 # Bond Discount amortization for FCFF calculation

Lets say a company holds some dicount bonds on its balance sheet, Would we need to add this amorization of discount to the FCFF calcultation or subtract it.

Im thinking we need to subtract it, cos its a non cash item that increases the Net income …

ie Net income contains the interest amount ( Begining amortized cost x interest rate at issuence rather than the coupon received, so we would need to subtract it from the FCFF to adjust the Net income)

Any inputs would be much appriciated!

I know if it is a discount you add and if premium you subtract, that’s for sure.

This is how I think:

if its a discount bond then you bought it for price < par value. overtime the bond will rise on your balance sheet to the actual par value. so if bought somehting for 75 and itll pay you 100 at maturity. Now ask yourself, how should the coupon look like, in theory coupon and going interest rates sould be same for a bond selling at par. So for a discount bond, coupon < market int rate. This is because you are getting a gain of 25 by amortization. Now on NI, so your interest income would be coupon ± amortization. so your net income has gone up but you have received no cash.

Because coupon is less than the market rate, you must add the difference between coupon and market rate to arrive at your amortization.

under US gaap: to arrive at cfo using NI, you’d add the amortization & dep expenses, and subtract all amortization income.

under IFRS: interest income would CFI so CFO would be unaffected. i think.

someone pls clarify … thanks in advance.

Super confused…can anyone help? How does a discount amortization get added? Wouldnt it actually increase the net income, so to adjust for cash flow, we would subtract it out right?

Where are you seeing this???

Well, I just want to understand how its done. The book says discounts are added, but it just dont make sense to me!

Which page are you referring to and in which book? pls tell.

It doesn’t make sense to me either.

I can understand that dep and amortization (if reducing the NI) are added back. But there are times when you have interest income that’s less than the actual cash inflow. (such as the case would be for a discount bond). in that case, even though your NI has gone up, your CFO hasn’t. so I think you have to deduct, the tax on amortization, and the amortization itself from the NI to arrive at CFO. this is level 1 stuff if i am not wrong but haven’t come across anywhere that its being done in L2… so would like to clarify…

hey adq 123, I think u get confused because you miss 1 detail, bond discount (or premium) is included in Non cash charge category => So you are considered as Bond Issuer.

below is why we should add back amortization of bond discount.

What is discount bond and what does it mean? It means that your bond (you are issuer) have coupon is less than require yield.

what amount should u reflect on your finacial statement? It is require market yield ( to be exact, Effective market rate) not coupon bond. let’s say coupon is 50, required yield is 100. So you recognized 100 in your IS. Ignore tax for simplicity, it will lower your CFO by 100 (or Net income) Of course, it is not cash expense, so you need add up the different between 100-50=50=> FCFF should be add back 50,too.

the word “Amortization”, it means add up Liab in the case of Discount bond, and subtract from Liab in the case of Premium bond.

And this is how the BS be balanced: Expense increase 100 ( Equity decrease 100), Actual cash out flow 50 ( Asset decrease 50), longterm liab increase 50 (liab increase 50)

Apr9th, So your taking about it from the persective of the bond issuer.

That makes perfect sense, Now if I bought a discount bond I would have to add the amortization of discount right?

If we are investor, I think we need subtract amortize of discount bond to get FCFF, because it’s non cash gain

Sure Makes perfect sense if thats the case!

so then what I said was also right. I was taking the perspective of an investor (as the case may be) when you are investing in HELD TO MATURITY instruments.