Original Issue Discount (OID)
February 25, 2025
What is an Original Issue Discount (OID)?
An Original Issue Discount (OID) is created when debt is offered at a discount to its par value. This typically happens on debt with low or no interest, such as a zero-coupon bond. The investor buys the debt at a discount (for example, at 90) and then redeems it at maturity (e.g., 100), and their return would be the capital appreciation (in this case, 10). The advantage of issuing this type of debt is that the issuer does not have to make regular interest payments to the investor.
Key Learning Points
- When debt securities are sold at a price below the par or redemption price, it is known as an Original Issue Discount
- This is typical for low or zero-coupon bonds
- The OID is calculated as the difference between the redemption price and the sale value – this is also known as a ‘haircut’
How an Original Issue Discount (OID) Works
An OID works by offering debt at a discount, allowing the investor to make a profit when the debt matures. The OID can also be used to account for debt issuance fees. These fees are paid in cash to the bank or financial institution that helped issue the debt. The issuer of the debt can capitalize these fees and amortize them over time.
Formula and Calculation of OID
The OID is calculated as the difference between the redemption price and the purchase price. The OID is then amortized over the life of the debt, gradually reducing the debt balance on the balance sheet. The unamortized fees or OID can be used as a separate line item on the balance sheet, but typically it’s very small so it’s typically just netted off against the debt.
OID Formula
Original Issue Discount Pros and Cons
Pros
- The opportunity to make a profit from the capital appreciation when the debt matures
- OID allows the issuer to spread the debt issuance fees over the life of the debt, which can be beneficial for accounting purposes
Cons
- The OID reduces the debt balance on the balance sheet, which can make the company’s financial position appear stronger than it actually is
- The OID must be amortized over the life of the debt, which can complicate the accounting process
- Discounted bond issuances can indicate that a company is having financial trouble and trying to entice new investors
Example of an OID
Let’s look at an example of a company issuing debt with a life of five years. At the deal date, the company had an ending unamortized liability of 10 – this is the OID or the unamortized debt issuance fees. At the beginning of the next period (deal date plus one), the company still had the same 10. However, in that following year, the company amortized two of it away, and the negative liability gradually reduced from 10 to eight, and then from eight to six. The amortization was then included within the company’s finance costs on the income statement.
So, on the Income Statement, at the deal date, nothing happened (as shown on the Income Statement below), but at deal date plus one, the company included amortization of 2 within its finance costs. This continues until the unamortized liability reaches zero.
Download the free Financial Edge Original Issue Discount Template.
Conclusion
The Original Issue Discount (OID) is a financial concept that allows investors to purchase debt at a discount and realize a profit upon maturity through capital appreciation. This mechanism is particularly useful for debt with low or no interest, such as zero-coupon bonds. The OID also provides benefits for issuers by enabling the amortization of debt issuance fees over the life of the debt, which can be advantageous for accounting purposes.
However, it is important to note that the OID can complicate the accounting process and may present a stronger financial position than reality due to the reduction of the debt balance on the balance sheet. Understanding the intricacies of OID is crucial for both investors and issuers to effectively manage and capitalize on this financial tool.