Amortization of discount on serial bonds;

              44 HASKINS & SELLS June
Amortization of Discount on Serial Bonds
BONDS issued originally at a discount
exceed in number by far those issued
otherwise. An increasing proportion of
these bond issues contain a provision for
their redemption on a serial basis. The
accounting treatment of the bond discount
on the books of the issuing company be­comes
a practical problem of amortization.
Assume an issue of 5% bonds of $10,000,-
000 is to be floated, maturing serially
during the succeeding ten-year period, and
the investment house underwriting the
bonds agrees to take over the entire issue
at 90. In making an offer of 90 the invest­ment
house perhaps will allow five points
for the estimated expenses of underwriting.
The profit for underwriting will depend
upon the price for which the bonds ulti­mately
are resold. A price of 98 perhaps
would constitute sufficient spread between
the original offer of 90 and the resale price
to permit the investment house to realize a
reasonable profit for underwriting the issue.
The issuing company will be faced with
the problem of disposing of the $1,000,000
bond discount. Two things are fairly
certain about writing off the discount:
(1) it is not necessary for the company to
write off the entire discount in the year in
which the bonds originally are issued;
(2) the discount should be written off
entirely by the time the last bond matures.
Evidently the $1,000,000 discount is to be
amortized in some way over the life of the
bonds, ten years. There are several
methods which may be presented for con­sideration.
Probably the simplest method for writing
off the discount is the straight-line, or
equal-instalment, method. The total dis­count
is prorated over the entire number of
years that the bonds will be outstanding.
In this case the discount would be written
off at the rate of $100,000 per year for the
ten-year period. This method provides
for the distribution of the discount expense
equally over the life of the bonds. It does
not take into consideration the fact that
the bonds outstanding during the early
years constitute a much greater amount
than the bonds outstanding during the
later years. If the bonds are being pur­chased
in the open market and the dis­count
applicable to bonds purchased by
the company during any year should ex­ceed
the straight-line amortization, then
the larger figure would be used.
Care should be taken in wording the
provision for writing off the discount in
case bonds are purchased annually in the
open market and retired through a sinking
fund. The provision may stipulate that
all the discount should be written off on the
bonds as they are retired through the