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. This means that when a bond’s book value decreases, the amount of interest expense will decrease. In short, the effective interest rate method is more logical than the straight-line method of amortizing bond premium. This entry is similar to the entry made when recording bonds issued at a discount; the difference is that, in this case, a premium account is involved.

The effective interest method of amortizing the discount to interest expense calculates the interest expense using the carrying value of the bonds and the market rate of interest at the time the bonds were issued. For the first interest payment, the interest expense is $469 ($9,377 carrying value × 10% market interest https://kelleysbookkeeping.com/gross-profit-vs-net-income/ rate × 6/ 12 semiannual interest). The semiannual interest paid to bondholders on Dec. 31 is $450 ($10,000 maturity amount of bond × 9% coupon interest rate × 6/ 12 for semiannual payment). The $19 difference between the $469 interest expense and the $450 cash payment is the amount of the discount amortized.

Amortizable Bond Premium

Lighting Process, Inc. issues $10,000 ten‐year bonds, with a coupon interest rate of 9% and semiannual interest payments payable on June 30 and Dec. 31, issued on July 1 when the market interest rate is 10%. Discount on bonds payable is a contra account to bonds payable that decreases the value of the bonds and is subtracted from the bonds payable in the long‐term liability section of the balance sheet. Initially it is the difference between Amortization Of Premium On Bonds Payable the cash received and the maturity value of the bond. On July 1, Lighting Process, Inc. issues $10,000 ten‐year bonds, with a coupon rate of interest of 12% and semiannual interest payments payable on June 30 and December 31, when the market interest rate is 10%. Premium on bonds payable is a contra account to bonds payable that increases its value and is added to bonds payable in the long‐term liability section of the balance sheet.

She has worked in multiple cities covering breaking news, politics, education, and more. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Amortizing Premiums and Discounts

Another way to calculate the $5,228 is to divide the total interest cost of $52,278, as just calculated, into the 10 interest periods of the bond’s life. See a comparison between secured vs unsecured bonds, and term bonds vs serial bonds. Although the borrower receives all of the funds at the time of the issue, the matching convention requires that it be recognized over the life of the bond. In effect, the premium should be thought of as a reduction in interest expense that should be amortized over the life of the bond.

• Once the bond premium is calculated, you need to decide how the bond premium shall be amortized.
• Under this method, the amount of bond premium is equally amortized each year or accounting period.
• Depending on the type of bond, the premium can be tax-deductible and amortized over the life of the bond on a pro-rata basis.
• Notice that under both methods of amortization, the book value at the time the bonds were issued ($104,100) moves toward the bond’s maturity value of $100,000.
• This, in turn, will reduce the amount of taxable income the bond generates, and thus any income tax due on it as well.
• As with the straight‐line method of amortization, at the maturity of the bonds, the discount account’s balance will be zero and the bond’s carrying value will be the same as its principal amount.