Unearned Discount

When a note is discounted, the interest for the full time is deducted immediately and the proceeds turned over to the borrower. The income thus received is treated, in many banks, as an earning, without consideration of the fact that the interest so received is really earned day by day and is spread over the life of the note. If a 1000 dollars note were discounted October 1^st for three months, at 6 percent, the interest would be 15 dollars, which, under ordinary practice, would be credited to discount account immediately.

If we were to take off a statement as of November 15^th, it follows that only half of the 15 dollars belongs in the subsequent period. All well managed banks take cognizance of these facts and do not consider as earnings anything that is not realized during the period under review.

This may be accomplished in several ways, one of which is to credit such earnings to “unearned discount,” and once a month the actual interest earned is charged to unearned discount and credited to “interest received.”

A simple method is to take the maturity tickler and make a total of the notes due each day. If, for instance, there is 50,000 dollars due on November 16^th, using the date of November 15^th as the date report, it is apparent that we have taken one day’s more discounts on 50,000 dollars than should be allowed for the period prior to November 15^th. On November 17^th we find 20,000 dollars maturing. On this we have taken two days more interest than is allowable and so on through to the last note falling due.

Questionnaire:

• What is unearned discount according to banking?
• Give an example and explain unearned discount.