If the market rate has fallen below the contract rate, then it is the corporation that will be reluctant to issue these bonds that pay such a relatively high rate. Accordingly, to compensate itself, the corporation will issue the bond at a premium—above the par. At maturity, however, it will only have to pay back par (you always pay what the bond says!). Thus the premium may be viewed as a reduction of the interest expense.
It is January 1, 19X1. A corporation wishes to sell a $10,000, 4-year bond. The contract rate is 10% but the market rate is only 8%. Accordingly the price is set to 104 (104% of $10,000 = $10,400). This is a premium situation.
It is January 1, 19X1. A corporation wishes to sell a $10,000, 4-year bond. The contract rate is 10% but the market rate is only 8%. Accordingly the price is set to 104 (104% of $10,000 = $10,400). This is a premium situation.
Cash 10,400
Bonds Payable 10,000
Bond Premium 400
The premium account is not a contra; it is an addition to the Bonds Payable account. However, as time goes by, the premium will be slowly amortized down to zero by the maturity date. Thus, at that time, the corporation will only have to pay back the par of $10,000.