AGNC analysis of the income account> extraordinary losses> amortization of bond discount

American Capital Agency Corp. (AGNC) has not floated any bonds since it began operating in May 2008.  Therefore, no adjustments to its income account are necessary for amortization of bond discount.  You can see from their most recent quarterly 10-K filing that they have no bond liabilities.  Their biggest liabilities are repurchase agreements (6.6 billion dollars).  Repurchase agreements are not bonds.

 

The bottom line is that companies can manipulate their future earnings by charging amortization of bond discounts to their surplus instead of their income statements.

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Here is the relevant section from Securities Analysis:

 

Amortization of Bond Discount. Bonds are usually floated by corporations at a price to net the treasury less than par. The discount suffered is part of the cost of borrowing the money, i.e., part of the interest burden, and it should be amortized over the life of the bond issue by an annual charge against earnings, included with the statement of interest paid. It was formerly considered “conservative” to write off such bond discounts by a single charge against surplus, in order not to show so intangible an item among the assets on the balance sheet. More recently these write-offs against surplus have become popular for the opposite reason, viz., to eliminate future annual deductions from earnings and in that way to make the shares more “valuable.”

 

Example: Associated Gas and Electric Company charged against surplus in 1932 the sum of $5,892,000 for “debt discount and expense” written off.

 

This practice has aroused considerable criticism in recent years both from the New York Stock Exchange and from the S.E.C. As a result of these objections a number of companies have reversed their previous charge to surplus and are again charging amortization of bond discounts annually against earnings.

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Published in: on September 16, 2010 at 9:28 pm  Leave a Comment  

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