Multiple Choice
In 2014, ABC Company issued $100,000, 10%, bonds while the market interest rate was 12%. The bonds mature in the current year. The amount of principal that ABC Company will repay in the current year is equal to:
11. Long Term Liabilities
Discount on Bonds
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The balance in Discount on Bonds Payable is best described as:
A
An asset account that increases the carrying value of bonds payable.
B
An equity account that represents interest earned on bonds.
C
A contra-liability account that reduces the carrying value of bonds payable.
D
A liability account that increases the carrying value of bonds payable.
Verified step by step guidance1
Understand the concept of 'Discount on Bonds Payable': It represents the difference between the face value of the bond and its issuance price when the bond is issued at a discount. This discount reflects the additional interest expense that the issuer will incur over the life of the bond.
Recognize the classification of 'Discount on Bonds Payable': It is categorized as a contra-liability account. Contra accounts are used to reduce the balance of a related account—in this case, Bonds Payable.
Learn how 'Discount on Bonds Payable' affects the carrying value of bonds: The carrying value of bonds payable is calculated as the face value of the bonds minus the balance in the Discount on Bonds Payable account. This adjustment reflects the true liability of the issuer.
Understand the amortization process: Over the life of the bond, the discount is amortized using methods such as the straight-line method or the effective interest method. This amortization increases the carrying value of the bonds payable and allocates the discount as interest expense.
Review the correct answer: Based on the explanation above, the balance in Discount on Bonds Payable is best described as 'A contra-liability account that reduces the carrying value of bonds payable.' This aligns with its role in financial accounting.
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