Financial Accounting and Reporting-CPA Practice Exam

Amortization of the discount on bonds occurs as a way to recognize the additional interest expense that is effectively paid by the borrower to compensate investors for purchasing the bond at a price lower than its face value. This discount represents the difference between the face value of the bonds and their issue price.

As the bond approaches maturity, the issuer recognizes this discount as an increase in interest expense over the life of the bond. Each period, a portion of the discount is amortized, which enhances the total interest expense reflected on the income statement. This is aligned with the effective interest method or the straight-line method of amortization, but the critical point is that the amortization will lead to an increase in the reported interest expense for each period.

In this context, the other options do not correctly describe how the discount is treated. The discount does not represent additional payments to investors at issuance nor does it increase reported cash payments at maturity. Discount amortization does not distribute the same expense equally over the life of the bond; instead, it influences the interest expense variable each period until the bond matures. Thus, the correct approach is recognizing the increase in interest expense through the amortization process associated with the bond discount.