In this tutorial, you'll learn what "Original Issue Discount" or OID on Debt issuances means, and how it works on the financial statements.
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Table of Contents:
0:51 The Short, Simple Answer
4:04 The Longer Answer – OID on Debt with Principal Repayments
10:28 Recap and Summary
OID comes up when a company issues Debt at a discount to par value, e.g., a bond is worth $100, but the company issues it for $90.
Usually, the company does this because the bond's coupon rate (interest rate) is below the rates of other, similar bonds, and the company needs to incentivize investors to buy it.
It may also happen if there are doubts about the company's credit quality and ability to eventually repay the bond.
The company amortizes this discount on the financial statements and keeps increasing the Book Value of Debt on the Balance Sheet.
But the company still pays Interest based on the Face Value of that Debt – the $100!
So, for Debt with a Face Value of $100 at a 10% Interest Rate, issued at $90, there will be $10 in Cash Interest and $2 of OID Amortization per year.
On the Income Statement, there will be $12 in Total Interest Expense, which reduces Pre-Tax Income, Taxes, and Net Income.
On the Cash Flow Statement, Net Income is lower, and we add back the $2 in OID Amortization each year since it's a non-cash expense.
On the Balance Sheet, the Book Value of Debt increases from $90 to $100 over time, going up by $2 per year, but the Face Value is a constant $100 (the Face Value is not shown on the BS).
THE LONGER ANSWER:
When there are Mandatory or Optional Repayments on the Debt, you must amortize the OID more rapidly.
Companies call this "Extra Amortization" something like "Loss on Unamortized OID on Repayment," and it's based on % Debt Principal repaid in the current year * OID balance after OID Amortization in the current year.
So, if the Beginning OID Balance is $10, and there's $2 OID Amortization with $20 Repayment in Year 1, it's ($20 / $100) * $8, or $1.6.
The Amortization of OID itself also changes in this scenario, and it's now based on -MIN(OID Beginning Balance, OID Beginning Balance / Years Remaining in OID Amortization Period).
The net effect is that instead of straight-line amortizing $2 of OID per year, we amortize a total of $4, then $3, then $2, then $1, then less than $1.
On the financial statements, the "Loss on Unamortized OID on Repayment" counts as another expense on the Income Statement.
Cash Interest, OID Amortization, and Loss on Unamortized OID on Repayment all reduce the company's Pre-Tax Income, Taxes, and Net Income.
On the CFS, Net Income is lower, and you add back the last two components since they're both non-cash expenses.
These items boost the company's FCF because they're non-cash items that reduce the company's taxes, similar to Depreciation.
Does OID Really Matter?
In most cases, no, not really.
Most Debt is not issued at a huge discount to par value; the 1-3% range is typical in normal markets.
The company saves a tiny amount on taxes as a result, especially
in countries with relatively low corporate tax rates…
…and it takes a lot of extra work to set up these OID calculations, especially if there are many tranches of Debt.
So, be familiar with OID, but don't obsess over it. You could easily simplify it or ignore it in case studies and modeling tests and be fine.