Accounting Deep Discount Bonds - I GAAP & IFRS

A. Zero Coupon Bond (Deep Discount Bond)

Zero-coupon bond (also called a discount bond or deep discount bond) is a bond issued at a price lower than its face value, with the face value repaid at the time of maturity. It does not make periodic interest payments, or have so-called "coupons," hence the term zero-coupon bond. When the bond reaches maturity, its investor receives its par (or face) value.

B. Accounting entries for Zero Coupon / Deep Discount Bonds under Indian GAAP

i. Issue of Bonds at Discount

When Bonds are issued at less than their nominal value they are said to be issued at discount. For example, Bond of Rs. 100 each is issued at Rs. 80 per Bond. Companies Act, 1956 has not laid down any conditions for the issue of Bonds at a discount, as have been laid down in case of issue of shares at discount.

Journal entry for issue of Bonds at discount (at the time of allotment)

(Bond money received and the amount of discount is @ Rs 20 per bond accrued)

In case company issues Bonds on discount the total amount of discount is not charged to Profit and Loss Account of the company in the accounting year in which this discount is allowed. Company gets the benefit of funds by issuing Bonds over a number of years. Hence the discount is to be amortised over the term of the bond. Unamortised amount is parked under ‘Other Assets’ schedule under Revised Schedule VI and is bifurcated into current and non-current based on its expected amortization in next 12 months.

The amount of Bond discount can be written off in the following way:

When Bonds are redeemed in installments but over a fixed period, the amount of discount will be written off each year in proportion to the amount of Bond redeemed. The amount of discount on issue of Bonds to be written off each year is calculated as amount of discount to be written off annually.

(Amount of Discount on Issue of Bonds written off)

ii. The above accounting entries under Indian GAAP can be substantiated as under:

Liability is defined as an obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future.

Discounting of liability at present value is not allowed under Indian GAAP. Para 35 of AS 29 - Provisions, Contingent Liabilities and Contingent Assets states as under:

“The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date. The amount of a provision should not be discounted to its present value.”

Thus Liability will appear in the balance Sheet at face value i.e. gross of discount.

C. Accounting of Deep Discount Bonds under IFRS

i. Excerpt from IAS 39: Financial Instruments: Recognition and Measurement

Para 9 Definitions:

“The amortised cost of a financial asset or financial liability is the amount at which the financial asset or financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount, and minus any reduction (directly or through the use of an allowance account) for impairment or uncollectibility.

The effective interest method is a method of calculating the amortised cost of a financial asset or a financial liability (or group of financial assets or financial liabilities) and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, an entity shall estimate cash flows considering all contractual terms of the financial instrument (for example, prepayment, call and similar options) but shall not consider future credit losses. The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs, and all other premiums or discounts.”

ii. Accounting under IFRS

Assuming the bond face value of Rs 100, discount of Rs 20 and term of 4 years, we shall first calculate the amortization schedule of the deep discount bond using effective interest rate in built in the instrument. Thus we first calculate the Internal Rate of Return (IRR) and amortise the discount over the period using the derived IRR as follows:

Accounting entries are as follows:

(Being liability initially recognized and measured as per para 9 of IAS 39)

(Being Interest accrued at IRR on the liability for period 1 and so on..)

D. Difference in GAAPs in brief

Sanjay Chauhan

Email: sachauhan@gmail.com