Unamortized bond discount definition
/What is an Unamortized Bond Discount?
An unamortized bond discount refers to the accounting applied to a bond sold below its face amount . When the stated interest rate associated with a bond is lower than the market interest rate on the date when the bond is sold, investors will only agree to purchase the bond at a discount from its face amount. By paying less, investors are effectively increasing their return on investment when they are paid interest by the bond issuer . The difference between the face amount of a bond and the amount actually paid for it is the bond discount. The bond issuer writes off the full amount of the bond discount over the remaining term of the bond with which it is associated. The amount written off is charged to interest expense . The amount of the bond discount that has not yet been written off is called the unamortized bond discount.
How to Calculate an Unamortized Bond Discount
An unamortized bond discount is the difference between the par value of a bond and the issuer’s proceeds from the initial sale of the bond, minus any subsequent amortizations of this discount. The par value of a bond is its value when it matures - which is the amount that the issuer must redeem from investors. There are likely to have been prior amortizations of this discount, since the standard accounting for it is to recognize a small portion of the discount in monthly increments until the bond matures. The following exhibit shows the declining amount of an unamortized discount over the life of a bond.
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Accounting for an Unamortized Bond Discount
The issuing entity can elect to write off the entire amount of a bond discount at once, if the amount is immaterial (e.g., has no material impact on the financial statements of the issuer). If so, there is no unamortized bond discount, because the entire amount was amortized at once. Much more commonly, the amount is material, and so is amortized over the life of the bond, which may span a number of years. In this latter case, there is nearly always an unamortized bond discount if bonds were sold below their face amounts, and the bonds have not yet been retired.
When an unamortized bond discount is first recorded, there is a debit to cash in the amount of the cash received, a debit to the bond discount contra account in the amount of the discount, and a credit to the bonds payable account in the amount of the face value of the bonds issued. As the discount is amortized, there is a debit to interest expense and a credit to the bond discount contra account.
Presentation of Unamortized Bond Discounts
An unamortized bond discount is reported within a contra liability account in the balance sheet of the issuing entity.
Unamortized Bond Premium
The reverse of an unamortized bond discount is the unamortized bond premium. This premium arises when a bond is sold at a higher price than its face value. The situation arises when the coupon interest rate is higher than the current market interest rate, so investors are willing to pay more to acquire the bond. The issuer amortizes the premium over the remaining life of the bond, with the amortized amount being used to reduce interest expense with a credit to that account.
