Discount on bonds payable is a counter account to bonds payable that reduces the value of the bonds and is deducted from bonds payable in the long-term liabilities area of the balance sheet. It is initially the difference between the cash received and the bond’s maturity value.
What is a discount on bond due account?
The amount of unamortized discount connected with outstanding bonds is reported in this contra liabilities account. When bonds are issued for less than their face or maturity value, a discount on bonds payable occurs. Over the life of the bonds, the debit balance in this account will be amortized to bond interest expense, resulting in more interest expense than interest paid. See Explanation of Bonds Payable for further information.
On the balance sheet, where does the discount on bonds payable go?
The premium or discount on bonds payable that has not yet been amortized to interest expense will be reflected in the liabilities section of the balance sheet immediately after the par value of the bonds. The amounts will be reported in the long-term or noncurrent liabilities column of the balance sheet if the bonds do not mature within one year of the balance sheet date.
How do you keep track of bond discounts?
When a company prepares a bond to be issued/sold to investors, it may need to factor in the interest rate that will appear on the bond’s face and in its legal contract. Assume that the company issues a $100,000 bond with a 9% interest rate. A financial crisis happens just before the bond is issued, and the market interest rate for this sort of bond rises to 10%. If the company proceeds with the sale of its 9% bond in the 10% market, it will receive less than $100,000. A bond is considered to have been sold at a discount when it is sold for less than its face value. The difference between the amount received (excluding accrued interest) and the bond’s face amount is known as the discount. The terms “discount on bonds payable,” “bond discount,” and “discount” are used to describe the difference.
Assume a corporation prepares a 9% $100,000 bond dated January 1, 2020 in early December 2019 to demonstrate the discount on bonds payable. Until the bond matures on December 31, 2024, interest payments of $4,500 ($100,000 x 9% x 6/12) will be due on June 30 and December 31 each year.
Let’s now say that the market interest rate on this bond rises to 10% immediately before it is offered to investors on January 1st. Rather of revising the bond paperwork to reflect the market interest rate, the firm decides to sell the 9% bond. Because the corporation is selling its 9% bond in a market that is wanting 10%, the corporation will receive less than the bond’s face value.
Assume that on January 1, 2020, the 9 percent bond is sold in the 10% market for $96,149 plus $0 accrued interest to demonstrate the accounting for bonds payable issued at a discount. The following is the journal entry that the corporation will make to document the bond sale:
Because it will have a debit balance, the account Discount on Bonds Payable (or Bond Discount or Unamortized Bond Discount) is a contra liability account. The account Bonds Payable will always show a discount on Bonds Payable on the balance sheet. In other words, if the bond is a long-term liability, the balance sheet will show both Bonds Payable and Discount on Bonds Payable as long-term liabilities. The book value or carrying value of the bonds is the sum of these two accounts, or the net of these two accounts. The book value of this bond on January 1, 2020 is $96,149 (the $100,000 credit balance in Bonds Payable minus the $3,851 debit amount in Discount on Bonds Payable).
Discount on Bonds Payable with Straight-Line Amortization
The sum in the account Discount on Bonds Payable must be lowered to zero over the life of the bond. Amortizing or amortization is the process of reducing the account amount in a rational manner. Because the difference between a bond’s stated and market interest rates causes the discount, the journal entry for amortizing the discount will use the account Interest Expense.
The bond discount of $3,851 in our example arises from the firm getting only $96,149 from investors but needing to pay them $100,000 when the bond matures. Over the life of the bonds, the $3,851 discount is recognized as an additional interest charge. Straight-line amortization occurs when the same amount of bond discount is recorded each year. The straight-line amortization in this case would be $770.20 ($3,851 divided by the bond’s 5-year duration).
Straight-Line Amortization of Bond Discount on Annual Financial Statements
If a company only publishes yearly financial statements on December 31, bond discount amortization is frequently reflected when the company makes semiannual interest payments. In our case, the straight-line technique will result in the following journal entries for 2020:
The total interest expense for 2020 will be $9,770 (two semiannual interest payments of $4,500 each + two semiannual bond discount amortizations of $385 each). The entries for the year 2020 are shown in the T-account for Interest Expense:
The T-account below shows how the balance in Discount on Bonds Payable will decrease over the bond’s 5-year tenure.
The bond’s book value will increase from $96,149 on the date the bond was issued to $100,000 at maturity as the bond discount is amortized:
Straight-Line Amortization of Bond Discount on Monthly Financial Statements
The monthly amount of bond discount amortization under the straight-line technique will be $64.18 ($3,851 of bond discount divided by the bond’s life of 60 months) if the corporation releases monthly financial statements. During the year 2020, the 12 monthly journal entries for bond interest and bond discount amortization, as well as the entries for the June 30 and December 31 semiannual interest payments, will result in the following 14 entries:
If all of the bonds remain outstanding, the journal entries for the future years will be similar.
Why is a bond discount a risk?
If a bond is offered at a discount, such as 90 cents on the dollar, the issuer is still required to return the full face value of the bond at par. This interest amount represents a liability for the issuer because it has not yet been paid to bondholders.
Why is a contra obligation discount on bonds payable?
Because it is a liability account with a debit balance, the Discount on Bonds Payable account is a contra account. Some accountants refer to both the Discount on Bonds Payable and the Premium on Bonds Payable as auxiliary accounts, while others refer to both as valuation accounts.
How should the discount on payable bonds be shown in the financial statements premium on payable bonds?
The discount (premium) on bonds payable should be represented as a straight deduction from (addition to) the face amount of the bond in the balance sheet. Both of these accounts are liability valuation accounts.
Quizlet: What is the balance in the discount on bonds payable account?
Interest expense is represented by the account Discount on Bonds Payable, which will be amortized over the bond’s life. Bondholders have the right to vote for the board of directors when a corporation sells bonds.
Discount on notes payable is a type of account that often has a debit or credit balance.
A discount on payable notes or bonds is an example of a contra liability. The balance of contra liabilities is negative.
In the financial accounts, where should a discount or premium appear?
As a result, the discount or premium must be represented as a direct reduction from or increase to the face value of the note on the balance sheet. Debt issuance costs associated with a note must also be shown in the balance sheet as a direct deduction from the note’s face amount.