The effective interest method is an accounting practice used to discount a bond. This method is used for bonds sold at a discount or premium; the amount of the bond discount or premium is amortized to interest expense over the bond’s life.
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.
How do you amortize bond premium or discount?
First, calculate the bond premium by subtracting the face value of the bond from what you paid for it. Then, figure out how many months are left before the bond matures and divide the bond premium by the number of months remaining. That tells you how much to amortize on a monthly basis.
When the effective interest method is used the amortization of the bond premium?
The correct answer is Option #2 decreases interest expense each period. This is because the question asks about amortisation of Bonds PREMIUM. When Bonds are issued at Premium, their carrying value is maximum in first year, which decreases after every amortisation at interest payment.
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.
Why do you amortize bond discount?
Discounted bonds’ amortization always leads to an effective interest expense that is higher than the payment of the bond interest coupon for each period. If a bond is sold at a discount, it means that the market interest rate is above the coupon rate.
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.
Why is there a need to amortize discount or premium?
Therefore, bond discounts or premiums have the effect of increasing or decreasing the interest expense on the bonds over their life. Under these conditions,it is necessary to amortize the discount or premium over the life of the bonds by using either the straight-line method or the effective interest method.
What is the effective interest method?
The effective interest method is an accounting standard used to amortize, or discount a bond. This method is used for bonds sold at a discount, where the amount of the bond discount is amortized to interest expense over the bond’s life.
What is the treatment of bond issue cost under the effective interest method?
Chapter 7. FINANCIAL INSTRUMENTS
The amortization of bond issue costs is recognized by debiting interest expense and crediting bond issue cost. Under the effective interest method of amortization, the bond issue cost should be aggregated to the discount on bonds payable and netted against the premium on bonds payable.