Investment in Bonds
Overview
In business, the company may purchase the bond as an investment in order to earn extra revenue while maintaining a low risk on the investment. Likewise, the company needs to make the journal entries for the investment in bonds to account for various transactions, such as the purchase of the bond, interest accrued, etc. until the bond is redeemed or sold back at its maturity or before the maturity.
Investment in bonds is the type of debt investment which the company invests in order to receive the fixed extra income with low risk comparing to other investments such as stock investments. The investment in bonds that company purchases can be government bonds or corporate bonds.
Investment in bonds journal entry
Purchase of bonds
The company can make the investment in bonds journal entry by debiting the investment in bonds account and crediting the cash account on the date it purchases the bond.
| Account | Debit | Credit |
|---|---|---|
| Investment in bonds | 000 | |
| Cash | 000 |
Investment in bonds account is an asset account in which its normal balance is on the debit side. The cost of the investment in bonds includes all expenses necessary to acquire the bonds, such as the price paid for the bond plus commission (e.g. brokerage fee), if any.
Interest on bond investment
Interest accrued
The company can make the journal entry for the interest on bond investment at the period-end adjusting entry by debiting the interest receivable account and crediting the interest revenue account.
| Account | Debit | Credit |
|---|---|---|
| Interest receivable | 000 | |
| Interest revenue | 000 |
This journal entry is made to recognize the interest revenue that the company has earned through the passage of time on the investment in bonds as well as to recognize its right to receive the future benefit in form of interest receivable.
Interest received
When the company receives the interest payment from the investment in bonds, it can make the journal entry by debiting the cash account and crediting the interest receivable account.
| Account | Debit | Credit |
|---|---|---|
| Cash | 000 | |
| Interest receivable | 000 |
This journal entry is made to eliminate the interest receivable that the company has recorded previously for the accrued interest on the bond investment.
Redemption of bond investment
When the bond is redeemed by the bond issuer at the maturity date, the company can make the journal entry to remove the investment in bonds from the balance sheet by debiting the cash account and crediting the investment in bonds account.
| Account | Debit | Credit |
|---|---|---|
| Cash | 000 | |
| Investment in bonds | 000 |
Investment in bonds example
For example, on January 1, 2020, the company ABC purchases a $10,000, five-year, 8% bond at the face value. The company ABC receives the interest paid annually on January 1 for this bond.
What are the journal entries for the investment in bonds?
- On January 1, 2020, when the company ABC purchase the bond
- On December 31, 2020, when the company ABC make the period-end adjusting entry
- On January 1, 2021, when the company receives the first interest payment of the investment in this bond.
- When the bond is redeemed by the issuer at the end of its maturity
Solution:
On January 1, 2020
When the company ABC purchases the bond for $10,000 at its face value, it can make the investment in bonds journal entry on January 1, 2020, as below:
| Account | Debit | Credit |
|---|---|---|
| Investment in bonds | 10,000 | |
| Cash | 10,000 |
On December 31, 2020
When the company ABC makes the period-end adjusting entry on December 31, 2020, it needs to record the accrued interest of $800 ($10,000 x 8%) on the investment in bonds for the first year as below:
| Account | Debit | Credit |
|---|---|---|
| Interest receivable | 800 | |
| Interest revenue | 800 |
If this journal entry is not made, the total assets on the balance sheet and total revenues on the income statement of ABC will be understated by $800 as of December 31, 2020.
On January 1, 2021
When the company receives the first interest payment of the investment in this bond on January 1, 2021, it can make the journal entry as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 800 | |
| Interest receivable | 800 |
The interest revenue is not recorded here as it is not the revenue that is earned in 2021 period but in 2020 period. Likewise, it has already been recognized and recorded in 2020.
Redemption of bond
When the $10,000 bond is redeemed by its issuer at its maturity date, the company can make the journal entry to remove this bond from the balance sheet as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 10,000 | |
| Investment in bonds | 10,000 |
Sale of bond investment before maturity
The company may decide to sell the bond investment before it matures, in which it can get more or less than the amount it pays for the bond investment. There may be various reasons that make the company deciding to sell the bond investment before its maturity. One of the common reasons may be the fluctuation of the interest rate on the market.
In this case, if there is an increase in the interest rate on the market after the bond was purchased, the bond value may have already declined. On the other hand, if the interest rate have decreased after the bond was purchased, its value will increase instead.
Likewise, the company needs to record the difference resulting from selling the bond before its maturity in the gain or loss on sale of investments account.
Gain on sale of bond investment
The company can make the journal entry for the gain on sale of bond investment by debiting the cash account and crediting the gain on sale of investments account and investment in bonds account.
| Account | Debit | Credit |
|---|---|---|
| Cash | 000 | |
| Gain on sale of investments | 000 | |
| Investment in bonds | 000 |
Gain on sale of investments is an income statement item in which it is usually reported under the “other revenues” section.
Loss on sale of bond investment
On the other hand, the company can make the journal entry for the loss on sale of bond investment by debiting the cash account and the loss on sale of investments account and crediting the investment in bonds account.
| Account | Debit | Credit |
|---|---|---|
| Cash | 000 | |
| Loss on sale of investments | 000 | |
| Investment in bonds | 000 |
Similarly, loss on sale of investments is also an income statement item in which it is usually reported under the “other expenses” section.
Sale of bond investment before maturity example
For example, assume the company ABC above sells the $10,000 bond on the fourth year for $10,300 after receiving the annual interest payment.
In this case, the company ABC can make the journal entry for the $10,000 bond investment that is sold before its maturity for $10,300 by recording the difference of $300 as a gain on sale of investments as below:
| Account | Debit | Credit |
|---|---|---|
| Cash | 10,300 | |
| Gain on sale of investments | 300 | |
| Investment in bonds | 10,000 |
