eliminating the liability. Understanding these concepts is crucial for mastering the accounting cycle and managing accrued liabilities.

Issuing Face Value Bonds

Alright. Let's start with the easier case of face value bonds. Remember, the face value bonds, this is where the stated rate and the market rate are going to be equal. So let's check out this simpler example. A bond is issued at face value when the stated rate is equal to the market rate. So that means that our bonds, we're saying, "Hey, everybody. Come buy our bonds that we're offering 10% interest and everyone else on the market is also offering 10% interest." So since it's equal, they're going to be sold at face value, okay? And, sometimes we get into why we price the bonds like this and it has to do with present value calculations, okay? So present value, this has to do with the time value of money and it's saying if we take back all the value of the interest payments and the principal payments we're going to get in the future, what's that worth to me today? Okay? And some of you are going to go into a little more calculations with that and some of you won't. So that's the main idea of how these prices come about, but in this class, we usually don't go too deep with it. Alright? So let's go ahead and start thinking about, we're going to have this table at the top of the next few pages as a summary to keep our head thinking about how the stated rate and market rate impact the selling price of a bond. Okay? This is the biggest part of this chapter of what you need to memorize of when we're going to have discounts, when we're going to have premiums, when it's face value. It all has to do with this interest rate. The stated rate and the market rate. So when the stated rate equals the market rate, just like we're talking about right now, 10% and 10%, well, that's the price of the bond will be equal to the face value.

Remember, the face value of the bond, that's the principal amount. And, in general, when we talk about the face value, they're usually $1,000 bonds, but we might sell tons of bonds, right? So the face value of a $2,000 bond is $1,000,000, alright? So we would have sold a $1,000,000 worth of bonds for $1,000,000 in that case, okay? So the stated rate equals the market rate when we sell at face value. Now let's look at our 2 other situations. It could be when the stated rate is less than the market rate and that would be a situation where the stated rate we're saying, "Hey, our bonds are offering 8%, and the market is offering 10%." Well, our bonds are not as enticing to investors. Right? So they're not going to be willing to pay us the full face value. They will be the price of the bond will be less than the face value. Okay? And that'll be a situation where we have a discount, and then the last situation, well, this would be when the stated rate is greater than the market rate. Right? Now, we're offering 12% when the market's offering 10%. Well, this the price of the bond will be greater than face value, okay? So notice how the the stated rate and the price of the bond go in equal directions, right? If we have a better stated rate than the market, well then the price of the bond will be greater than the face value. Okay? So they go in the same direction there. Premium on bonds when the stated rate is greater than market rate, but let's focus on this first situation where they're sold at face value and sometimes that's called par value as well. Same thing. Okay?

So let's go ahead and see how we make the journal entries for face value bonds. Let's start here with issuance. On January 1, 2018, ABC Company issues $50,000 of 9% bonds payable, maturing in 5 years. So notice, $50,000 this is the principal amount, the face value. Now this principal amount might be the amount of cash we actually receive. The amount of cash we actually receive depends on that percentage, right, when they tell us we're going to sell them for 100%, 103%, 92%. Remember when we did those examples? Well, that's going to tell us how much cash we actually receive. Another way we can see how much cash we receive is to compare the interest rates. If the interest rate, in this case, they told us these have 9% bonds payable. Well, this is the stated rate right here. This 9% bond payable because that's where it states it. ABC Company is issuing $50,000 of 9% bonds payable, that means they're going to pay 9% and they're maturing in 5 years. So this is the maturity date, it's in 5 years. Interest is payable semi-annually; remember, semi-annual interest means twice per year. So it's not just going to be yearly that we pay interest, we're going to pay it every 6 months, basically, on January 1st and July 1st. And finally, it tells us the market interest rate is equal to 9%, right? So we've got the stated rate of 9%, the market rate of 9% and that's why in this case, we have face value bonds, right? We have the stated rate equal to the market rate. They could have also told us, these bonds sold for 100 and that meant they sold for 100% of their face value, which would be equal to the face value. And this is why these are the easiest because the face value equals the cash received, okay?

Now I know we've gone through a lot of terminology there, right? We had our principal amount, our stated rate, our market rate, maturity period. There's a lot of information going on here, but you're going to see as we go through more and more examples, this is going to stay constant. You're going to get used to it as we go on and on. So in this case, we the stated rate equaled the face, equaled the market rate, so we're going to receive the full face value of the bonds. Okay? They're going to sell for face value and we're going to receive all of that amount in cash. So this journal entry, remember we're selling bonds here, we're selling a liability, we're going to receive cash and we're going to owe money later, okay? So this journal entry, we're receiving cash, so we're going to debit cash for $50,000 and then we're going to credit our bonds payable, right? We have a liability now for bonds payable that we're going to pay in the future, and that's going to be in the amount of $50,000. Okay? The bonds payable account will always hold the face value, okay? Will always, always be face value. Even when we're dealing with the discounts and the premiums, we always in the bonds payable account, we'll put the face value of the bonds. Okay? So we'll see more details about that once we get to discounts and premiums. Alright? So in this case, we received cash, right? The cash received was $50,000, so that increased our assets by $50,000, but how did we get that cash? How did we pay for it? With a liability, right? Now, we owe $50,000 in the future. So we took on a liability for $50,000, our assets increased, and our liabilities increased by $50,000.

Alright. Let's pause here and then let's start dealing with interest expense as time goes on.

Face Value Bonds:Interest Expense and Cash

Alright. When we deal with face value bonds, interest expense is really easy. It's just going to be equal to the cash amount of interest that we pay, okay? So let's go ahead and figure that out. It told us that $50,000 of bonds are paying 9% interest. Well, we take the $50,000, and this is the principal amount of the bonds times 9% (0.09), and let's find out how much that is. $50,000 times 0.09 equals 4,500. Okay? So $4,500 is the yearly amount of interest that we're going to pay. Right? Yearly interest because it's a 9% bond, but notice when we pay the interest in these cases. In this example, we're paying interest semiannually which is twice per year, so we're going to make journal entries every 6 months. Every 6 months, we're going to owe interest and we're going to take on our interest expense for those 6 months and then the next 6 months we'll take the rest of the interest expense for the year. So July 1st, remember only 6 months have passed. We issued them on January 1st, and now it's July 1st. So 6 months of interest, months of interest, well, that's going to equal our yearly amount of interest, the $4,500 divided by 2, which comes out to $2,250, right? So from January through June, those 6 months, we have to pay 6 months of interest, which is half of the 9%. Right? So we're going to pay $2,250 in cash on July 1st, and this is what our journal entry is going to look like. Well, we have to credit cash, right? Because cash is coming out of our pocket for $2,250. So this is always going to be the easiest part of your interest expense journal entry. For face value bonds, it's very easy, but once we get to premiums and discounts, it's going to get a little hairier. So I always like to start with the cash part because you're just taking the principal amount times your stated interest rate. Right? Principal amount times stated interest rate and if it's semiannual, well then you have to divide it by 2. Just like we did in this case. Okay. Stated amount times principal amount and that gives us our yearly interest, divide by 2, gives us the 6 months of interest. So we're going to credit cash for $2,250 and in this case, that equals our interest expense because it's a face value bond. So it's very easy to calculate in this case. We're going to debit interest expense for $2,250, credit cash for $2,250 and our journal entry is complete, right? We took cash out of our pocket and paid that in interest and that is equal to our interest expense, okay? So our cash is decreasing by $2,250 and interest expense, well, this is going to our income statement, right? It's an expense. It goes to the income statement and it's going to lower our equity, right? Our expenses lower equity. So interest expense of $2,250. Well, that lowers our equity by $2,250 and we stay balanced here, alright? Let's pause and let's keep going with this exam.

Face Value Bonds:Interest Expense and Interest Payable

Alright. So as time continues, we're going to have to keep paying interest, right? But what's going to happen before our next interest payment date, right? The next interest payment date is going to be when January 1st rolls around. Well, we're going to issue our financial statements at the end of the year on December 31st. Right? But that still means that 6 months have gone by. Right? The other 6 months of interest have gone by. So we would still calculate it the same. We'd have the $50,000 in principal times 0.09 which gives us the yearly amount of interest which we had calculated to be $4,500 yearly, right? But we divide that by 2 to get the 6 months of interest, right? So we had already taken 6 months of interest expense in the previous journal entry in the previous video and now we're going to take the next 6 months from July through December. So on December 31, 2018, we're going to make another journal entry for the other $2,250. Okay? Now this one's a little technical, but in general, it's just good to know how we're making this entry. So on December 31, 2018, well, what are we going to do? We're going to take our interest expense, right? And that was since it's a face value bond, well, we know it was going to be the $2,250, but what's the other side? We haven't paid it in cash yet. We don't pay it in cash until January 1st, the next day. So technically, the cash is still in our pocket, so what we have is interest payable. Okay? On December 31, 2018, we have interest payable, we have this extra liability to pay this interest on January 1st, right? We need to accrue for the 6 months of interest that have passed since July 1st, so we have to take the $2,250 as interest payable and that's going to be our interest expense as well in this case. Okay? And just to show you, on January 1st, 2019, the very next day when we pay the interest, right? Because on December 31, 2018, we're issuing our financial statements, but we haven't paid that cash yet. So we don't want to reduce our cash. It's still in our bank account as of that day. The very next day, we pay it off and we're going to debit interest payable because we no longer have this liability for the interest payable, and we're going to credit cash, right? Because we're paying out in cash and that'll be the $2,250. So notice the difference between this set of entries and what happened in the previous page for our interest expense. On July 1st, well, that was still during the reporting period and we paid it out in cash, we took the interest expense. Here, we had to create a liability on the last day of the year, to accrue for those 6 months and then we paid it off on January 1st. Okay? So nothing too crazy there, we're still just seeing our interest expense and just calculating our interest based on our stated interest rate, our principal amount, and then dividing it by 2 because it's semi-annual periods, okay. So our interest expense and our interest payable, notice what happens here. Interest payable, that's a liability, right? Because it's a payable and that's $2,250. It's an increase in our payables and the interest expense, well, that lowers our equity just like we did in the previous journal entry up above. So we stay balanced here, right? The liabilities increase, the equity decreases, we're good. And then once we make the next entry, the payable, right? Well, in that blue entry, the payable decreased by the $2,250 and the cash decreased by $2,250. So that also stays balanced there, okay? So that's about it here. Let's go ahead and move on to the next journal entry.

Face Value Bonds:Repaying Principal at Maturity

Alright, so you can imagine throughout the life of the bonds, we would have kept making those journal entries. Every year, we would have kept taking interest expense, every 6 months we would have been taking interest expense for those 6 months, paying out cash, and noting interest payable at the end of the year. This would have continued every year until we got to the final year and it was time to repay the principal. Remember, we had those bonds on our books for $50,000—we had this liability for $50,000. Well, now it was finally time to pay it, right? January 1, 2023, comes around and it's time to pay off the principal.

Now, one thing I want to note: on January 1, 2023, right, because this is 5 years later when it's finally time to pay it off, we would have also been paying off this final amount of interest. We're paying interest semiannually every January 1st. But that journal entry is going to be just like we did above where we had our interest payable and then we're going to pay it off on January 1st and close out the payable liability. So here, let's just focus on the principal repayment, right? We're taking that $50,000 and now everyone's saying, "Hey, it's been 5 years. Time to pay me back on my bond, right?" So now we have that $50,000 of bonds that have become due and we need to pay them back. So what's going to happen is we're going to pay them back and we have to get rid of our liability. We're going to debit bonds payable, right? Because it had a credit balance, it was a liability with a credit balance of $50,000. Well, guess what? We're paying them back now. We no longer have that liability. So we debit bonds payable for $50,000 and we credit cash for $50,000, right? We're paying them in cash. The $50,000 in cash is coming out of our pocket on January 1st, and we get rid of the liability. We no longer owe them that liability. It's off of our books. So at this point, our bonds payable, our liabilities decrease by the $50,000, and our cash decreases by $50,000 because of that credit, right? So there we go. Those journal entries are pretty simple, right? We're just closing out a liability; we had a liability and we repaid it. So we get rid of it. Alright? So that's about it for face value bonds. Let's see how this compares to discounted bonds and premium bonds in the upcoming videos, alright? Let's check that out.

Here’s what students ask on this topic:

What is a face value bond?

A face value bond is a type of bond issued when the stated interest rate equals the market interest rate. This means the bond sells at its face value, which is the principal amount. For example, if a bond has a face value of $1,000 and the stated interest rate is 10%, and the market rate is also 10%, the bond will sell for $1,000. The face value is the amount the issuer agrees to pay back at maturity, along with periodic interest payments.

How do you calculate interest expense for face value bonds?

To calculate the interest expense for face value bonds, multiply the principal amount by the stated interest rate. For example, if a bond has a face value of $50,000 and a stated interest rate of 9%, the annual interest expense is calculated as:

$\mathrm{50,000}\times 0.09=\mathrm{4,500}$

If interest is paid semi-annually, divide the annual interest by 2:

$\mathrm{4,500}÷2=\mathrm{2,250}$

What journal entries are made when issuing face value bonds?

When issuing face value bonds, the journal entry involves debiting cash and crediting bonds payable. For example, if a company issues $50,000 of bonds at face value, the entry would be:

Debit Cash $50,000

Credit Bonds Payable $50,000

This entry reflects the receipt of cash and the creation of a liability to repay the bond principal at maturity.

How is interest expense recorded for face value bonds?

Interest expense for face value bonds is recorded by debiting interest expense and crediting cash. For example, if the semi-annual interest payment is $2,250, the entry would be:

Debit Interest Expense $2,250

Credit Cash $2,250

This entry reflects the payment of interest and the corresponding expense recognized on the income statement.

What happens at the maturity of face value bonds?

At the maturity of face value bonds, the principal amount is repaid. The journal entry involves debiting bonds payable and crediting cash. For example, if the bond's face value is $50,000, the entry would be:

Debit Bonds Payable $50,000

Credit Cash $50,000

This entry eliminates the liability and reflects the cash outflow to repay the bondholders.