Definition§
An unamortized bond discount is the difference between the face value (par value) of a bond and the proceeds received from the sale of the bond, minus the portion that has been written off to date as an expense. This adjustment is recorded periodically on the profit and loss statement. The unamortized discount progressively decreases as it is amortized over the life of the bond until it reaches zero at the bond’s maturity.
Examples§
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Corporate Bonds: A corporation issues a $1,000 bond for $950 due to market conditions. The $50 difference is initially recorded as a bond discount. If $10 is amortized in the first year, the unamortized bond discount at the end of the first year would be $40 ($50 - $10).
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Government Bonds: A government issues a $5,000 bond but receives only $4,900 due to investor preferences. The $100 difference is a bond discount. Over the bond’s term, the $100 is gradually amortized, with the remaining unamortized discount decreasing each year.
Frequently Asked Questions§
Q: Why is there a bond discount?
A: A bond discount arises when the bond’s market interest rate is higher than the coupon rate, making the bond less attractive unless sold at a lower price to yield the market rate of return.
Q: How is the unamortized bond discount recorded in financial statements?
A: The unamortized bond discount is recorded as a contra-liability account on the balance sheet and reduces the bond’s carrying amount.
Q: What is the effective interest method for amortizing bond discounts?
A: The effective interest method involves calculating the bond’s interest expense based on its carrying amount, producing a constant rate of interest over the bond’s life.
Q: How does amortizing a bond discount affect the profit and loss statement?
A: Amortizing a bond discount increases interest expense on the profit and loss statement, thereby reducing net income over the bond’s life.
Q: Can a bond have both a premium and a discount?
A: No, a bond can either be issued at a discount or at a premium based on the market interest rate relative to its coupon rate.
Related Terms§
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Bond Premium: The amount by which the sale price of a bond exceeds its face value. This is amortized as an income over the bond’s life.
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Coupon Rate: The annual interest rate paid by the bond’s issuer relative to its face value.
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Carrying Amount: The net amount at which a bond is reported on the balance sheet, including any unamortized premium or discount.
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Effective Interest Rate: The actual interest rate earned by the bond’s holder, considering the bond’s issue price, coupon payments, and the amortization of discount or premium.
Online References§
- Investopedia - Understanding Bond Discount
- The Balance - How to Account for Bonds
- Corporate Finance Institute - Bond Discounts
Suggested Books for Further Studies§
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“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
A comprehensive guide on accounting principles, including detailed chapters on bonds and their amortizations. -
“Financial Accounting” by Robert Libby, Patricia A. Libby, and Daniel G. Short
This book provides insights into financial accounting, including bond liabilities and investments. -
“Essentials of Corporate Finance” by Stephen A. Ross, Randolph W. Westerfield, and Bradford D. Jordan
A fundamental resource covering various aspects of corporate finance, including bond valuation and interest calculations.
Fundamentals of Unamortized Bond Discount: Accounting Basics Quiz§
Thank you for exploring the fundamentals of unamortized bond discounts with this detailed definition and quiz. Continue to excel in your understanding of financial concepts!
