For example, under this method, each period’s dollar interest expense is the same. However, as the carrying value of the bond increases or decreases, the actual percentage interest rate correspondingly decreases or increases. When you use the effective interest method, the carrying value of the bonds is always equal to the present value of the future cash outflow at each amortization date. For example, a semi-annual bond has two interest payments each year and the number 2 would be entered.

The effective interest rate method is commonly used for bond premiums amortization. Suppose the company issues 2000 bonds for $ 22,800 each, and the face value of the bonds is $ 20,000. The amortization can be done equally in each accounting period up to the end of the bond’s life. As is to be expected, the calculation for Straight-Line is more straightforward than the Effective Rate Method outlined above. We can use the example of the Series 2022 Bonds we used for our effective interest rate calculations.

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Typically companies make an amortization table for the amortization of bond premiums each year. When a discounted bond is sold, the amount of the bond’s discount must be amortized to interest expense over the life of the bond. When using the effective interest method, the debit amount in the discount on bonds payable is moved to the interest account. Therefore, the amortization causes interest expense in each accounting period to be higher than the amount of interest paid during each year of the bond’s life. When a corporation prepares to issue/sell a bond to investors, the corporation might anticipate that the appropriate interest rate will be 9%.

In the premium example, the same conceptual problem occurs, except that the percentage rate continuously increases as the carrying value of the bond decreases from $107,722 to $100,000. The interest expense based on straight-line amortization for the period between 2 January 2020 and 1 July 2020 is $6,702. A bond trading for less than Accounting for In-Kind Donations to Nonprofits 100 would be priced for less than $1,000; it is considered a discount. A bond trading for more than 100 would be priced for more than $1,000; it is considered a premium. Generally, a bond will come with a face value of $1,000 or some other round number. Based on market conditions, the price could be less than or greater than $1,000.

What is a Bond Amortization Schedule?

DebtBook also offers another acceptable form of the Effective Interest method that takes into account the callability of maturities. In the event a bond is a callable premium bond, there is a higher likelihood that the bond will be called before or at the call date. DebtBook’s Effective Interest Rate to Call method amortizes the premium on these maturities with that likelihood in mind. The following table summarizes the effect https://adprun.net/crucial-accounting-tips-for-small-start-up/ of the change in the market interest rate on an existing $100,000 bond with a stated interest rate of 9% and maturing in 5 years. The following T-account shows how the balance in the account Premium on Bonds Payable will decrease over the 5-year life of the bonds under the straight-line method of amortization. With the figures given above, the monthly payments are $1,073.64, which works out to be $12,883.68 per year.

• The format of the journal entry for amortization of the bond premium is the same under either method of amortization – only the amounts change.
• The bondholders are reimbursed for this accrued interest when they receive their first six months’ interest check.
• The table below shows how this discount is amortized using the effective interest method over the life of the bond.
• The difference between the required cash interest payment of $6,000 in Column 3 ($100,000 x 6%) and the effective interest expense of $6,508 is the required discount amortization of $508 in Column 4.

If the book value of the investment declines, then the interest earned will decline also. Although some bonds pay no interest and generate income only at maturity, most offer a set annual rate of return, called the coupon rate. The coupon rate is the amount of interest generated by the bond each year, expressed as a percentage of the bond’s par value. As with the discount example, the total interest expense over its lifetime under the straight-line and the effective interest methods is the same. Regardless of when the bonds are physically issued, interest starts to accrue from the most recent interest date. Firms report bonds to be selling at a stated price “plus accrued interest.” The issuer must pay holders of the bonds a full six months’ interest at each interest date.

Methods of Amortization of Bond Premium

Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs. Take your learning and productivity to the next level with our Premium Templates.

For the years in which you own the bond for all 12 months, you simply take amortization of 12 times the monthly amount. For the year of purchase and the year of sale or maturity, you have to account for a partial year, multiplying the monthly amount by the number of months during the year that you actually owned the bond. Par value, in turn, is simply another term for the bond’s face value, or the stated value of the bond at the time of issuance.