When the stated interest rate associated with a bond is lower than the market interest rate on the date when the bond is sold, investors will only agree to purchase the bond at a discount from its face amount. By paying less, investors are effectively increasing their return on investment when they are paid interest by the bond issuer. The difference between the face amount of a bond and the amount actually paid for it is the bond discount. The bond issuer writes off the full amount of the bond discount over the remaining term of the bond with which it is associated. The amount written off is charged to interest expense. The amount of the bond discount that has not yet been written off is called the unamortized bond discount.
The issuing entity can elect to write off the entire amount of a bond discount at once, if the amount is immaterial (e.g., has no material impact on the financial statements of the issuer). If so, there is no unamortized bond discount, because the entire amount was amortized at once. Much more commonly, the amount is material, and so is amortized over the life of the bond, which may span a number of years. In this latter case, there is nearly always an unamortized bond discount if bonds were sold below their face amounts, and the bonds have not yet been retired.
An unamortized bond discount is reported within a contra liability account in the balance sheet of the issuing entity.
When an unamortized bond discount is first recorded, there is a debit to cash in the amount of the cash received, a debit to the bond discount contra account in the amount of the discount, and a credit to the bonds payable account in the amount of the face value of the bonds issued. As the discount is amortized, there is a debit to interest expense and a credit to the bond discount contra account.