27 Mar 2020

What Is an Unamortized Bond Discount?

An unamortized bond discount is an accounting methodology for certain bonds. The unamortized bond discount is the difference between the par value of a bond—its value at maturity—and the proceeds from the sale of the bond by the issuing company, less the portion that has already been amortized (written off in gradual increments) on the profit and loss statement.

KEY TAKEAWAYS

  • An unamortized bond discount represents a difference between the face value of a bond and the amount actually paid for it by investors—the proceeds reaped by the bond’s issuer.
  • The bond issuer amortizes—that is, writes off gradually—a bond discount over the remaining term of the associated bond as an interest expense. The amount of the bond discount that has not yet been written off is the unamortized bond discount.
  • The flip side or an unamortized bond discount is an unamortized bond premium, which comes into play when the bond is selling for more than its face value.

How Unamortized Bond Discount Works

The discount refers to the difference in the cost to purchase a bond (its market price) and its par, or face, value. The issuing company can choose to expense the entire amount of the discount or can handle the discount as an asset to be amortized. Any amount that has yet to be expensed is referred to as the unamortized bond discount.

A bond discount to par value occurs when the current interest rate associated with a bond is lower than the market interest rate of issues of similar credit risk. If on the date a bond is sold, the listed bond’s coupon or interest rate is below current market rates; investors will only agree to purchase the bond at a “discount” from its face value.

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. So the bond will be priced at a discount to its par value.

Accounting for the Unamortized Bon Discount

The bond’s issuer can always 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). If so, there is no unamortized bond discount, because the entire amount was amortized, or
written off, in one gulp. Usually, though, 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.

A bond’s unamortized discount to par will:

  1. turn into a recognized capital loss if the bond is sold before its stated maturity; or,
  2. shrink as the bond’s market price rises with the passage of time as the bond nears its maturity date, which the bond will then be priced at its par value.

Unamoritzed Bond Premium

The flip side or an unamortized bond discount is an unamortized bond premium. A bond premium is a bond that is priced higher than its face value. Unamortized bond premium refers to the amount between the face value and the higher amount the bond was sold at, minus the interest.The unamortized bond premium is the part of the overall bond premium that the issuer will amortize—that is, write off incrementally against expenses in the future. The amortized amount of this bond is credited as an interest expense.

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