In addition, the bonds were actually sold at a discount from their face value, so that investors can earn a higher interest rate. The amount of this discount scheduled to be amortized in the current period is $20,000. These two figures are added together to arrive at a total bond interest expense of $80,000 for the reporting year. Net interest cost (NIC) is one method that companies use to compare bids from underwriter syndicates. When a company issues a bond–reaching out to a pool of investors to lend it money over a specified period of time in exchange for a payment–they usually sell them to a syndicate of underwriters. This temporary group of investment banks and broker-dealers are then responsible for selling the bonds to the public.
A discount bond is one whose price is below its face value, while a premium bond tends to sell for prices higher than the par value. They want underwriters that produce the least amount of interest costs, the cumulative amount a borrower pays on a debt obligation over the life of the loan. That means that when a debt issuer uses the net interest cost (NIC) to evaluate their underwriter bids, they’ll usually contract with the syndicate offering the lowest net interest. This may not be the best method for selecting underwriters as some may have a low net interest cost (NIC), but a higher total interest cost (TIC) over the lifetime of the bond. Interest expense does not include other fixed payment obligations of a company such as paying dividends on preferred stock.
Interest expense is determined by a company’s average debt balance, i.e. the beginning and ending debt carrying amounts. In short, the amount of interest expense owed is a function of a company’s projected debt balances and the terms stated in the original lending arrangement. When governments, institutions and corporations want to raise money to finance their public service projects or business activities, many of them issue bonds.
Remember, though, that at the end of the 10 interest payment periods, the company also has to return the $1,000,000 to its investors. Below is an example of how to calculate the bond interest expense for a bond issuer known as Flowers Inc. Each period the interest expense (5,338) is the interest paid to the bondholders based on the par value of the bond at the bond rate (4,800) plus the discount amortized (538). Each period the interest expense (4,249) is the interest paid to the bondholders based on the par value of the bond at the bond rate (4,800) less the premium amortized (551). To take the time value of money (TMV) under consideration, it is necessary to use the “true interest cost (TIC)” method. TIC includes all ancillary fees and costs, such as finance charges, possible late fees, discount points, and prepaid interest, along with factors related to the TMV.
Long-Term Debt Financing Assumptions
The $19.6 million ending balance becomes the beginning balance for 2023, which is again reduced by the $400k in principal repayment. But to prevent a financial model from showing errors due to the endless loop of calculations – i.e. a “circularity” – a circularity switch is necessary, as we’ll soon demonstrate in our modeling tutorial. Using an interest expense calculator for bonds is the easiest way to calculate what a corporate entity owes. Volatility profiles based on trailing-three-year calculations of the standard deviation of service investment returns. The “number of bond-year dollars” equals the sum of the product of each year’s maturity value and the number of years to its maturity.
What Is Net Interest Cost (NIC)?
An identical process is followed if the bonds are issued at a discount as the following example shows. You can deduct investment interest expense against any investment income — but only if you itemize your tax deductions. The easiest way to avoid paying interest expense is to avoid buying stocks on margin. Our hypothetical company’s annual interest expense is forecasted as $990k in 2022, followed by an interest expense of $970k in 2023. Or, as an alternative solution, the beginning debt balance can also be used to avoid the circularity issue altogether.
- Usually, the bond maturity period refers to the length of time that the bond issuer will pay interest to investors before ceasing and returning the principal to them.
- The straight line bond amortization method is one method of amortizing the premium or discount on bonds payable over the term of the bond, the alternative more acceptable method is the effective interest rate method.
- A simple answer for traditional bonds Most bonds involve companies paying a specified interest rate for the stated length of time between when the company issues the bond and its maturity.
- Volatility profiles based on trailing-three-year calculations of the standard deviation of service investment returns.
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies how to find bond interest expense and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.
Example of Net Interest Cost (NIC)
This occurs when the prevailing market interest rate is lower than the coupon rate. Debit interest expense by the difference of the interest payment and the premium amortization, credit cash by the interest payment amount and debit premium on bonds payable by the amortization amount. From the bond amortization schedule, we can see that at the end of period 4, the ending book value of the bond is reduced to 120,000, and the premium on bonds payable (2,204) has been amortized to interest expense.
Balance Sheet
From the straight line bond amortization schedule, we can see that at the end of period 4, the ending book value of the bond is increased to 120,000, and the discount on bonds payable (2,152) has been amortized to interest expense. As before, the final bond accounting journal would be to repay the face value of the bond with cash. Calculate the interest expense for bonds issued at a premium to par, meaning the issuing price is more than the par value.