In case a bond is sold for less than the face or the par value, the amount by which the bond is sold low is known as a bond discount. This present value of a bond is the amount that is cheaper than the face value because the bond discount is the interest savings to the issuer since they are borrowing money at an effective rate lower than the bond’s coupon rate. In the following sections, this research aims to find out whether a discount on bonds payable operates as a contra account.
A contra account is defined as a special account that is used when the value of goods bought or sold on credit by two businesses are similar in amount and in the opposite direction they are offset against each other.
A contra account is an account that is usually paired with another account and usually has the opposite of the normal balance. This way, it offers a company the chance to report a net amount in the financial statements instead of presenting two accounts individually. Some examples of common contra accounts include:
- Total Amount - Property, Plant, and Equipments 060 000 000 Accumulated Depreciation - Contra to Property, Plant, and Equipment
- This account shows the amount provided for bad debts; this account is a contra to the accounts Accounts Receivable account.
-: Discount on Bonds Payable: A contra to Bonds Payable account is created when bonds are issued at a discount to both parties involved.
The Contra account will have a normal credit balance while the account it is balancing will have a normal debit balance. To record both accounts separately in the balance sheet would be cumbersome and inefficient, presenting the combined total makes for a neat appearance.
The question that often arises in the minds of the users of financial statements is whether Discount on Bonds Payable is a contra account or not.
Yes, a discount on bonds payable is another example of a contra-liability account. In particular, it serves as an account against bonds payable.
1. Normal credit balance – Just like in the case of bonds payable, the discount on bonds payable account has a normal credit balance, which is the reverse of bonds payable.
2. Reduces bonds payable – The credit balance in the discount on bonds payable is used to offset the amount reported under bonds payable. Instead of recording the liability at the face value, contra account enables it to be recorded at the carrying value being face value less unamortized discount.
3. Reduces chances of overemphasizing the liability – By recording the discount separately on the balance sheet, the chances of the bonds payable being overemphasized are eliminated. Since the actual amount borrowed is less than the par value, a discount on bonds payable is unbefitting face value for reporting the book value.
4. Combined two related accounts – while using a bond payable and a discount account separately, the use of a contra helps sum up the two related accounts to display one net figure.
5. Reduces overloading on balance sheet accounts – It offsets the related accounts which enhances a balance sheet’s presentation by eliminating unnecessary repetitiveness and enabling accounts to be reported at their actual carrying values.
Hence, in sum, a discount on bonds payable constitutes a contra account in the sense defined by textbooks. That liability account is due when paid and carries the opposite normal balance of bonds payable to allow the balance sheet to report the net bonds payable amount and directly reduce it.
Discount on bonds payable is an amount which is in direct opposition to the par value of bonds payable but the amount of discount gradually reduces over the bonds’ period. This is done through what is known as the process of amortization.
During each accounting period, the bond discount account is credited and interest expense is debited to recognize the discount over the bond period responsibly. The interest expense then leads to a rise in the net carrying amount for bonds payable as shown in the equation. This is because by the time the bonds get to the respective years of maturity, the contra account balance will be zero and the bonds payable will then be equal to the par value.
Nevertheless, since this account is a contra liability account, any credit balance in discount on bonds payable is considered a temporary account. The amount is lower and reduces gradually as the discount is moved to interest expense through the use of the amortization process.
All in all, it can be said that a discount on bonds payable is a contra account as the definition of this term was described above. It has a normal credit balance which directly eliminates the related bonds payable, enhances balance sheet appearance, and reports bonds payable at the net carrying amount. Debit accounts like bond discounts are rather more accurate in financial reporting than when several accounts are recorded separately. Nevertheless, with the use of the amortization schedule for the entire life of the bond, this contra account balance gets reduced till it is zero at the bond’s maturity.
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