Question

Under what conditions of a bond issuance does a discount arise?

How are discounts reported on the face of the financial statements?

Describe the two methods of amortizing a discount. Why does GAAP find the effective-interest method of discount amortization preferable?

Answer 1

1. Discounts on bonds held when the interest rate of the bond is less than the bond maket interest rate. And it is also depends on the number of year before the bonds mature.

2. Discount on bonds is shows in the balance sheet in the liabilities section because it is not yet amortized to interest expense.

3. The two methods of amortzing a discount are-

a) Effective rate method- Under this method the amount of interest expense will correlate with the the amount of the bond's book value at the beginning of the accounting period because of that the book value increases and the amount of expense will also increase.

b) Straight line method- According to this method the amount of premium for each and every year will be same. We can get it by dividing the bond premium by the number of years.

According to GAAP the interest cost of borrowing have to be shown in the form of interest expense which is recognise at a constant interest rate, this rate is known as the effective interest method. It is applicable to a discount or a premium realized upon issuancecosts incurred on the transaction.