Bonds and the effective interest method

A bond is a loan split into tradable units. The issuer promises a fixed coupon each period (face value × coupon rate) and repayment of the face (nominal) value at maturity. Investors pay whatever those cash flows are worth at the market rate for similar risk:

Issue price = PV of the coupons (an annuity) + PV of the face value, both at the market rate.

• Coupon rate below the market rate → investors pay less than face: a discount.
• Coupon rate above the market rate → they pay more: a premium.
• Equal rates → issued at face (par).

Initial measurement (IFRS 9.5.1.1). A financial liability not at fair value through profit or loss is first recognised at fair value minus transaction costs (underwriting fees, legal costs) directly attributable to the issue. Costs are not expensed on day one; they are spread over the bond's life through the effective rate.

Subsequent measurement — amortised cost (IFRS 9.4.2.1). Each period: - interest expense = opening carrying amount × effective interest rate (the rate that discounts the estimated cash flows exactly to the initial carrying amount); - cash paid = the coupon; - the difference amortises the discount (carrying amount rises toward face) or premium (falls toward face).

So the expense isn't the coupon. With a discount, the issuer pays back more than it received; that extra cost is part of the interest expense, spread over the term. The carrying amount reaches exactly the face value at maturity, when the face value is repaid.

Total interest expense over the life = all coupons + discount (or − premium) + transaction costs. Bonds are presented as non-current liabilities until the final year, when they become current. In our chart the discount is netted into Bonds payable (carrying amount); some companies keep a separate discount account — the net figure is the same.

US GAAP (ASC 835-30) reaches the same carrying amounts: the discount or premium and the debt issuance costs are presented as a direct deduction from (or addition to) the debt and amortised using the interest method. One practical difference: US GAAP allows straight-line amortisation if the result isn't materially different, whereas IFRS 9 requires the effective interest method. Either way, the interest expense is never simply the coupon.