Unamortized Bond Discount: Definition and How It Works
An unamortized bond discount is the remaining portion of a bond’s discount that has not yet been written off as interest expense. It represents the difference between a bond’s face (par) value and the proceeds received when the bond was issued, after subtracting any portion already amortized.
Why a Bond Sells at a Discount
- A bond sells at a discount when its coupon rate is lower than current market rates for similar credit risk.
- Because bond prices and interest rates move inversely, an issuer’s fixed coupon becomes less attractive if market rates rise after issuance. Investors will pay less than par to achieve a market-equivalent yield, creating a discount.
Accounting and Amortization
- Issuers can either expense the entire discount immediately (if immaterial) or amortize it over the life of the bond.
- Amortization spreads the discount across periods as additional interest expense, increasing the issuer’s reported interest expense each period.
- The unamortized bond discount is the portion still remaining on the balance sheet until fully written off.
What Happens Over Time
- As the bond approaches maturity, the unamortized discount is gradually reduced through amortization, and the bond’s carrying value moves toward par.
- If the bond is sold before maturity, the remaining unamortized discount may result in a recognized capital loss for the holder.
Unamortized Bond Premium (The Reverse)
- A bond premium occurs when a bond sells above par because its coupon rate is higher than prevailing market rates.
- The unamortized bond premium is the portion of that premium yet to be amortized. Amortizing a premium decreases interest expense over time.
Key Points Summary
- Unamortized bond discount = portion of issuing discount not yet written off.
- Occurs when a bond’s coupon < market interest rates at issuance or after rates rise.
- Typically amortized over the bond’s life, increasing interest expense each period.
- Remaining discount decreases over time or becomes a loss if the bond is sold before maturity.
- The opposite concept is an unamortized bond premium, which reduces future interest expense when amortized.