Step-by-Step Guide to Understanding Bonds Payable in Accounting
Last Updated March 26, 2024
What are Bonds Payable?
Bonds Payable are a form of debt financing issued by corporations, governments, and other entities in order to raise capital. As part of the financing arrangement, the issuer of the bonds is obligated to pay periodic interest across the borrowing term and the principal amount on the date of maturity.
Bonds Payable: Balance Sheet Liability Accounting
Bonds payable represent a contractual obligation between a bond issuer and a bond purchaser.
Bonds are an agreement in which the issuer obtains financing in exchange for promising to make interest payments in a timely manner and repay the principal amount to the lender at maturity.
Normally, the interest on bonds is paid on a semi-annual basis, i.e. every six months until the date of maturity.
The exact terms of bonds will differ from case to case and are clearly stated in the bond indenture agreement.
For corporations, the benefit of issuing bonds rather than issuing stock is that debt is considered a “cheaper” source of financing (i.e. lower cost of capital) as long as the default risk is kept at a manageable level, the interest on bonds is tax-deductible (i.e. creating the “tax shield“), and bondholders do not dilute the ownership interests in a company’s equity.
Of course, in the case of bankruptcy — i.e. the worst case scenario, where a borrower defaults — debt lenders are placed higher in the capital structure and their claims are thus prioritized, so their recoveries are much higher relative to equity shareholders.
However, for financially sound companies, bond issuances represent a valuable method to raise capital while avoiding diluting equity interests as well as providing other benefits.
Bonds Payable: Current vs. Non-Current Portion
The “Bonds Payable” line item can be found in the liabilities section of the balance sheet.
Since bonds are financing instruments that represent a future outflow of cash — e.g. the interest expense and principal repayment — bonds payable are considered liabilities.
Moreover, the “payable” term signifies that a future payment obligation is not yet fulfilled.
Depending on how far in the future the maturity date is from the present date, bonds payable are often segmented into “Bonds payable, current portion” and “Bonds payable, non-current portion”.
- Current Portion → Maturity Date < 12 Months
- Non-Current Portion → Maturity Date > 12 Months
Bonds Payable Journal Entry Example (Debit, Credit)
Suppose a company raised $1 million in the form of bond issuances. The journal entries would be as follows:
- Cash Account → Debit by $1 million
- Bonds Payable → Credit by $1 million
For each month that the bond is outstanding, the “Interest Expense” is debited, and “Interest Payable” will be credited until the interest payment date comes around, e.g. every six months.
After each periodic interest expense payment (i.e. the actual cash payment date) per the bond indenture, the “Interest Payable” is debited by the accumulated interest owed, with “Cash” representing the offsetting account.
- Interest Payable → Interest Expense Obligation
- Cash → Interest Expense Obligation
Similarly, the journal entry on the date of maturity and principal repayment is essentially identical, since “Bonds Payable” is debited by $1 million while the “Cash” account is credited by $1 million.
- Bonds Payable → Debit by $1 million
- Cash Account → Credit by $1 million
At maturity, the outstanding balance owed by the issuer is now zero, and there are no more obligations on either side, barring unusual circ*mstances (such as the borrower being unable to repay the bond principal).
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