the carrying value at maturity is equal to the face amount of bonds issued at:

E Authors

2 min read

·

10-10-2024

99

0

Share

Understanding Carrying Value and Face Amount of Bonds: A Simple Explanation

When a company issues bonds, it's essentially borrowing money from investors. These bonds have a face amount (also known as par value) that represents the principal amount the company will repay at maturity. The carrying value, on the other hand, reflects the bond's current market value on the company's balance sheet.

But what happens when the carrying value at maturity equals the face amount? The answer lies in how the bonds were initially issued:

Carrying Value at Maturity Equals Face Amount: The Case of Bonds Issued at Par

When bonds are issued at par, the carrying value at maturity will be equal to the face amount. This occurs because the bond's interest rate (coupon rate) matches the prevailing market interest rate at the time of issuance.

• Example: A company issues $1,000,000 worth of bonds with a 5% coupon rate. If the market interest rate for similar bonds is also 5%, the bonds will be issued at par. The initial carrying value will be $1,000,000, and this value will remain constant throughout the bond's life until maturity when the company repays the $1,000,000 face amount.

Why is this important?

• Straightforward Accounting: When bonds are issued at par, the accounting treatment is simpler. Interest expense is recorded consistently each period based on the coupon rate, without the need for complex amortization calculations.

• Market Equilibrium: Bonds issued at par indicate that the market perceives the company's creditworthiness as aligned with the promised interest payments.

When the Carrying Value Doesn't Match the Face Amount:

• Bonds Issued at a Discount: If the coupon rate is lower than the market interest rate, the bonds will be issued at a discount. The carrying value will be less than the face amount at issuance. Over time, the carrying value will increase until it reaches the face amount at maturity.

• Bonds Issued at a Premium: If the coupon rate is higher than the market interest rate, the bonds will be issued at a premium. The carrying value will be greater than the face amount at issuance. Over time, the carrying value will decrease until it reaches the face amount at maturity.

Understanding the Dynamics:

The carrying value of a bond reflects the market's perception of its risk and return. When the carrying value equals the face amount, it signifies that the market believes the bond's promised return aligns with its risk profile. This situation is ideal for both the company and the investor.

Important Note: This article is for informational purposes only and does not constitute financial advice. It is crucial to consult with a qualified financial professional before making any investment decisions.

Sources:

• *"Bonds Payable" by James A. Heintz, David C. Dugan, and David A. Hayes. Accounting Principles. 12th ed., Pearson Education, 2015, pp. 764-833.

This information is based on the provided context and may not fully cover all relevant aspects of bond accounting. It is crucial to consult with a qualified financial professional for accurate and comprehensive information.