Definition of Bond Discount

A bond discount occurs when a bond is issued or traded for less than its face (par) value. In Canadian finance and accounting, this typically happens when the bond’s coupon rate is lower than current market interest rates, making it less attractive unless sold at a reduced price.

For example, if a bond with a face value of $1,000 and a 3% annual coupon is sold for $950 when similar bonds yield 5%, the $50 difference is the bond discount.

Purpose of Bond Discounts in Canadian Financial Markets

Bond discounts exist to make lower-yielding bonds competitive and align with market expectations:

1. Aligns Yield with Market Rates – Offsets a lower coupon rate to match current yields.
2. Increases Investor Appeal – Provides capital appreciation upon maturity.
3. Reduces Borrowing Costs for Issuers – Allows financing at lower interest expenses.
4. Affects Tax and Accounting Treatment – Influences how gains and expenses are reported.
5. Reflects Credit Risk or Market Conditions – Discounts may also indicate perceived issuer risk.

Accounting for Bond Discounts in Canada

For Issuers

When a bond is issued at a discount, the difference is recorded as a contra-liability (discount on bonds payable) and amortized over the bond’s life.

Example Journal Entry (on issuance):

• Debit: Cash $950
• Debit: Bond Discount $50
• Credit: Bonds Payable $1,000

Amortization Methods:

• Effective Interest Method (required under IFRS)
• Straight-Line Method (permitted under ASPE)

For Investors

Investors record the bond at cost and gradually increase its carrying value to par as they recognize interest income.

Bond Discount vs. Bond Premium

Feature	Bond Discount	Bond Premium
Sale Price	Below face value	Above face value
Market Rate	Higher than the coupon rate	Lower than the coupon rate
Accounting Impact	Increases effective interest	Decreases effective interest
Investor Yield	Higher than the coupon rate	Lower than the coupon rate

Advantages and Disadvantages of Bonds Sold at a Discount

Advantages (for Investors)

• Higher Yield to Maturity – Boosts overall return despite low coupon.
• Capital Appreciation – Gain when the bond matures at face value.
• Entry Opportunity – Accessible investment in high-interest environments.

Disadvantages (for Investors)

• Interest Income May Be Lower – Periodic payments are smaller.
• Tax Complexity – Amortized discount may need to be reported as income.
• Default Risk – Discount may reflect the issuer's financial risk.

Related Terms

• Bond Premium – When a bond sells above its face value.
• Par Value – The nominal value repaid at maturity.
• Yield to Maturity (YTM) – The total return expected if held to maturity.
• Amortization of Discount – The gradual recognition of the discount over the bond’s term.

Interesting Fact

Did you know? In Canada, certain zero-coupon bonds are issued at a deep discount and pay no interest until maturity—making them ideal for long-term investors focused on future payouts.

Statistic

According to Bank of Canada data, more than 40% of secondary market corporate bond trades involve discounted bonds during rising interest rates, as older, lower-yielding bonds become less attractive at face value.

Frequently Asked Questions (FAQ)

Why are some bonds sold at a discount?

A price adjustment is required to attract buyers because their coupon rate is lower than the prevailing market rate.

How is the bond discount treated in accounting?

It is amortized over the bond’s term, either increasing interest expense (for issuers) or interest income (for investors).

Are discounted bonds riskier?

Not necessarily. Discounts may reflect interest rate changes, not credit risk—though some may indicate a higher chance of default.

Do Canadian investors pay tax on bond discounts?

Yes. The amortized discount is typically treated as interest income and must be reported unless held in a registered account.

What happens at maturity with a discounted bond?

The investor receives the full face value, realizing a capital gain if purchased below par.