How should a bond discount or premium be amortized?
The preferred method for amortizing the bond premium is the effective interest rate method or the effective interest method. Under the effective interest rate method the amount of interest expense in a given year will correlate with the amount of the bond’s book value.
How do you amortize a bond premium straight line?
Under the straight line method, the premium or discount on the bond is amortized in equal amounts over the life of the bond. This is best explained by example. Suppose a company issues $100,000 of 10-year bonds that pay an 8% annual coupon.
How do you amortize a bond discount?
Multiply the current balance of the bond by the effective interest rate to arrive at the interest expense to record for the period. Calculate the difference between the interest payment (step 2) and the interest expense (step 3). This is the discount or premium on the bond to be amortized in the period.
What are the two methods of amortization of bonds discount premium?
Effective-interest and straight-line amortization are the two options for amortizing bond premiums or discounts. The easiest way to account for an amortized bond is to use the straight-line method of amortization.
Why do you amortize bond discount?
A bond discount occurs when an issuer sells a bond and receives proceeds from investors for less than the face value of the bond. By amortizing a bond discount, the amount of amortization for each period can be used to determine periodic interest expense, as well as the changing bond carrying value over time.
What is the effective interest rate of a bond measured at amortized cost?
The effective interest rate is multiplied times the bond’s book value at the start of the accounting period to arrive at each period’s interest expense. The difference between Item 2 and Item 4 is the amount of amortization.
What is straight line interest method?
The straight-line method is the simplest way to account for the amortization of a bond on a company’s financial statements. To calculate the interest for each period, simply divide the total interest to be paid over the life of the bond by the number of periods, be it months, quarters, years or otherwise.
Do you have to amortize bond premiums?
If the bond yields tax-exempt interest, you must amortize the premium. As long as the bond is held to maturity, there will be no capital gain or loss associated with the bond. If the bond is sold before maturity, you may have capital gain or loss based is the portion of the premium which has not yet been amortized.
What happens to bond book value as a discount is amortized increase or decrease?
The carrying value of a bond refers to the net amount between the bond’s face value plus any un-amortized premiums or minus any amortized discounts. Premiums and discounts are amortized over the life of the bond, therefore book value equals par value at maturity.
When to use straight line method of amortization?
In the straight-line method of amortization of bond discount or premium, bond discount or premium is charged equally in each period of the bond’s life. When the coupon rate on a bond is lower than the market interest rate, the bond is issued at a discount to par value.
How does amortization of a bond premium work?
Therefore, the amortization of the bond premium will involve the account Interest Expense. Each accounting period during the life of the bond there needs to be a credit to Interest Expense and a debit to Premium on Bonds Payable. In this section we will illustrate the straight-line method of amortization.
How does the company calculate the discount to amortize?
The company calculates the amount of premium or discount to amortize by multiplying the market interest rate by the book value of the bond. These amortization methods contain several similarities. The amortization methods both record the amortization as interest. If the company amortizes a premium, the interest reduces net income.
What is the interest expense on a straight line Bond?
Each period the interest expense (4,249) is the interest paid to the bondholders based on the par value of the bond at the bond rate (4,800) less the premium amortized (551).