Mastering Bond Accounting for the CPA Exams

Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD

Bond questions show up regularly on FAR, but they're some of the most predictable questions on the exam once you can build an amortization schedule. A bond is debt: the issuer receives cash up front and promises to pay interest over time plus the face value at maturity.

Why do bonds trade at a premium or discount?

When a bond is issued, Cash is debited and Bonds Payable is credited for the face value. The actual cash received often differs from the face value because the bond's stated rate (what sets the annual cash payment) differs from the market's effective rate.

• Stated rate below the market rate → the bond is less attractive, so it's issued at a discount (cash received < face value)
• Stated rate above the market rate → the bond is more attractive, so it's issued at a premium (cash received > face value)

That premium or discount gets amortized over the bond's life using the effective-interest method.

Cash paid = Face value × Stated rate
Interest expense = Beginning carrying value × Market rate
Amortization = Cash paid − Interest expense

Worked example: a 6% bond priced to yield 5%

On January 1, Year 1, Bluestone Corp issues 6% seven-year bonds with a $300,000 face value, paying interest annually. The market rate is 5%, and the bond proceeds are $317,359 — a premium, since Bluestone's 6% stated rate beats the market's 5%.

The fixed annual cash payment is $300,000 × 6% = $18,000 every year. Each year's interest expense is the beginning carrying value × 5%, and the difference between the two amortizes the premium down toward the $300,000 face value:

Year	Beg. carrying value	Interest expense	Cash	Amortization	End carrying value
1	317,359	15,868	18,000	2,132	315,227
2	315,227	15,761	18,000	2,239	312,988
3	312,988	15,649	18,000	2,351	310,638
4	310,638	15,532	18,000	2,468	308,170
5	308,170	15,408	18,000	2,592	305,578
6	305,578	15,279	18,000	2,721	302,857
7	302,857	15,143	18,000	2,857	300,000
Total	—	108,641	126,000	17,359	—

Notice the Year 7 ending carrying value lands exactly on the $300,000 face value — that's the built-in check that an amortization schedule is done correctly.

What are the journal entries?

The initial entry records the cash received, the face value as Bonds Payable, and the difference as a Premium account:

Account	Debit	Credit
Cash	317,359	—
Premium on Bonds Payable	—	17,359
Bonds Payable	—	300,000

Every year after that follows the same pattern: debit Interest Expense for the year's effective interest, debit the Premium account for that year's amortization (shrinking the premium), and credit Cash for the fixed $18,000 payment. Plug in each year's numbers straight from the schedule above:

Year	Dr. Interest Expense	Dr. Premium (amortization)	Cr. Cash
1	15,868	2,132	18,000
2	15,761	2,239	18,000
3	15,649	2,351	18,000
4	15,532	2,468	18,000
5	15,408	2,592	18,000
6	15,279	2,721	18,000
7	15,143	2,857	18,000

Finally, at maturity, the bond is fully amortized (carrying value = face value), so the last entry simply retires it:

Account	Debit	Credit
Bonds Payable	300,000	—
Cash	—	300,000

Build the schedule first, then the entries follow automatically. Once you have beginning carrying value, interest expense, cash, amortization, and ending carrying value for every year, every journal entry is just those same five numbers rearranged into debits and credits.

Want the full FAR framework?

My free CPA 101 course covers the study approach I used to score 90+ on every CPA exam section.

Start CPA 101 free

More on FAR debt and cash topics

Understanding Cash Flow Statements Cash to Accrual Adjustments

Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 95 on FAR. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.