Definition | Examples | Journal Entry | Calculation Formula | Financial Statements
When a bond is sold at a discount, the Discount on Bonds Payable contra liability account carries the difference between the reduced price at which the bond was sold and its face value, which is the principal amount that the issuer will be required to pay back at maturity.
In other words, a discount on bond payable means that the bond was sold for less than the amount the issuer will have to pay back in the future.
Such discounts occur when the interest rate stated on a bond is below the market rate of interest and the investors consequently earn a higher effective interest rate than the stated interest rate.
The unamortized debit balance in the Discount on Bonds Payable contra liability account will decrease as it is amortized (i.e., allocated) to Interest Expense over the life of a bond, until it reaches a nil balance when the bond is finally redeemed.
The carrying amount of the outstanding bonds payable by an entity is calculated as the difference between the credit balance in its Bonds Payable liability account and the unamortized debit balance in the associated contra liability account Discount on Bonds Payable.
|Net Book Value of Bonds Payable
|Liability with a credit balance
|(Less: Discounts on Bonds Payable)
|(Contra-liability with a debit balance)
|= Net Book Value of Bonds Payable
|Carrying amount, current value
Discount on Bonds Payable is a contra liability account with a debit balance, which is contrary to the normal credit balance of its parent Bonds Payable liability account.
|Debit or Credit - Discount on Bonds Payable
|Parent liability account
|Discount on Bonds Payable
|Contra liability account
When a bond is sold at a discount, the issuer records the cash received from the bond sale with a debit to a Bank account asset, while also increasing the liability of Bonds Payable with a credit entry, which is partially offset by a debit to the Discounts on Bond Payable contra liability account.
Company A issued bonds with a face value of $1,000,000. The investors paid only $900,000 for these bonds in order to earn a higher effective interest rate. Company A recorded the bond sale in its accounting records by increasing Cash in Bank (debit asset), Bonds Payable (credit liability) and the Discount on Bonds Payable (debit contra-liability).
|Journal Entry - Discount on Bonds Payable - Issue
|Cash in Bank
|Discount on Bonds Payable
The debit balance in the Discount on Bonds Payable account will gradually decrease as it is amortized to Interest Expense over their life.
In the financial statements, Discount on Bonds Payable contra-liability reduces the Bonds Payable liability balance sheet line-item in order to report the net carrying value of bonds issued by an entity that are outstanding as of the balance sheet date.
If the discount amount is immaterial, the parent and contra accounts can be combined into a one balance sheet line-item.
|Balance Sheet > Long-Term Liabilities > Bonds: Issue Date
|Bonds Payable - Gross
|(Less: Discount on Bonds Payable)
|Bonds Payable - Net
|Book Value (current carrying amount)
Over time, as the balance in the Discount on Bonds Payable contra liability account will gradually decrease due to amortization, the net amount of Bonds Payable (= liability + contra liability) reported in the balance sheet will increase proportionally, until the date when the bonds will be repaid to the investors.
Sign up for our Newsletter
Get more articles just like this straight into your mailbox.