How to Calculate Interest Expense on Bonds Payable

The straight line bond amortization method is one method of amortizing the premium or discount on bonds payable over the term of the bond, the alternative more acceptable method is the effective interest rate method. The advantage of the straight line method, is that the amortization is simple to calculate and the interest expense and therefore the bond accounting journals, are the same for each period over the lifetime of the bond. Compute the interest expense for bonds issued at a discount to par, meaning the issuing price is less than the par value. This occurs when the prevailing market interest rate is greater than the coupon rate. The straight-line method amortizes this discount equally over the life of the bond.

Calculate Interest Expense on Bonds

Similarly, convertible bonds give investors the chance to convert their bonds to stock in a company, and some bonds give bondholders the right to choose the time at which they wish to do so. With any bond, you can at least get a ballpark range of likely total bond interest expense by looking at worst-case and best-case scenarios. Once calculated, interest expense is usually recorded by the borrower as an accrued liability. The entry is a debit to interest expense (expense account) and a credit to accrued liabilities (liability account). When the lender eventually sends an invoice for the expense, the credit is shifted to the accounts payable account, which is another liability account. When the interest is paid, the accounts payable account is debited to flush out the amount, and the cash account is credited to show that funds were expended.

1. Net interest cost (NIC) takes into account any premium or discount applicable to the issue (that is, whether the bond is selling above or below face value).
2. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.
3. The face value of the bond is the price that the bond issuer will pay at its maturity.
4. The formula for calculating the annual interest expense in a financial model is as follows.
5. But in the future, if rates go up, then the interest expense automatically rises to adjust to the changing conditions.

Also not included in interest expense is any payment made toward the principal balance on a debt. For example, if a company pays $1 million to its creditors and $200,000 is applied toward the principal debt, then the interest expense is $800,000. It can have slightly different meanings depending on the context, but in corporate finance, interest expense is generally the primary financing expense on a company’s income statement.

From the straight line bond amortization schedule, we can see that at the end of period 4, the ending book value of the bond is increased to 120,000, and how to find bond interest expense the discount on bonds payable (2,152) has been amortized to interest expense. As before, the final bond accounting journal would be to repay the face value of the bond with cash. Calculate the interest expense for bonds issued at a premium to par, meaning the issuing price is more than the par value.

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In addition, the bonds were actually sold at a discount from their face value, so that investors can earn a higher interest rate. The amount of this discount scheduled to be amortized in the current period is $20,000. These two figures are added together to arrive at a total bond interest expense of $80,000 for the reporting year. Net interest cost (NIC) is one method that companies use to compare bids from underwriter syndicates. When a company issues a bond–reaching out to a pool of investors to lend it money over a specified period of time in exchange for a payment–they usually sell them to a syndicate of underwriters. This temporary group of investment banks and broker-dealers are then responsible for selling the bonds to the public.

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Our interest rate assumption will be set at a fixed 5%, and we’ll create a circularity switch (and name it “Circ”). We’ll now move to a modeling exercise, which you can access by filling out the form below.

The $19.6 million ending balance becomes the beginning balance for 2023, which is again reduced by the $400k in principal repayment. But to prevent a financial model from showing errors due to the endless loop of calculations – i.e. a “circularity” – a circularity switch is necessary, as we’ll soon demonstrate in our modeling tutorial. Using an interest expense calculator for bonds is the easiest way to calculate what a corporate entity owes. Volatility profiles based on trailing-three-year calculations of the standard deviation of service investment returns. The « number of bond-year dollars » equals the sum of the product of each year’s maturity value and the number of years to its maturity.

A discount bond is one whose price is below its face value, while a premium bond tends to sell for prices higher than the par value. They want underwriters that produce the least amount of interest costs, the cumulative amount a borrower pays on a debt obligation over the life of the loan. That means that when a debt issuer uses the net interest cost (NIC) to evaluate their underwriter bids, they’ll usually contract with the syndicate offering the lowest net interest. This may not be the best method for selecting underwriters as some may have a low net interest cost (NIC), but a higher total interest cost (TIC) over the lifetime of the bond. Interest expense does not include other fixed payment obligations of a company such as paying dividends on preferred stock.

This occurs when the prevailing market interest rate is lower than the coupon rate. Debit interest expense by the difference of the interest payment and the premium amortization, credit cash by the interest payment amount and debit premium on bonds payable by the amortization amount. From the bond amortization schedule, we can see that at the end of period 4, the ending book value of the bond is reduced to 120,000, and the premium on bonds payable (2,204) has been amortized to interest expense.