Question

Under what conditions of bond issuance does a discount on bonds payable arise? Under what conditions of bond issuance does a premium on bonds payable arise?

Answer 1

Discount on bonds payable

Discount on bonds payable arises when the interest rate of the bond is less than the bond's market interest rate. This can be easily explained with an example. If a bond of $20000 is issued at an interest rate of 7% per annum and the bond market demands 7.5%, the bonds will sell for less than $20000. The difference between the face value($20000) and the amount the bond market is willing to pay is the discount on bonds payable. Further, the amount of discount is influenced by the number of years of the bond issue and the difference in the bond rate and the market rate.

Premium on bonds payable

A premium on bond payable occurs when the opposite of the above happens, i.e, the market interest rate is less than the bond rate. In this case the buyers will be willing to pay more for the bond, which creates a premium.