Definition
The term accrued market discount refers to the increase in the value of a bond as it approaches the day it is redeemable at par. The calculation of a bond's accrued market discount is not affected by falling interest rates.
Explanation
When a bond is sold at a discount to par value, the market price of this security will increase as it approaches the maturity or redemption date. In addition to the interest payment on the security, the difference between the purchase price of the bond and its face value represents a return on the investment that may be taxable.
The rules for reporting accrued market discounts are fully explained in the Internal Revenue Service (IRS) Publication 550 (Investment Income and Expenses); in the section that describes Discounts on Debt Instruments. These guidelines provide for one important exception to this rule. Taxpayers must include in taxable income what is called the Original Issue Discount (OID) unless the discount is considered a De Minimis OID.
The taxpayer can treat the discount as zero if it is less than one-fourth of 1%, or 0.25% (0.0025) of the stated redemption price multiplied by the number of full years to maturity. For example, a discounted bond is purchased for 98.125, matures in ten years, and has a par value of 100. The first step in determining if an accrued market discount must be reported as income would be to test the discount to see if it is considered a De Minimis OID:
= 10 years to Maturity x 0.0025, or 2.500
The next step involves subtracting the above De Minimis OID value from the par value of the bond:
= 100.000 - 2.500, or 97.500
Since the purchase price of the bond (98.125) is greater than the OID (97.500), the bond has a De Minimis OID, and is not reportable as taxable income. If the bond does not qualify for the De Minimis OID exception, the taxpayer has the option of accruing the market discount over the remaining maturity of the bond, and classifying this accrual as interest income. Alternatively, the taxpayer could choose not to accrue the discount and include as interest income the difference between the purchase price and the eventual selling price of the bond.
Related Terms
The cash basis accounting method calls for the recording of economic business events as cash is received or paid. Therefore, the cash method of accounting requires the reporting of revenues when cash is received from customers and payments are made for expenses.
Moneyzine EditorJanuary 10th, 2024
The matching principle is a financial accounting term that refers to a standard, which states that revenues generated in an accounting period need to be matched with the expenses incurred in that same accounting period.Moneyzine EditorFebruary 8th, 2024
Also referred to as "receivables," this is the accounting term used to describe claims the company has against others for goods, services, or money. Accounts receivable are usually non-written promises to pay for goods or services received but not yet paid for by a customer.Moneyzine EditorJanuary 3rd, 2024
Also referred to as "payables," this is the accounting term used to describe balances owed to trade partners for materials, supplies, goods and services that were purchased on credit. Accounts payable recognizes the timing difference between the company's receipt of the benefit or asset, and the payment for this expense.Moneyzine EditorDecember 12th, 2023
The financial accounting term accrued expense refers to costs incurred during an accounting period, but not yet paid for in cash by a company in that same accounting period.Moneyzine EditorJanuary 3rd, 2024
The financial accounting term accrued revenue refers to income earned during an accounting period, but not yet recorded or received prior to the company's financial closing date.Moneyzine EditorJanuary 3rd, 2024
The term accrued interest refers to the funds that are payable but not yet received because of a timing difference of cash flows. Accrued interest is oftentimes use in the context of a bond or another type of fixed income security.Moneyzine EditorJanuary 3rd, 2024
