Is an interest expense still recorded for zero coupon bonds to reflect the amortization of the discount each year? I understand that the firm records the proceeds received at issuance as a liability. I’m uncertain what goes on from there. Any help would be much appreciated. Thanks.
I guess zero coupon is a non-amortization bond.
Yes, the interest expense is still recored on the Income Stmt based on YTM of the bond at issuance.
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And IE ammortizes the deep discount (a deep built in loss given that you receive a deep discount from the face value, yet you have to return the face value at maturity), the deep discount being registered as a counter account of the Bond Liability (Bond discount goes down with each IE “payment”).
If you issue a $1000 par value 10 year zero when interest rates are 5% you will receive $610.27 (based on semi-annual compounding). So at initiation (say Jan 1) DR Cash 610.27 DR Disc. on BP 389.73 CR Bonds Payable 1000 06/01: DR Interest Expense 15.26 CR Disc. on BP 15.26 12/31: DR Interest Expense 15.63 CR Disc. on BP 15.63 No cash is paid and the book value of the bond at year end is $641.16. Even if you are not making periodic interest payments, you are still incurring an expense to borrow the money as time passes.
^edit, the date should be 06/30, not 06/01
Thanks Whodey - How would one classify the Discount on BP? Would that act like a contra account to the liability (bonds payable)?
Correct, it would be a contra liability and the bond’s book value would be the net.
awesome - thanks whodey