A company issues $1,000,000 of 8% bonds for $924,000 and books the $76,000 as a Year 1 loss. Three years later it retires the same bonds at 102, comparing the $1,020,000 call price to the $1,000,000 face value. Both moves are wrong, and each one is a high-frequency FAR trap.
ASC 470 governs notes and bonds payable. The recognition principle: record debt at the present value of expected cash flows discounted at the market rate at issuance. From there, every subsequent measurement question is some version of "where do we stand on the amortization schedule, and what changed?"
A bond promises a fixed stream of cash: semi-annual coupon payments at the stated rate (also called coupon or contract rate) plus the face amount at maturity. Investors discount that stream at the market rate they require for similar risk. When the two rates differ, the present value differs from the face value.
If a 6% bond hits the market when investors demand 5%, investors pay extra to lock in the above-market coupon. Price exceeds face. That is a premium.
Common mistakes
- Treating bond premium or discount as a gain or loss at issuance. A $1,000,000 bond issued for $924,000 generates a $76,000 discount, not a $76,000 loss. The discount is amortized over the bond's life as additional interest expense.
- Comparing reacquisition price to face value on extinguishment. Bonds with $500,000 face, $12,000 unamortized discount, and $5,000 unamortized issuance costs retired at 102. The trap answer compares $510,000 (reacquisition) to $500,000 (face) and reports a $10,000 loss. Correct answer: net carrying = $500,000 - $12,000 - $5,000 = $483,000.
- Capitalizing issuance costs as a deferred asset. ASU 2015-03 eliminated this treatment for U.S. GAAP. A $24,000 issuance cost should reduce the bond carrying amount, not appear as an asset on the balance sheet. Trap appears in older textbooks; the current standard is netting.
Bottom line
- Stated rate vs. market rate at issuance determines premium (stated > market), discount (stated < market), or par (rates equal). Premium and discount are amortization adjustments, not gain or loss.
- Effective interest method: interest expense = carrying amount x market rate; cash interest = face x stated rate; the difference is amortization.
- Issuance costs (ASC 835-30) are a contra-liability that reduces the carrying amount, amortize via effective interest, and are written off on early extinguishment.
- Net carrying amount = face plus or minus unamortized premium or discount, minus unamortized issuance costs; never face value alone.
Exam shortcut
For early extinguishment, build net carrying amount from the bottom up before comparing to reacquisition price: Face +/- unamortized premium or discount - unamortized issuance costs. If a multiple-choice answer equals just the call premium times face value, that is the trap that ignores unamortized balances.
The full lesson (about 4,678 words, 31 min read) adds 8 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- II.H1
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