Bonds payable is the liability an issuer records for bonds it has issued. It starts at the face amount the issuer must repay at maturity and is adjusted on the balance sheet by any unamortized discount or premium, so the reported balance is the carrying amount of the debt rather than its face. The discount or premium is the difference between what the issue raised and the face amount, and it is amortized to interest expense across the life of the bonds, which brings the carrying amount to face by maturity.
What the Balance Is Made Of
The guidance that governs the measurement calls every instrument in its scope a note, and its own examples of what that covers are secured and unsecured notes, debentures, bonds, mortgage notes, equipment obligations, and some accounts receivable and payable (APB Opinion No. 21, paragraph 2). Bonds are named there, so the rules below are the bond rules.
A discount or premium is not a separate asset or liability. It results from the determination of present value and is not separable from the note that gives rise to it, so it is reported in the balance sheet as a direct deduction from or addition to the face amount and is not classified as a deferred charge or deferred credit (FASB Accounting Standards Update 2015-03, Subtopic 835-30, paragraph 45-1A). That is what makes the reported number a carrying amount: face, less unamortized discount, or plus unamortized premium.
Debt issuance costs now follow the same presentation. Costs related to a note are reported as a direct deduction from the face amount of that note, and their amortization is reported as interest expense, in the same way as amortization of discount or premium (FASB Accounting Standards Update 2015-03, Subtopic 835-30, paragraphs 45-1A and 45-3). This is one of the places where an older textbook is now wrong. The original Opinion told issuers to report issue costs in the balance sheet as deferred charges (APB Opinion No. 21, paragraph 16), and that treatment no longer holds.
The disclosure that makes the carrying amount readable survived that change. The description of the note has to include the effective interest rate, and the face amount is disclosed in the financial statements or in the notes to them (FASB Accounting Standards Update 2015-03, Subtopic 835-30, paragraph 45-2). A reader who sees only the carrying amount cannot work backwards to either one, which is why both are required.
The Effective Interest Method
The difference between the present value and the face amount is treated as discount or premium and amortized as interest expense over the life of the note in such a way as to result in a constant rate of interest when applied to the amount outstanding at the beginning of any given period. That is the interest method (APB Opinion No. 21, paragraph 15).
Straight-line amortization is not forbidden outright. Other methods of amortization may be used if the results obtained are not materially different from those the interest method would produce (APB Opinion No. 21, paragraph 15), which is a materiality judgment on the engagement rather than a free choice of policy.
A Worked Example
Say a client issues five-year bonds with a stated coupon below what the market wants that day, so the issue raises less than face and the shortfall is the discount. The first period runs like this.
Face amount 500,000
Stated coupon rate 5%
Market rate at issue 6%
Cash raised at issue 478,938
Discount at issue 500,000 - 478,938 = 21,062
Period 1
Interest expense 478,938 x 6% = 28,736
Coupon paid 500,000 x 5% = 25,000
Discount amortized 28,736 - 25,000 = 3,736
Carrying amount, end 478,938 + 3,736 = 482,674Interest expense is larger than the cash coupon because the issuer is paying for the discount as well as the stated interest. Each period the carrying amount climbs by that difference, and by the last period it has climbed all the way to face. A premium runs the same machinery in reverse: expense is smaller than the coupon and the carrying amount falls toward face.
Where the Balance Sits in a Firm’s Work
On a balance sheet filed under Regulation S-X, bonds sit under the long-term debt caption, stated as bonds, mortgages and other long-term debt, including capitalized leases. Each issue or type of obligation is stated separately in the balance sheet or in a note, with the general character of each type of debt including the rate of interest, the date of maturity or a brief indication of the serial maturities, an appropriate indication of any contingency in the payment of principal or interest, a brief indication of priority, and the basis if it is convertible (17 CFR 210.5-02).
The part coming due soon does not stay in that caption. The same rule lists the current portion of long-term debt among the items that may belong on the other current liabilities line (17 CFR 210.5-02), so a single bond issue is usually reported in two places at once. How that current liabilities caption is laid out, and when an item inside it has to be stated separately, is set out in accounts payable.
The corporate return asks for the same split under the term itself. Schedule L carries mortgages, notes, bonds payable in less than 1 year on one line and mortgages, notes, bonds payable in 1 year or more on another, with accounts payable on its own line above them and other current liabilities on its own line in between (IRS, Form 1120, Schedule L, lines 17 and 20). A preparer who books the whole issue to one of those lines has a balance sheet that ties and a maturity profile that does not.
A Governmental Client Follows GASB, Not FASB
For a state or local government the same bonds run through a different board’s rules. General long-term debt, in the definition the standard carries forward, is the unmatured principal of bonds, warrants, notes or other forms of noncurrent or long-term general obligation indebtedness, and general long-term liabilities are not reported as liabilities in governmental funds at all. They are reported in the governmental activities column of the government-wide statement (GASB Statement No. 34, paragraphs 81 and 82). A bond issue that would be one long-term liability for a commercial client therefore never appears as a liability on the fund balance sheet.
Issuance costs diverge as well. Debt issuance costs, except any portion related to prepaid insurance costs, are recognized as an expense in the period incurred, and prepaid insurance costs are reported as an asset and recognized as an expense in a systematic and rational manner over the duration of the related debt (GASB Statement No. 65, paragraph 15). Carrying the commercial treatment across to a governmental client puts the entry wrong on day one.
What Bonds Payable Is Not
It is not accounts payable. A trade payable arises from a transaction with a customer or supplier in the normal course of business, due in customary trade terms not exceeding approximately one year, and the imputation rules that create a bond’s discount or premium are not intended to apply to it (APB Opinion No. 21, paragraph 3). There is no stated rate sitting against a market rate, so there is nothing to amortize and no indenture to disclose.
It is not notes payable, though the measurement is. Both sit inside the same scope, so the interest method, the presentation of discount and premium, and the disclosure of the effective rate work identically on each (APB Opinion No. 21, paragraph 2). What separates them is the instrument. A bond issue is normally one borrowing divided into securities held by many investors under an indenture, while a note payable is normally a single agreement with one lender. The arithmetic does not change; the disclosure each one carries does.
Common Questions
A credit. Bonds payable is a liability, so the account carries a credit balance and an issuance increases it. An unamortized discount sits against that balance and reduces it without being an asset of its own, because the discount is not separable from the note and is presented as a direct deduction from the face amount (FASB Accounting Standards Update 2015-03, Subtopic 835-30, paragraph 45-1A). Which side of an entry increases which kind of account is set out in debit vs credit.
Only the part coming due within the year. The rest stays in long-term debt, and the corporate return asks for exactly that split, with mortgages, notes and bonds payable in less than 1 year on one line and the same items payable in 1 year or more on another (IRS, Form 1120, Schedule L, lines 17 and 20).
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