Question

11. If a company issue a long-term note with no interest (zero-coupon), does this mean that the company will not be required to recognize interest expense? Explain. if you want you can explain with the example.

Answer 1

Even if there is no interest on zero coupon bond , still company has to recognize the interest expense on these bonds.

Zero coupon bonds are issued at a discount and this discount is calculated using the interest rate of market.

Example - there is a zero coupon bond with one year maturity. The face value of the bond is 6000. Now the current rate of interest in market is 20%. So buyer would like to purchase this bond only if he gets similar return on this bond.

So company will issue this bond @ 5000$ . So there will be a profit of 1000$ to the buyer. Which is equal to the 20% of the investment of $5000.

This difference in bond issue Price and face value will be recorded as interest by the company.