You can calculate the interest expense after tax on a bond by subtracting a company’s tax rate from 100 percent and multiplying it by the interest expense. The latter is a value that you can obtain when you multiply the total bond value by the bond’s coupon rate (rate of interest) and then add the result to the amount that has undergone amortization.
How Bonds Work
According to Investor.gov, governments usually issue bonds to fund public-interest projects, while companies issue corporate bonds to increase their capital to pay debts, expand their businesses and improve their cash flow. And bond issuers consider them liabilities.
Most bonds make interest payments semi-annually from the time of issuance until the maturity of the bond and are low risk compared to other kinds of securities.
Generally, corporate bonds that are high-risk tend to offer higher coupon rates or bond yields, while those with associated lower risks pay interest at lower rates. Further, Investor.gov highlights that U.S. savings bonds are usually considered some of the most stable debt securities. That’s because they are backed by the full faith and credit of the U.S. government.
You can obtain a bond discount when you purchase the bonds at less-than-market prices. However, you may also be forced to deal with bond premiums when the market prices are more than the face value of the bond.
How Companies Record Bonds
When companies issue bonds, they take on long-term debts because they are borrowing money from investors. To pay for that loan they obtain from investors, they typically must make interest payments twice a year to bondholders based on specified interest rates for the duration of the loan and account for them in relevant financial statements.
When the bond matures, regardless of the amount of interest paid out, they must return the principal back to the lenders. During the duration of the bond prior to maturity, companies must account for the bond interest expenses they incur paying the interest to investors within each accounting period.
Usually, when a company issues a bond, it creates a liability account known as bonds payable on its balance sheets, explains the Corporate Finance Institute. It shows it has committed to paying the principal amount in the future and also making interest payments on a semi-annual basis. For as long as the bond exists until it matures, companies must keep a record of bonds payable in the non-current liabilities section.
When a bond is issued at a premium or discount, the excess amount undergoes amortization over the life of the bond. And every six months, when coupon payments are issued, the company will incur an interest expense, which must be recorded in its income statement.
Formulas for Interest Expense Recording
The formula for the annual interest expense is:
Interest Expense = (Total Bond Value x Coupon Rate of Bond) + (Amortized Amount)
If the bond is issued at par value (face value of the bond), the amount that has undergone amortization will be zero. However, if amortization occurs, it would be easier to opt for the straight-line method.
In addition, companies also tend to record the after-tax interest expense. This refers to the interest a company pays on a debt after deducting its income tax savings.
Per Accounting Coach, the after-tax interest rate formula is:
After-Tax Interest Rate = (1 – Company’s Effective Tax Rate) x Bond Interest Rate
So, you can use that to get the after-tax interest expense in dollars by expanding the formula as follows:
After-Tax Interest Expense = Interest Expense x (100 percent – Company’s Tax Rate)
Or the following:
After-Tax Interest Expense = Total Bond Debt x After Tax Interest Rate
How to Calculate Interest Expense After Tax on a Bond
To calculate the after-tax interest expense on a bond, you will need to follow several steps.
First, you need to find out all the necessary information concerning the company whose after-tax interest expense you want to calculate. For example, suppose Marine Engineering Works Ltd. issued a corporate bond worth $4 million paying a 10 percent interest rate with interest payments twice a year for 10 years. Also suppose there is no amortization on this bond and the company pays tax at a rate of 25 percent.
Next, you should determine the interest expense amount. In this case, that would be ($4 million x (10/100)) + $0, which remains $400,000 per year for 10 years since there is no amortization (and over a time period of five years amounts to $2 million paid to lenders as total interest).
The third step is to use the correct formula to calculate the after-tax interest expense. In this case, you would perform the math as follows:
Interest expense x (100 percent – 25 percent), which is like $400,000 x 0.75, which equals $300,000.
Alternatively, you could use the formula: (1 – Company’s Effective Interest Rate) x Bond Interest Rate x Total Bond Debt. That is similar to 0.75 x 0.1 x 4 million. In this case, you would get 0.075 x 4,000,000, which is equal to $300,000.
The result you get after using the calculations shows the annual interest expense the company incurs each year for borrowing money via a bond.
- Do not rely solely on a company's debt expense when deciding to purchase its bonds. Consult a financial adviser if you have questions about investing.
I hold a BS in Computer Science and have been a freelance writer since 2011. When I am not writing, I enjoy reading, watching cooking and lifestyle shows, and fantasizing about world travels.