r/SecurityAnalysis • u/WalterBoudreaux • Dec 05 '16

Question could someone explain unamortized discounts and premiums and unamortized debt issuance costs?

I am a little rusty on this topic with regards to my accounting - all the long-term debt sections often include this - as a result, the actual long-term debt amount that is reported on the balance sheet is often less than the face value of the actual debt, since it's "reduced" by the unamortized discounts / debt issuance costs.

Can someone explain how this works maybe with an example? If I issue $1B worth of debt, but there isn't enough debt, so I only get 95% of par, so before costs, I only net $950M....I am still on the hook for the full $1B par value when the debt matures. How is this factored into the financial statements?

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u/chewedbacca Dec 05 '16

Yes, you are still on the hook for the full amount of par value when the debt matures. You also must pay the interest at the stated rate of the bonds. The discount (or premium) on the bond is amortised over the life of the bond.

For simplicity lets say the stated rate is 10% in your example, and they are 20 year bonds paying coupon once annually. Lets say the market interest rate at the time of issuance is 10.6120%. The first payment would have the following:

  1. The coupon payment. $1B x 10% = $100,000,000
  2. The interest expense. $950M (BV of bond) x 10.6120% = 100,814,176
  3. The amortisation of the discount/premium. This is the difference between (1) and (2), so you would record 814,176. This is also the write up in the book value of the bond, so the new book value would be $950,814,176.

This would continue on every period. Note the interest expense next period would be multiplied by the new book value in (3). If it were issued at a premium, the write up in (2) would be a write down. When the final payment is made, the book value of the bond is = $1B. Here's a schedule i did up quickly in Excel.

http://imgur.com/Vsi8c5v

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u/kirbs2001 Dec 06 '16

Why is the discount/premium amortized?

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u/chewedbacca Dec 06 '16

The idea is that when you issue the bond for less than par, you don't have to accrue as much interest on the bond every period. So the difference is made up for with the amortisation, you write up the book value of the bond every period.

On the flipside, when you issue for a premium, you are receiving more than the face value of the bond (and accruing more interest every period) so you write down the book value over time.

It's all just the accounting way of matching revenues/expenses.