Question

What is the discount on notes payable (what type of account)?

What is a contingent liability and when is it recorded versus disclosed?
How do you account for bond issuance costs under GAAP?

Answer 1

1.) What is the discount on notes payable (what type of account)?

A discount on notes payable occurs when the note’s face value is greater than its carrying value. The difference between the greater face value and the lesser carrying value is considered the discount. It represents the added interest that must be paid over the life of the note.

2.) What is a contingent liability and when is it recorded versus disclosed?

A contingent liability is a potential liability that may or may not become an actual liability. Whether the contingent liability becomes an actual liability depends on a future event occurring or not occurring.

In accounting, some contingent liabilities and their related contingent losses are:

• Recorded with a journal entry
• Are limited to a disclosure in the notes to the financial statements
• Not recorded or disclosed

Disclosing a Contingent Liability

A loss contingency which is possible but not probable will not be recorded in the accounts as a liability and a loss. Rather, it will be disclosed in the notes to the financial statements.

A loss contingency that is probable or possible but the amount cannot be estimated means the amount cannot be recorded in the company's accounts or reported as liability on the balance sheet. Instead, the contingent liability will be disclosed in the notes to the financial statements.

3.) ​​​​​​​ How do you account for bond issuance costs under GAAP?

Bond issue costs are the fees associated with the issuance of bonds by an issuer to investors. The accounting for these costs generally involves initially capitalizing them and then charging them to expense over the life of the bonds. Bond issue costs may include:

• Accounting fees
• Commissions
• Legal fees
• Printing costs
• Registration fees
• Underwriting fees

These costs are recorded as a deduction from the bond liability on the balance sheet. The costs are then charged to expense over the life of the associated bond, using the straight-line method. Under this amortization method, you charge the same amount to expense in each period over the life of the bonds. The full period over which bond issue costs should be charged to expense is from the date of bond issuance to the bond maturity date.

The amount of bond issuance costs charged to expense appears in the income statement in the period in which the charge is recognized.

We use this accounting treatment because, under the matching principle, we recognize expenses at the same time that we recognize the benefits associated with those expenses - thus, the benefit of having the bonds outstanding in any given year is matched with a portion of the original bond issue cost.

An alternative treatment when bond issuance costs are immaterial is to charge them to expense as incurred.

If a bond issuance is paid off early, then any remaining bond issuance costs that are still capitalized at that time should be charged to expense when the remaining bonds are retired.