Definition of Premium on Bonds Payable
Premium on bonds payable (or bond premium ) occurs when bonds payable are issued for an amount greater than their face or maturity amount. This is caused by the bonds having a stated interest rate that is higher than the market interest rate for similar bonds.
Example of Premium on Bonds Payable
Assume that a corporation prepares to issue bonds having a maturity value of $10,000,000 and a stated interest rate of 6%. However, when the 6% bonds are actually sold, the market interest rate is 5.9%. Since these bonds will be paying investors more than the interest required by the market ($300,000 semiannually instead of $295,000 semiannually), the investors will pay more than $10,000,000 for the bonds. If we assume the investors pay $10,150,000 for the bonds, the corporation will record the transaction with a debit to Cash of $10,150,000; a credit to Bonds Payable of $10,000,000; and a credit of $150,000 to Premium on Bonds Payable (an adjunct liability account ).
Over the life of the bonds, the $150,000 premium is to be accounted for as a reduction of the corporation's interest expense. This is done through the amortization of premium on bonds payable .
The combination of 1) the unamortized credit balance in the account Premium on Bonds Payable, 2) the unamortized debit balance in the account Bond Issue Costs, and 3) the $10,000,000 credit balance in Bonds Payable is known as the book value or the carrying value of the bonds payable.
