Long-term bonds help companies gain capital to finance their businesses. Investors purchase bonds, thus making a long-term loan to the company. After 10 or 20 years, the company must pay the investors back for their investment with interest. Company accountants list bonds payable as a long-term liability on the balance sheet.
When a company sells bonds, it usually classifies the bond's value as a long-term liability. It lists the market price of bonds sold as a debit against cash and a credit to bonds payable. Then, when the bond matures, the company lists the payment of the principal as a debit against bonds payable, and a credit to cash.
If a company offers bonds at a discounted price, it must record the amount of the discount as well as the value of the bonds. For example, if the market rate is 10 percent interest and the company issues bonds at 9 percent interest, the company lists the amount it gets for the bonds as a debit against cash. It lists the difference between the actual price and the discounted price as a debit against the discount on bonds payable, and lists the bond's total price as a credit to bonds payable.
If bonds are issued at a discount, the discounted value of the bonds is called the carrying amount. Every year prior to maturity of the bond, the company lists the bond's value as a long term liability and a debit against bonds payable. However, the amount of the discount is listed and subtracted from the bonds payable. The new amount, which is equal to the carrying amount, is a credit to the discount on bonds payable.
The company must also account for interest it pays bond holders who cash in their bonds. The company adds the total interest to the principal to determine the total cash paid out. It then subtracts the carrying amount, which is the amount investors paid to get the bonds, to determine its total interest expense. Most companies amortize, or spread out, the interest expense over the life of the bond.