Discount on bonds payable occurs when a bond's stated interest rate is less than the bond market's interest rate.

If a $1,000,000 bond issue promises to pay interest of 8% per year and the bond market demands 8.125%, the bonds will sell for less than $1,000,000. The difference between the $1,000,000 of face value and the amount the bond market is willing to pay is the discount on bonds payable.

The amount of the discount is a function of 1) the number of years before the bonds mature, and 2) the difference in the bond's stated interest rate and the market's interest rate.

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