How Do I Enter A Municipal Bond with Accrued Interest?

rk911
rk911 Member
edited July 2022 in Investing (Windows)
I'm not a newbee with regards to investing and using Quicken. but I AM a newbee with regards to bonds. My wife and I (using a financial advisor) are creating a 5-yr municipal bond ladder in a new investment account. I also have created a new Quicken account for this purpose and we've seeded both the real and Quicken accounts with $X in cash transferred from another investment account.

I'm starting to get transaction notifications all of which show the # of bonds purchased (in $1000 increments), the price per bond, the maturity date, the promised yield at matutity, etc. In all of the bond purchases I'm seeing an amount in accrued interest. I don't know how to show this in Quicken.

Example: XYZ City, 25-$1000 bonds at $104.429 per bond for a total purchase of $52,214.50. But the transaction report also shows accrued interest of $638.49. On the transaction notification the interest amount is added to the purchase price for a total of $52,852.99. Quicken logs that accrued interest as a MISC EXPENSE. So far, we have purchased (through the investment advisor) a number of muni bonds from 20+ municipal entities and each purchase shows $X in accrued interest.

Entering the accrued interest in the purchase results in a MISC EXPENSE which, cumulatively, shows a negative cash balance. Intuitively that seems wrong, and the FA agrees. he said to show the accrued interest as a credit but that seems wrong, too, since we haven't held the bond long enough to generate ANY interest. Besides, interest on muni bonds (coupons) is generally paid twice a year. Other research I've done seems to indicate that accrued interest is due to the seller which makes me think this SHOULD be a debit and that the negative cash in the Quicken account is right. I'm very, very, confused.

What does the accrued interest represent and is it correctly added to the purchase price? If so, that must mean the negative cash balance is correct. and if that's true how does that balance straighten itself out over time? am I entering the data into Quicken correctly?

I would truly appreciate a non-technical explanation of what's happening and how I should enter new purchases and/or correct existing purchases to accurately reflect the true debits to the account.

Thanks.

Rich
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Best Answer

  • Tom Young
    Tom Young SuperUser ✭✭✭✭✭
    Answer ✓
    rk911 said:

    Those bonds were purchased on 6/16/22 with a settlement date of 6/17/22. The coupon dates on these bonds are Jan 1st and July 1st. The previous owner has already collected his Jan 1st coupon interest but not his July 1st coupon interest. The $691.97 we paid that owner represents interest earned between Jan 1st and the date of sale (or date of settlement??). On July 1st, assuming we hold the bond at that date (which we will...we plan on holding all our bonds to maturity), we will receive the $691.97 back + an unknown amount for the period between the sale or settlement date to June 30, 2022. Do I have that right?

    Rich
    Yes.  You've purchased two distinct things here: 1) A Bond and, 2) A Receivable of $691.97. 
    From a strict accounting standpoint both of these are "assets", debits on your balance sheet.  You'll collect that receivable with the next coupon payment to you.  The amount of that payment over and above the $691.97 will be your interest income for the period you've owned the bond.
    Quicken's method of accounting for the bond purchase takes that second item - the receivable for $691.97 - and instead of setting it up on your balance sheet, expenses it immediately.  Over time your net interest income will come out properly, but if the purchase is in one year and the coupon payment is in the following year then each year's net interest income will by incorrect by the amount of the accrued interest.
    I've outlined one way to have your income properly calculated for each period: you create a pseudo-security for the accrued interest, "buy" that security when you make your bond purchase, then "sell" that security at no gain or loss using the appropriate amount of the coupon payment as the "proceeds" from the sale.
    You may choose to simply follow Quicken's "expense the accrued interest" method as it's certainly simpler.

Answers

  • Tom Young
    Tom Young SuperUser ✭✭✭✭✭
    edited June 2022
    It's been a long time since I've purchased a corporate bond but I seem to remember running into Quicken's somewhat funky accounting convention previously.
    When you buy a bond between coupon dates, the problem arises that you are going to receive the entire next coupon payment, let's say it's $500, but you're only entitled to the interest income for the time between your purchase and the next coupon date.  For sake of argument let's say that you're actually only entitled to $100 of that next $500 coupon.  Accordingly, when you buy the bond you are charged an extra $400, which is then passed along to the seller. 
    There's two ways that you might account for this $400 in your accounting records: 
    Here's the "correct" (GAPP) accounting:
    Debit (increase) an "Accrued Interest Receivable" asset   $400
    Credit (decrease) Cash in Investment Account                $400
    (To record $400 interest paid to seller)
    When you actually receive the $500 coupon you'd record this entry:
    Debit (increase) Cash in Investment Account                 $500
    Credit (decrease) "Accrued Interest Receivable" asset    $400
    Credit (increase) Bond Interest Income Category           $100
    (To record receipt of coupon, eliminate Accrued Interest Receivable asset, and recognize interest income)
    This is the method I used when I was buying bonds.  In a Quicken Investment Account I would create a pseudo-security called something like Accrued Interest (Ford Motors) and "Buy" that security alongside my purchase of a Ford Motors bond, then "Sell" that pseudo-security at no gain or loss when the next coupon payment was made.  This worked fine and everything was correct, but I never had more that 2 -3 bonds at any one time, so it wasn't particularly confusing.
    Here's Quicken's accounting for that same situation:
    Debit (increase) Bond _Accrued Interest          $400
    Credit (decrease) Cash in Investment Account $400
    (To record $400 interest paid to seller)
    Upon receipt of the $500 the entry is
    Debit (increase) Cash in Investment Account                 $500
    Credit (increase) Bond Interest Income Category           $500
    (To record coupon payment)
    The net income with this accounting works out to be the same as the GAAP accounting ($500-$400=$100) but the two accounting entries might straddle periods (e.g., years) resulting in incorrect period income figures but correct income over the longer term.
    The GAAP method produces the correct accounting for any period but does involve more work, while the Quicken method gives the same income figures overall, though period income might be misstated, and is easier. 
    You can decide what approach you want to take here.
  • Boatnmaniac
    Boatnmaniac SuperUser ✭✭✭✭✭
    edited June 2022
    If you want to keep it simple, you might want to not do anything in Quicken with that accrued interest.  If you do try to deal with it in Quicken it can get complex.  And then there is the risk that it will mess up Quicken's tax and investment performance planning and reporting features if the actions taken are done incorrectly.  Accrued interest is really nothing until it is actually paid out and then that is when you want to account for it in Quicken. 
    In some ways it is similar to stock prices in that the stock value increases/decreases are unrealized gains/losses until the stock is actually sold.  And if it is a dividend paying stock, once the dividend is announced it is an accrued dividend but do you do anything with it when it is announced or do you wait until the dividend is actually paid out?
    Or perhaps more applicable:  What do you do with interest as it accrues in interest bearing checking and savings accounts?  Do you enter the interest as it accrues or do you wait until the bank pays it out?
    I take the same approach with both Bonds and CDs:  Let the transaction downloads from the broker control what gets entered into the account register.  And never bother doing anything in Quicken with the accrued interest.  It doesn't get any easier than that.
    (QW Premier Subscription: R44.20 on Windows 11)
  • Tom Young
    Tom Young SuperUser ✭✭✭✭✭
    "If you want to keep it simple, you might want to not do anything in Quicken with that accrued interest."
    If you don't do anything in Quicken with that accrued interest then the cash in the Account is going to chronically misstated and your interest income will always be misstated.
    Quicken's approach makes a certain amount of sense because the product is aimed towards non-accountants.  To most non-accountants "cash out" is an "expense" and "cash in" is "income" and Quicken's default accounting comports with that notion.  While a period's expense or income might be misstated, once you combine the two periods, (purchase in one period, income in the next period), then your net income is correct, and your cash is always correct in both periods.
  • Rocket J Squirrel
    Rocket J Squirrel SuperUser ✭✭✭✭✭
    edited June 2022
    Accrued interest is an expense. You pay the interest which accrued to the previous bond owner. It is properly represented as a one-time expense at bond purchase time. A MiscExp categorized as _Accrued Int is correct.
    Quicken user since version 2 for DOS, now using QWin Premier Subscription (US) on Win10 Pro.
  • q_lurker
    q_lurker SuperUser ✭✭✭✭✭
    Accrued interest is an expense. You pay the interest which accrued to the previous bond owner. It is properly represented as a one-time expense at bond purchase time. A MiscExp categorized as _Accrued Int is correct.
    Fundamentally, I agree. 
    I choose to enter the transaction either as a MiscExp transaction using the category of _IntInc (or _IntIncTaxFree if applicable) or as an IntInc transaction with a negative interest value. My primary goal is to have the interest income reported to me correctly for my tax return preparations which my choices do for me. 
    I am not sure that the _Accrued Int category was in place when I started this process. 
  • Tom Young
    Tom Young SuperUser ✭✭✭✭✭
    "Accrued interest is an expense."
    Strictly speaking it's not an expense, it's a receivable, but calling it an expense that offsets an income down the road isn't the worst thing in the world.  The only problem with that approach is that period income might be misstated.
  • q_lurker
    q_lurker SuperUser ✭✭✭✭✭
    Tom Young said:
    "Accrued interest is an expense."
    Strictly speaking it's not an expense, it's a receivable, but calling it an expense that offsets an income down the road isn't the worst thing in the world.  The only problem with that approach is that period income might be misstated.
    I’ll add to that also that it seems in some cases, tax wise the ‘credit’ for paid accrued interest against interest received can be deferred to the next tax year. If you ‘pay’ the interest in December but don’t receive the interest until January you may be able to defer the interest paid ‘expense’ from one year to the next. That’s what I’ve seen in my 1099s at least. 
    In such cases, I add two transactions dated 12/31 and 1/1 to represent that deferral and to get my Quicken data consistent with the tax state. 
  • rk911
    rk911 Member
    thanks to you all who took the time to reply.

    a little about me. i have no formal training or experience in bookkeeping or accounting. I do understand some fundamentals...accounts payable, accounts receivable, purchasing stocks and mutual funds, cap gains, realized vs unrealized gains and the like. When I was working I kept track of our budget, income and expenses using Quickbooks and have been using Quicken for decades for our own finances.

    We are building a municipal bond ladder on the advice of our financial advisor. We seeded the account with $X in cash and the firm, at our direction, began buying municipal bonds. A typical purchase from a transaction advice notice looks like this:

    Trade Date: 6/16/2022
    Bought
    XYZ Municipality
    Quantity: 30,000 (30-bonds at $1000 each)
    Price: $103.06799
    Principal: $30,920.40
    Interest: $691.97
    Total: $31,612.07

    Logging onto my account I see the total outlay of $31,612.07 matches the amount debited from the account for the purchase of these bonds. I understand what some have said that the interest is due to the seller of this bond (the seller accrued this interest but it had not yet been paid to the buyer by the issuer. right?) but...when all of the bond purchases including the accrued interest are added up in Quicken it shows a negative cash balance. In simple terms if the account started with $X dollars the cash balance in the account is now a negative number. How can that be? How can more $ be spent buying bonds that was available to be spent? ????

    Rich
  • q_lurker
    q_lurker SuperUser ✭✭✭✭✭
    @rk911
    Is the negative balance equivalent to the sum of the accrued "Interest" in your bond purchases?
    I suppose it is possible that the brokerage is treating the interest similar to what @Tom Young laid out - as a temporary liability.  That when the interest does get paid to you in the next semi-annual payment (maybe $750 assuming a 5% bond), they will only credit your account the net of the bond interest less the accrued interest ($750-691.97 = 58.03).   
  • rk911
    rk911 Member
    Follow-up. I'm pretty sure I have this figured out but please check me on this.

    First, I missed a cash transfer into the bond ladder fund. duh. Don't know how I missed it but I did. So that takes care of the negative cash balance in the fund.

    Second, I think I understand the interest thing. Re-reading your comments helped illuminate that particular set of neurons in my brain. Using the example in my previous comment...

    Those bonds were purchased on 6/16/22 with a settlement date of 6/17/22. The coupon dates on these bonds are Jan 1st and July 1st. The previous owner has already collected his Jan 1st coupon interest but not his July 1st coupon interest. The $691.97 we paid that owner represents interest earned between Jan 1st and the date of sale (or date of settlement??). On July 1st, assuming we hold the bond at that date (which we will...we plan on holding all our bonds to maturity), we will receive the $691.97 back + an unknown amount for the period between the sale or settlement date to June 30, 2022. Do I have that right?

    Rich
  • Tom Young
    Tom Young SuperUser ✭✭✭✭✭
    Answer ✓
    rk911 said:

    Those bonds were purchased on 6/16/22 with a settlement date of 6/17/22. The coupon dates on these bonds are Jan 1st and July 1st. The previous owner has already collected his Jan 1st coupon interest but not his July 1st coupon interest. The $691.97 we paid that owner represents interest earned between Jan 1st and the date of sale (or date of settlement??). On July 1st, assuming we hold the bond at that date (which we will...we plan on holding all our bonds to maturity), we will receive the $691.97 back + an unknown amount for the period between the sale or settlement date to June 30, 2022. Do I have that right?

    Rich
    Yes.  You've purchased two distinct things here: 1) A Bond and, 2) A Receivable of $691.97. 
    From a strict accounting standpoint both of these are "assets", debits on your balance sheet.  You'll collect that receivable with the next coupon payment to you.  The amount of that payment over and above the $691.97 will be your interest income for the period you've owned the bond.
    Quicken's method of accounting for the bond purchase takes that second item - the receivable for $691.97 - and instead of setting it up on your balance sheet, expenses it immediately.  Over time your net interest income will come out properly, but if the purchase is in one year and the coupon payment is in the following year then each year's net interest income will by incorrect by the amount of the accrued interest.
    I've outlined one way to have your income properly calculated for each period: you create a pseudo-security for the accrued interest, "buy" that security when you make your bond purchase, then "sell" that security at no gain or loss using the appropriate amount of the coupon payment as the "proceeds" from the sale.
    You may choose to simply follow Quicken's "expense the accrued interest" method as it's certainly simpler.
  • rk911
    rk911 Member
    Thanks, Tom...and to everyone else as well. For now I'm going to let Quicken do it's thing. Your help was truly appreciated.

    Rich
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