Unamortized Bond Discount Definition

The premium account balance of $1,246 is amortized against interest expense over the twenty interest periods. Unlike the discount that results in additional interest expense when it is amortized, the amortization of premium decreases interest expense. The total interest expense on these bonds will be $10,754 rather than the $12,000 that https://personal-accounting.org/cash-basis-accounting-definition/ will be paid in cash. An unamortized bond discount is reported within a contra liability account in the balance sheet of the issuing entity. 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).

The straight-line approach suffers from the same limitations discussed earlier, and is acceptable only if the results are not materially different from those resulting with the effective-interest technique. Then, the company will amortize the amount of the difference to the account Bond Interest Expense throughout the bond’s life. Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University. J.B. Maverick is an active trader, commodity futures broker, and stock market analyst 17+ years of experience, in addition to 10+ years of experience as a finance writer and book editor.

Financial Accounting

Auditors prefer that a company use the effective interest method to amortize the discount on bonds payable, given its higher level of precision. To illustrate the discount on bonds payable, let’s assume that in early December 2021 a corporation prepares a 9% $100,000 bond dated January 1, 2022. The interest payments of $4,500 ($100,000 x 9% x 6/12) will be required on each June 30 and December 31 until the bond matures on December 31, 2026. The unamortized bond premium is the part of the bond premium that will be amortized (written off) against expenses in the future.

• At that point, the carrying value of the bond should equal the bond’s face value.
• 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.
• The straight-line approach suffers from the same limitations discussed earlier, and is acceptable only if the results are not materially different from those resulting with the effective-interest technique.
• This entry records $1,000 interest expense on the $100,000 of bonds that were outstanding for one month.
• If a bond is issued at a premium or at a discount, the amount will be amortized over the years through to its maturity.
• The discount amortized for the last payment may be slightly different based on rounding.

Just like with a discount, the premium amount will be removed over the life of the bond by amortizing (which simply means dividing) it over the life of the bond. The premium will decrease bond interest expense when we record the semiannual interest payment. When we issue a bond at a discount, remember we are selling the bond for less than it is worth or less than we are required to pay back. The difference between the price we sell it and the amount we have to pay back is recorded in a contra-liability account called Discount on Bonds Payable.

What are Bonds Payable?

As with the straight‐line method of amortization, at the maturity of the bonds, the discount account’s balance will be zero and the bond’s carrying value will be the same as its principal amount. See Table 2 for interest expense and carrying values over the life of the bond calculated using the effective interest method of amortization . The unamortized premium on bonds payable will have a credit balance that increases the carrying amount (or the book value) of the bonds payable.

A business or government may issue bonds when it needs a long-term source of cash funding. When an organization issues bonds, investors are likely to pay less than the face value of the bonds when the stated interest rate on the bonds is less than the prevailing market interest rate. The net result is a total recognized amount of interest expense over the life of the bond that is greater than the amount of interest actually paid to investors. The amount recognized equates to the market rate of interest on the date when the bonds were sold. The effective interest method of amortizing the discount to interest expense calculates the interest expense using the carrying value of the bonds and the market rate of interest at the time the bonds were issued.

Bonds Issued At A Premium

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. Because bond prices and interest rates are inversely related, as interest rates move after bond issuance, bond’s will be said to be trading at a premium or a discount to their par or maturity values. In the case of bond discounts, they usually reflect an environment in which interest rates have risen since a bond’s issuance. Because the bond’s coupon or interest rate is now below market rates, and investors can get better deals (and better yields) with new issues, those selling the bond have to, in effect, mark it down to make it more appealing to buyers.

The journal entries for the remaining years will be similar if all of the bonds remain outstanding. It’s a monetary figure reflected by the amount paid in addition to the fair market value of a company when that company is purchased. Goodwill usually isn’t amortized (except by private companies in some circumstances) because its useful life is indeterminate. However, impairment to the book value of goodwill is measured as fair value dips below book value. As a result, interest expense each year is not exactly equal to the effective rate of interest (6%) that was implicit in the pricing of the bonds.

Unamortized Bond Premium: What it Means, How it Works, Example

Suppose some investors purchase these bonds that will be worth $20,000,000 at maturity for $19,600,000. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, the balance in unamortized discount on bonds payable accountant, and consultant for more than 25 years. The following T-account shows how the balance in Discount on Bonds Payable will be decreasing over the 5-year life of the bond.