What does the unamortized discount mean? | Finance
By: Tiffany C. Wright
Publicly traded companies and large private companies issue bonds to raise debt capital to finance their operations, acquisitions or expansion initiatives. Companies try to issue bonds for the amounts shown on the front of their bonds. However, in times of fluctuating interest rates, this is not always possible. Companies sometimes have to issue bonds at a discount. When an enterprise does not immediately recognize the discount, unamortized discounts arise on these obligations.
Defined unamortized bond discount
The par of a bond is the bond’s value at maturity. A bond haircut is the excess of the face value of a bond over its sale price. An unamortized bond discount refers to the balance of a bond discount that remains to be amortized by the issuing company over the life of the bond until maturity. As the discount is amortized, it appears in the income statement of the issuing company as amortization or interest expense.
Bond investors buy bonds at a price lower than their face value, or face value, when the market interest rate exceeds the interest rate offered with the bonds on the date of issue. Buying below par allows investors to increase their effective return on investment on the interest paid by the bond issuer. Since the issuer has sold the bond for less than its face value, the issuer should reflect this discount on its balance sheet.
A company sells $ 100 million in bonds at a 5% discount; he only received $ 95 million in total proceeds. The company would show $ 100 million of bond value as a liability on its balance sheet and the $ 5 million offset against that liability, similar to accumulated amortization. Therefore, the total liability shown on the balance sheet is $ 95 million, which is equivalent to the cash the issuer received. The issuer then amortizes the $ 5 million, which appears as a haircut or amortized interest expense on the income statement over the life of the bond and reduces the $ 5 million haircut shown.
The accounting rules allow bond issuers to choose to write off the entire bond discount at once if the impact of the write-off does not have a significant impact on the issuer’s financial statements. When an issuer chooses to use this option, there is no unamortized haircut because the haircut has been written off all at once. However, due to the size of bond issues relative to a company’s bottom line, for most companies, waiving the entire haircut at one time would be important. Therefore, most companies write off the rebate. The unamortized haircut continues to exist on the balance sheet until the bonds mature or until the company withdraws the bonds, whichever occurs first.
Biography of the writer
Tiffany C. Wright has been writing since 2007. She is a business owner, Interim CEO and author of “Solving the Capital Equation: Financing Solutions for Small Businesses”. Wright has helped companies raise more than $ 31 million in financing. She holds an MA in Finance and Entrepreneurial Management from the Wharton School at the University of Pennsylvania.