Final answer:
The difference between the face amount and the cash proceeds from a zero-interest bearing note is recorded as a discount on notes payable. This discount represents the borrowing cost and aligns with the concept of the present discounted value. The value of bonds fluctuates with changes in market interest rates, impacting their present discounted value.
Step-by-step explanation:
When a company issues a zero-interest bearing note, the difference between the face amount of the note and the cash proceeds is indeed recorded as a discount on notes payable. This discount represents the cost of borrowing and is amortized over the life of the note, effectively acting as the interest expense on the note payable. Since a zero-interest-bearing note does not pay periodic interest, the present value of the note is calculated by discounting the future repayment using the market rate of interest at issuance. This present discounted value is the cash proceeds the company receives, and it is lower than the face amount of the note. The difference is recorded on the balance sheet as a discount, and over time, this discount is amortized to interest expense, which increases the carrying value of the note to its face value at maturity. This concept applies analogously to bonds.
For bonds, the market interest rate plays a vital role in determining their value. If market interest rates decrease after a bond is issued, the bond's value will increase above its face value. Conversely, if market rates increase, the value of the bond will decrease below its face value. This is because the fixed interest payments of the bond are more or less valuable depending on the current market interest rates, reflecting the bond's present discounted value to investors.