1. Define a “serial bond.”
2. Identify the steps to calculate the price of a bond and provide the proper accounting.
3. Record a serial bond over its life.
4. Explain the periodic determination of interest for a serial bond and the amount that must be compounded each period.
Question: The previous section of this chapter looked at term bonds. Interest was paid each period although
payment of the face value did not occur until the end of the four-year term. How does this process differ for a
serial bond where both interest and a portion of the face value are paid periodically?
To illustrate, assume that Smith Corporation issues a four-year, $1 million serial bond on January 1, Year One,
paying a 5 percent stated interest rate at the end of each year on the unpaid face value for the period. The bond
contract specifies that $250,000 of the face value is also to be paid annually at the same time as the interest. Smith
and the potential investors negotiate for some time and finally agree on a 6 percent annual effective rate. What
accounting is appropriate for a serial bond?
Answer: In reporting a term bond, five steps were taken:
1. The cash flows required by the bond contract are listed.
2. The total present value of these cash flows is computed using the effective rate of interest negotiated by
the parties. Present value mathematically removes all future interest at the appropriate rate. Only the
principal remains. Thus, this resulting figure is the exact amount to be paid so that the agreed-upon interest
rate is earned over the life of the bond.
3. The bond is recorded at the principal (present value) amount paid by the investors.
4. The debtor pays interest periodically on the dates indicated in the contract.
5. The effective rate method is applied. Interest to be reported for each period is determined by multiplying
the principal balance of the bond by the effective interest rate. The cash interest figure is adjusted to this
calculated amount with the difference compounded (added to the principal)1.