Publicly traded companies and large, privately owned companies issue bonds to raise debt capital to fund their operations, acquisitions or expansion initiatives. 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. Companies must sometimes issue bonds at a discount. When a company does not immediately expense the discount, unamortized discounts arise with respect to those bonds.
Unamortized Bond Discount Defined
A par of a bond is the bond's value at maturity. A bond discount is a bond's excess of par value over its selling price. An unamortized bond discount refers to the balance of a bond discount that remains to be amortized by the issuing firm over the bond's life until it matures. As the discount amortizes, it appears on the issuing firm's income statement as an amortization or interest expense.
Bond investors buy bonds at a discount from their face value, or par value, when the market interest rate exceeds the interest rate offered with the bonds on the date of issue. Buying below par enables investors to increase their effective return on investment on the interest the bond issuer pays. Because the issuer sold the bond for less than its face value, the issuer must reflect this discount on its balance sheet.
A company sells $100 million in bonds at a 5 percent discount; it only received $95 million in total proceeds. The company would show $100 million in bond value as a liability on its balance sheet and the $5 million discount as a contra account to that liability, similar to accumulated depreciation. Therefore, the total liability shown on the balance sheet is $95 million, which equals the cash the issuer received. The issuer then amortizes the $5 million, which appears as an amortized bond discount or interest expense on the income statement over the bond's life and reduces the $5 million discount shown.
One Time Expensing
Accounting rules allow bond issuers to opt to write off all of a bond discount at one time if the impact of the write-off has no material impact on the issuer's financial statements. When an issuer elects to use this option, no unamortized discount exists because the discount was written off at once. However, due to the size of bond issues in relation to a company's net profit, for most companies, writing off the entire discount at once would be material. Therefore, most companies amortize the 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.
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