Companies raise finance from various sources. One of the primary sources includes equity, which refers to any investment in a company from its shareholders. Usually, companies rely more on equity than any other finance.

However, companies also have the option to raise finance from debt. Debt refers to finance acquired from third parties other than shareholders.

Usually, equity is more costly compared to debt. However, companies do not have an obligation to return equity investments unless they go through liquidation. Similarly, companies only suffer optional cash outflows to equity investors.

However, the same does not apply to debt. Companies usually rack up debt from various sources, one of which includes bonds.

What is a Bond?

A bond is a fixed-income instrument that provides lenders with the opportunity to obtain finance. These lenders may include companies, municipalities, states, and sovereign governments.

When these entities require finance, they issue an instrument known as a bond. Investors then acquire these instruments in exchange for face value and future interest payments.

This way, entities get finance, represented by the aggregate of the face value of total bonds issued. In exchange, investors get the promise to receive fixed and regular interest payments.

Bonds also have a maturity date, which refers to the date on which they expire. On this date, lenders stop receiving interest payments. However, they also get their initial investment back, which is the face value of their bonds.

Usually, bonds carry a fixed income for investors. However, these may also include variable interest payments. Regardless of that, these payments represent an expense for the issuer. For the lender, they are an income.

Bonds also mention the dates on which the interest income becomes payable to the investor. However, these dates may also be implicit rather than explicit.

Overall, a bond is a fixed-income debt instrument that allows entities to raise debt finance. Unlike other debt finance sources, bonds initiate from the borrower rather than the lender.

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Similarly, they carry a coupon rate, which refers to the interest rate on instruments. Unlike equity, bonds come with a maturity date, on which the issuer must return the face value to the borrowers.

What are Bonds Payable?

When companies issue bonds to investors, they undertake an obligation. This obligation requires them to repay lenders at the specified maturity date.

When companies record the issue of bonds to lenders, they must account for them as a liability. Liabilities are obligations that result in future outflows of economic benefits. Since bonds meet this definition, they fall under a company’s liabilities.

Once companies issue bonds, they must record a liability on their accounts. Usually, they name the account bonds payable.

The bonds payable account includes an aggregate of face values of the total bonds issued by a company. Until the last year, this account appears as a non-current liability in a company’s balance sheet.

Sometimes, however, companies may not issue bonds at their face value. Some companies provide bonds at a premium, while others offer a discount. Either way, the face value of the bond will not be the same as the funds received. However, bonds only create an obligation for the face value. They do not require companies to pay the actual finance received.

Therefore, bonds payable only includes the aggregate of the face value of the bonds. If a company issues bonds at a premium or discount, the account will hold the same balance.

It is because the bond only creates a liability for the face value. Companies do not return any premium received. However, they have to bear an expense for the discount provided.

How is Bonds Payable presented on the Cash Flow Statement?

A company’s bonds payable balance appears on its balance sheet as a non-current asset. During the final year, this balance gets transferred to current liabilities. However, it does not impact the company’s cash flow statement.

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However, when companies acquire finance through bonds or repay them, this statement will experience an impact. Similarly, any interest payments made to bondholders also affect the cash flow statement.

The cash flow statement presentation for each of the above processes is as below.

Issuing bonds

When a company issues bonds, it receives finance. This finance increases its cash and cash equivalent balances while also giving rise to its liabilities.

Therefore, this transaction affects the statement of cash flows as well as the balance sheet. Nonetheless, companies must account for it in both of these financial statements.

When it comes to the cash flow statement, companies usually report on three components. These include operating activities, investing activities, and financing activities.

Issuing bonds relates to companies raising finance for operations. Therefore, the transaction falls under the cash flows from the financing activities component.

Since companies receive cash for issuing bonds, the transaction results in positive cash flows. Therefore, issuing bonds will be a cash inflow. The transaction will appear on the cash flow statement as follows.

Cash flows from Financing Activities
Issuance of bondsXXXX
Other investing activitiesXXXX/(XXXX)
Net cash flows from financing activitiesXXXX/(XXXX)

Repaying bonds

The repayment of bonds means companies decrease their cash and cash equivalent balances. It also lowers their liabilities.

Therefore, the transaction impacts both the cash flow statement and the balance sheet. Like issuance of bonds, companies must report the transaction in both the financial statements.

The treatment for repayment of bonds is similar to the issuance of bonds. It falls under the financing activities component of the cash flow statement.

The reason behind this treatment is that it decreases a company’s cash and cash equivalent resources. Since companies pay cash to settle this obligation, it results in negative cash flows. Therefore, it will be a cash outflow.

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The transaction for repayment of bonds will appear on the cash flow statement as follows.

Cash flows from Financing Activities
Repayment of bonds(XXXX)
Other investing activitiesXXXX/(XXXX)
Net cash flows from financing activitiesXXXX/(XXXX)

Interest payments

The treatment for interest payments is more complicated than the above two transactions. Usually, companies record interest expenses when accrued.

Therefore, companies must first readd this amounts to the net profits that come from the income statement. Once done, they must then subtract the actual payments under the financing activities component.

Companies add interest expense back to the amount along with other non-cash expenses. It is a requirement for the indirect method of preparing the cash flow statement. It is because interest expense does not represent actual payments.

Therefore, companies must calculate the cash outflows relating to interest payments and decrease them under financing activities.

The transaction will appear on the cash flow statement as follows.

Cash Flow Statement
Net profitsXXXX
Interest expenseXXXX
Other non-cash expenses(XXXX)
Non-cash incomeXXXX
Cash flows from Operating Activities
Operating activitiesXXXX/(XXXX)
Net cash flows from operating activitiesXXXX/(XXXX)
Cash flows from Investing Activities
Investing activitiesXXXX/(XXXX)
Net cash flows from investing activitiesXXXX/(XXXX)
Cash flows from Financing Activities
Interest payments on bonds(XXXX)
Other investing activitiesXXXX/(XXXX)
Net cash flows from financing activitiesXXXX/(XXXX)

Example

A company, ABC Co., issues bonds having a face value of $100. The company manages to get investors to pay for 1,000 bonds. This transaction will appear on ABC Co.’s cash flow statement as follows.

ABC Co.
Cash Flow Statement
  
Cash flows from Financing Activities
Issuance of bonds (1,000 x $100)$100,000
Other investing activitiesXXXX/(XXXX)
Net cash flows from financing activitiesXXXX/(XXXX)

After issuance, ABC Co. incurs an interest expense of $5,000 on these bonds. However, the company only pays its shareholders $4,000 during the year. These transactions will appear on the cash flow statement as below.

ABC Co.
Cash Flow Statement
Net profitsXXXX
Interest expense$5,000
Other non-cash expenses(XXXX)
Non-cash incomeXXXX
Cash flows from Operating Activities
Operating activitiesXXXX/(XXXX)
Net cash flows from operating activitiesXXXX/(XXXX)
Cash flows from Investing Activities
Investing activitiesXXXX/(XXXX)
Net cash flows from investing activitiesXXXX/(XXXX)
Cash flows from Financing Activities
Interest payments on bonds($4,000)
Other investing activitiesXXXX/(XXXX)
Net cash flows from financing activitiesXXXX/(XXXX)

During the few years that ABC Co. holds these bonds, the same treatment will apply. At maturity, the company repays its bondholders for the full value of the bonds. The transaction will appear on ABC Co.’s cash flow statement as below.

ABC Co.
Cash Flow Statement
Cash flows from Financing Activities
Repayment of bonds($100,000)
Other investing activitiesXXXX/(XXXX)
Net cash flows from financing activitiesXXXX/(XXXX)

Conclusion

Companies issue bonds to raise debt finance. These bonds give rise to cash inflows and outflows during several stages.

Firstly, when a company issues bonds, it results in a cash inflow. Interest payments on these instruments give rise to cash outflows. Similarly, bond repayments result in cash outflows. All of these items appear in the cash flow statement under financing activities.