Question

Under what conditions of bond issuance does a discount on bonds payable arise? Under what conditions of bond issuance does a premium on bonds payable arise?

Answer 1

Bond payable:

A bond is a written promise by companies to pay back the principal on a loan, plus interest. In simple terms, you lend money to the companies in exchange to receive a piece of paper “the bond”.

Issuance of Bonds — Discount

The value of the principal specified to be paid back at maturity is known as the face value or par value. The rate of interest specified in the bond is known as the contract rate. If the contract rate is equal to the market rate then it is said that bond will be issued at its par value.

For example, A 10% bond whose par value is $100 payable annually is issued by the TML Inc and if the market rate is also 10%, then issuance will be recorded at par value.

But if the company announced a bond or print bond for issuance and market rate changes. In this case, if the contract rate is lower than market rates no one will be interested in buying bonds.

In this situation, the company opts for a discount method i.e. they sell the bond at discount but redeem at its par value or face value.

For example, A 10% bond whose par value is $100 payable annually is issued by the TML Inc. and if the market rate is 12%, then to attract buyers company offers to sell the bond at $96. However, redeem at $100.

Issuance of Bonds — Premium

Issuance of the bond at a premium is just opposite of discount method i.e if the market rates are lower than contract rates. In this situation companies reluctant to issue bonds at such high rates. Therefore to compensate the rates difference they issue bonds at premium i.e more than the par value of bonds.

For example, A 10% bond whose par value is $100 payable annually is issued by the TML Inc. and if the market rate is 8%, then to compensate the loss they sell the bond at $104.However, redeem at $100.