Discount on bonds payable (or bond discount) occurs when bonds are issued for less than their face or maturity amount. This is caused by the bonds having a stated interest rate which is lower than the market interest rate for similar bonds.
To illustrate the discount on bonds payable let's assume that a corporation will be issuing bonds with a maturity amount of $5,000,000 and a stated interest rate of 6% per year. However, the bonds are actually issued when the market demanded 6.1%. Since the investors will insist on earning the market interest rate of 6.1% the investors will not pay the full $5,000,000. If we assume that investors pay $4,900,000 for the bonds, the difference of $100,000 will be recorded by the issuer as a debit to the contra liability account Discount on Bonds Payable.
Over the life of the bonds the debit balance in Discount on Bonds Payable will decrease as it is amortized to Interest Expense. The combination of the unamortized debit balance in Discount on Bonds Payable, the unamortized debit balance in Bond Issue Costs, and the $5,000,000 credit balance in Bonds Payable is the book value or carrying value of the bonds payable.