What is the Discount on Bonds Payable?

The discount on bonds payable is the difference between the face amount of a bond and the reduced price at which it was sold by the issuer. This happens when investors need to earn a higher effective interest rate than the stated interest rate associated with a bond. The amount of this discount is stored in a contra liability account, which is paired with and offsets the bonds payable account. The discount is amortized to interest expense over the remaining life of the bond, which means that the issuer recognizes an increased amount of interest expense over the life of the bond. As the discount is amortized over time, it decreases in size until it reaches a zero balance when the bond is redeemed.

Example of the Discount on Bonds Payable

An issuer sells bonds with a face value of $1,000,000 to investors. The investors want to earn a higher effective interest rate on these bonds, so they only pay $950,000 for the bonds. In this case, the discount on bonds payable is $50,000. The $50,000 amount is recorded in a Discount on Bonds Payable contra liability account. Over time, the balance in this account is reduced as more of it is recognized as interest expense.