What is an 'Amortized Bond'

An amortized bond is a financial certificate that has been reduced in value for recording on financial statements. An amortized bond is one where the discount amount being amortized becomes part of its interest expense over the life of the bond. If a bond is issued at a discount—that is, offered for sale below its par or face value—the discount must be treated either as an expense, or it can be amortized as an asset.

BREAKING DOWN 'Amortized Bond'

An amortized bond is used specifically for tax purposes due to the fact that the amortized bond discount is treated as part of a company's interest expense on its income statement. The interest expense, a nonoperating cost, reduces a company's earnings before tax (EBT) and, therefore, the amount of its tax burden.

Specifically, amortization is an accounting method that gradually and systematically reduces the cost value of a limited life, intangible asset. Treating a bond as an amortized asset is an accounting method in the handling of bonds. Amortizing a bond allows bond issuers to treat the bond discount as an asset over the life of the bond until the bond's maturity date.

Amortizing a Bond

The easiest way to account for an amortized bond is to use the straight line method of amortization. Under this method of accounting, the bond discount that is amortized each year is equal over the life of the bond.

For example, a company may want to raise debt financing and issue a corporate bond with a face value of $100,000, a maturity of five years and a annual coupon payment of 10%. However, interest rates increase, and the company is only able to issue the bond at a discount, selling the bond for $80,000. The $20,000 difference between the face value of $100,000 and the carrying value of $80,000 is the amount that is amortized over the five-year life of the bond.

Each year the company has to pay an amortized amount of $4,000, derived as: ($20,000/5). Additionally, the company has to pay an annual interest charge of $10,000, derived as: ($100,000 x 0.10). Therefore, the company's total annual interest expense is $14,000, which is the addition of the annual amortized amount of $4,000 and the annual interest rate charge of $10,000.

Companies also use the effective interest rate method to amortize bonds. Under this method of accounting, the bond discount amortized each year is equal to the difference between the bond's interest expense and its interest payable. However, this method requires a financial calculator or spreadsheet software to derive.

An Example of an Amortized Bond

North Valley Regional High School, in response to much needed improvements, issued a 15-year amortized bond to help fund operating costs and capital improvements. The bond is projected to cost $323,000 and should reduce the taxpayers burden of the general fund being used to make these needed improvements to the school.

RELATED TERMS
  1. Effective Interest Method

    The practice of accounting for the discount at which a bond is ...
  2. Amortizable Bond Premium

    A tax term referring to the excess premium paid over and above ...
  3. Negative Amortization Limit

    A provision in certain loan contracts that limits the amount ...
  4. Discount Bond

    A bond that is issued for less than its par (or face) value, ...
  5. Fully Amortizing Payment

    A periodic loan payment, part of which is principal and part ...
  6. Bond Discount

    The amount by which the market price of a bond is lower than ...
Related Articles
  1. Investing

    Explaining Amortization In The Balance Sheet

    Amortization is important to account for intangible assets. Read to find out more about amortization.
  2. Investing

    Premium Bonds: Problems And Opportunities

    Learn all about premium bonds and how you can make them work for you.
  3. Personal Finance

    Mortgage Amortization Strategies

    Should you get a 30-year mortgage? A 15-year one? Ways to decide which mortgage is the best fit.
  4. Investing

    Taxation Rules for Bond Investors

    Several factors affect the taxable interest that must be reported. Learn more here.
  5. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  6. Investing

    Know Your Cost Basis For Bonds

    Nobody likes taxes, but tax reporting is an inevitable and unavoidable part of investing. If you buy stock, determining your costs basis is a slightly frustrating but fairly straightforward exercise. ...
  7. Investing

    The Basics Of Bonds

    Bonds play an important part in your portfolio as you age; learning about them makes good financial sense.
  8. Investing

    Investing in Bonds: 5 Mistakes to Avoid in Today's Market

    Investors need to understand the five mistakes involving interest rate risk, credit risk, complex bonds, markups and inflation to avoid in the bond market.
  9. Investing

    How To Evaluate Bond Performance

    Learn about how investors should evaluate bond performance. See how the maturity of a bond can impact its exposure to interest rate risk.
  10. Personal Finance

    What is an Amortization Schedule?

    An amortization schedule is a table that shows the amounts of principal and interest that comprise each loan payment.
RELATED FAQS
  1. What is the effective interest method of amortization?

    Find out more about the effective interest rate method and how the effective interest method is used to amortize a discounted ... Read Answer >>
  2. How can I calculate the carrying value of a bond?

    Learn what the carrying value of a bond means, how it can change and the easiest way to calculate a bond's carrying value ... Read Answer >>
  3. How should you choose the amortization period for your mortgage?

    Read about key considerations that homeowners should take into account before choosing the amortization period for their ... Read Answer >>
  4. What determines the price of a bond in the open market?

    Learn more about some of the factors that influence the valuation of bonds on the open market, and why bond prices and yields ... Read Answer >>
  5. Does gross profit include depreciation or amortization?

    Understand the distinction between depreciation and amortization, and learn under which circumstances either type of expense ... Read Answer >>
Hot Definitions
  1. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  2. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
  3. Tax Refund

    A tax refund is a refund on taxes paid to an individual or household when the actual tax liability is less than the amount ...
  4. Gross Domestic Product - GDP

    The monetary value of all the finished goods and services produced within a country's borders in a specific time period, ...
  5. Inflation

    The rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of ...
  6. Merchandising

    Merchandising is any act of promoting goods or services for retail sale, including marketing strategies, display design and ...
Trading Center