is accumulated by charges to interest expense and credits to the bond liability, the effective
amount of the liability gradually approaches maturity value.
It should be noted that bond issue costs are disregarded in computing the effective amount of the
bond liability. Though they are usually added to the discount or deducted from the premium,
bond issue costs should properly be treated as an asset. Such costs are incurred in the process of
acquiring borrowed funds and should be amortized over the period during which the funds are
$1,000,000. This basis for valuing bond liabilities, the amount due at maturity, is widely used in
practice. Its use is frequently supported on the grounds that it represents the amount of true legal
liability, since it is this amount that would be due and payable in the event of default. This
support disregards the accounting assumption of the going concern and, instead, emphasizes
This valuation basis is also supported on the grounds that the discount represents prepaid interest
and should therefore be classified as an asset. This argument has no merit because the discount
represents unpaid interest, not prepaid interest. Any bookkeeping entry which classifies discount
as prepaid interest does so only by failing to properly adjust to amount borrowed to its effective
The practice of recording bond liabilities at maturity value and setting up the discount as a
deferred charge is defensible only if the amounts involved are not material and it can be shown
that this treatment is expedient.
$1,780,000. The basis for this alternative--the total amount the Company is obligated to repay
over the remaining life of the bonds ($1,000,000 at maturity, plus 39 semiannual interest
payments of $20,000 each)--has no justification. It would require the difference between the
amount actually borrowed ($975,000) and the total amount the Company became obligated to
repay ($1,800,000) to be treated as an asset or a loss when the bonds were issued. To assume
that assets were acquired in excess of the amount actually borrowed or that a loss was incurred
in an arm's-length transaction is indefensible. The original bondholders invested $975,000 for
the right to receive $1,800,000 under the conditions stipulated in the contract (an annuity of
$20,000 for forty periods and $1,000,000 at the end of the fortieth period). Thus, at the date of
issuance the Company incurs a liability equal to the amount of the bondholders' investment. The
difference between this amount and $1,800,000 is the total amount of interest which will accrue
with the passage of time. It does not exist at the date the bonds are issued.
Except for the materiality of the amounts involved, the use of this alternative as a valuation basis
suffers from the same theoretical shortcomings as does the use of face value when bonds are
issued at a discount.