The preferred method for amortizing the bond discount is the effective interest rate method or the effective interest method. Under the effective interest rate method the amount of interest expense in a given accounting period will correlate with the amount of a bond’s book value at the beginning of the accounting period. This means that as a bond’s book value increases, the amount of interest expense will increase.

1. Since the corporation is selling its 9% bond in a bond market which is demanding 10%, the corporation will receive less than the bond’s face amount.
2. Because the issuer sold the bond for less than its face value, the issuer must reflect this discount on its balance sheet.
3. If the bond pays taxable interest, the bondholder can choose to amortize the premium, that is, use a part of the premium to reduce the amount of interest income included for taxes.
4. As time progresses and the bond discount is gradually expensed, the unamortized portion decreases.

Any amount that has yet to be expensed is referred to as the unamortized bond discount. The discount alludes to the difference in the cost to purchase a bond (its market price) and its par, or face, value. The responsible company can decide to expense the whole amount of the discount or can handle the discount as an asset to be amortized. Any amount that presently can’t seem to be expensed is alluded to as the unamortized bond discount.

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Companies try to issue bonds for the amounts shown on the face of their bonds. However, in periods of fluctuating interest rates, this is not always possible. When a company does not immediately expense the discount, unamortized discounts arise with respect to those bonds. Suppose ABC Corporation issues a 3-year, $1,000 face value bond with a stated annual interest rate of 5%. Because the bond’s interest rate is less attractive than the market rate, investors would be unwilling to pay the full face value for the bond.

The bond discount is the difference between the face value and the issuance price, which in this case is $30 ($1,000 – $970). Generally, however, the amount is material, as is amortized over the life of the bond, which might span a number of years. In this last option case, there is almost consistently an unamortized bond discount on the off chance that bonds were sold below their face amounts, and the bonds have not yet been retired. The unamortized bond premium is the part of the bond premium that will be amortized (written off) against expenses in the future. If the bond pays taxable interest, the bondholder can choose to amortize the premium, that is, use a part of the premium to reduce the amount of interest income included for taxes. Since bondholders are holding higher-interest paying bonds, they require a premium as compensation in the market.

Example of the Amortization of a Bond Discount

The unamortized discount continues to exist on the balance sheet until the bonds reach maturity or until the company retires the bonds, whichever occurs first. Unamortized Bond Discount refers to the portion of a bond’s initial discount that has not yet been amortized or allocated over the bond’s life. When a bond is issued at a price below its face or par value, the difference between the issuing price and the face value is considered as the bond discount. This outstanding bond discount is gradually amortized over the remaining life of the bond, and the unamortized portion represents the remaining discount that has not yet been accounted for in the financial statements.

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And the amortization of bond discount will increase the carrying value of the bonds payable on the balance sheet from one period to another until it equals the face value of the bond at the end of the bond maturity. After all, at the end of the bond maturity, the balance of the https://personal-accounting.org/ will become zero. It is useful to note that the unamortized bond discount account may also be called “bond discount” or “discount on bonds payable”. Though, the term “unamortized bond discount” here can also be used as a reminder, so that the company does not forget to amortize the bond discount in order to comply with the matching principle of accounting. The flip side or an unamortized bond discount is a unamortized bond premium.

Bond issuers who receive higher credit ratings are far likelier to fetch higher prices for their bonds than similar, lower-rated issuers. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. Founded in 1993, The Motley Fool is a financial services company dedicated to making unamortized bond discount the world smarter, happier, and richer. The Motley Fool reaches millions of people every month through our premium investing solutions, free guidance and market analysis on Fool.com, top-rated podcasts, and non-profit The Motley Fool Foundation. The journal entries for the remaining years will be similar if all of the bonds remain outstanding.

The premium or discount on bonds payable is the difference between the amount received by the corporation issuing the bonds and the par value or face amount of the bonds. If the amount received is greater than the par value, the difference is known as the premium on bonds payable. If the amount received is less than the par value, the difference is known as the discount on bonds payable. A contra liability account containing the amount of discount on bonds payable that has not yet been amortized to interest expense.

As time progresses and the bond discount is gradually expensed, the unamortized portion decreases. Amortizing bond premiums In order to figure out how much of your premium you can amortize each year, you have to know the coupon rate of the bond and the yield to maturity based on the price you actually paid. That is less than the 6% coupon rate stated because you’re paying more than face value for the bond. “Unamortized Bond Discount” refers to the portion of a bond discount that has not yet been amortized (or expensed) over the life of the bond. To understand this concept fully, it’s essential to start by grasping the basics of bond issuance at a discount. In our example, the bond discount of $3,851 results from the corporation receiving only $96,149 from investors, but having to pay the investors $100,000 on the date that the bond matures.

This figure is utilized by companies and investors to accurately calculate the book value of a bond and to determine the company’s financial position, enabling a proper reflection of the bond liability on the balance sheet. As the bond discount is gradually amortized, it increases interest expenses, thus affecting the company’s financial performance and tax liabilities. Consequently, understanding and monitoring the Unamortized Bond Discount is crucial for making informed financial decisions, optimizing a company’s funding strategy, and ensuring compliance with accounting standards.

For instance, with a 10-year bond paying 6% interest that has a $1,000 face value and currently costs $1,080 in the market, the bond premium is the $80 difference between the two figures. The following table summarizes the effect of the change in the market interest rate on an existing $100,000 bond with a stated interest rate of 9% and maturing in 5 years. To simplify the amortization, we’ll use the straight-line method over the bond’s 3-year life, although in real-world scenarios, the effective interest method is more commonly used. Bond issuers and the specific bond instruments they offer are rated by credit rating agencies such as Moody’s Investors Service and Standard & Poor’s.

Likewise, the company will make the journal entry to account for the bond discount by debiting the amount of the difference between the face value of a bond and its selling price in the unamortized bond discount account. The bonds have a term of five years, so that is the period over which ABC must amortize the discount. For example, if a company issues a 5-year bond with a face value of $1,000 at an issuance price of $950, it has an initial bond discount of $50. Over the five years, this $50 discount will be amortized as additional interest expense. If, after the first year, $10 of the discount has been amortized, the unamortized bond discount would be $40 ($50 initial discount – $10 amortized).

This method is required for the amortization of larger discounts, since using the straight-line method would materially skew a company’s results to recognize too little interest expense in the early years and too much expense in later years. Over the life of the bond, the balance in the account Discount on Bonds Payable must be reduced to $0. Reducing this account balance in a logical manner is known as amortizing or amortization. Since a bond’s discount is caused by the difference between a bond’s stated interest rate and the market interest rate, the journal entry for amortizing the discount will involve the account Interest Expense. Below is a comparison of the amount of interest expense reported under the effective interest rate method and the straight-line method.

The following T-account shows how the balance in Discount on Bonds Payable will be decreasing over the 5-year life of the bond. Also known as book value, the carrying value of a bond represents the actual amount that a company owes the bondholder at any given time. Once you’ve gathering this information, you can use a carrying value calculator such as a bond price calculator to determine the carrying value of the bond. Individuals who invest in discounted bonds typically receive higher returns.