What are the two methods of amortizing discount and premium on bonds payable?

If the company uses the amortized cost approach to measure a long-term debt, it can use two methods to amortize the discount and the premium: the effective interest rate method, or. the straight-line method (allowed only under U.S. GAAP).

Click to see complete answer. Besides, what is the amortization of premium on bonds payable?

The amortization of the premium on bonds payable is the systematic movement of the amount of premium received when the corporation issued the bonds. The premium was received because the bonds‘ stated interest rate was greater than the market interest rate.

One may also ask, how do you record bonds issued at a premium? If there was a premium on bonds payable, then the entry is a debit to premium on bonds payable and a credit to interest expense; this has the effect of reducing the overall interest expense recorded by the issuer.

Besides, what is the difference between the effective interest method and the straight line method when amortizing either a discount or a premium?

In short, the effective interest rate method is more logical than the straightline method of amortizing bond premium. 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.

Where is premium on bonds payable on balance sheet?

The account Premium on Bonds Payable is a liability account that will always appear on the balance sheet with the account Bonds Payable. In other words, if the bonds are a long-term liability, both Bonds Payable and Premium on Bonds Payable will be reported on the balance sheet as long-term liabilities.

Is Bond premium an asset?

Premium on bonds payable is the excess amount by which bonds are issued over their face value. This is classified as a liability, and is amortized to interest expense over the remaining life of the bonds.

Why do we amortize bond premium?

For a bond investor, the premium paid for a bond represents part of the cost basis of the bond, which is important for tax purposes. If the bond pays taxable interest, the bondholder can choose to amortize the premium—that is, use a part of the premium to reduce the amount of interest income included for taxes.

Does Bond premium amortization reduce interest income?

If the bond yields taxable interest, you can choose to amortize the premium. This generally means that each year, over the life of the bond, you use a part of the premium to reduce the amount of interest includible in your income. This amortized amount is not deductible in determining taxable income.

What is the effective interest method?

The effective interest method is the method used by a bond buyer to account for accretion of a bond discount as the balance is moved into interest income or to amortize a bond premium into an interest expense.

What type of account is premium on bonds payable?

A liability account with a credit balance associated with bonds payable that were issued at more than the face value or maturity value of the bonds. The premium on bonds payable is amortized to interest expense over the life of the bonds and results in a reduction of interest expense.

How do you find the effective interest rate on a discounted loan?

Here’s the calculation:
  1. Effective Rate on a Simple Interest Loan = Interest/Principal = $60/$1000 = 6%
  2. Effective rate on a Loan with a Term of Less Than One Year = $60/$1000 X 360/120 = 18%
  3. Effective rate on a discounted loan = $60/$1,000 – $60 X 360/360 = 6.38%
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Why is the effective interest method preferred?

Actual Interest Earned

It is considered preferable to the straight-line method of figuring premiums or discounts as they apply to bond issues because it is a more accurate statement of interest from the beginning to the end of a chosen accounting period (the amortization period).

How do you calculate straight line interest?

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. For most term bank debt like mortgages or installment loans, the straightline method is very simple.

When the effective interest method of bond discount amortization is used?

Therefore, the amortization causes interest expense in each period to be greater than the amount of interest paid during each year of the bond’s life. For example, assume a 10-year $100,000 bond is issued with a 6% semi-annual coupon in a 10% market. The bond is sold at a discount for $95,000 on January 1, 2017.

What is Bond premium?

A premium bond is a bond trading above its face value or in other words; it costs more than the face amount on the bond. A bond might trade at a premium because its interest rate is higher than current rates in the market.

What is the straight line method of amortization?

The straightline amortization method is the simplest way to amortize a bond or loan because it allocates an equal amount of interest over each accounting period in the debt’s life. The straight line amortization formula is computed by dividing the total interest amount by the number of periods in the debt’s life.

Is Bond premium taxable income?

If you pay a premium to buy a bond, the premium is part of your basis in the bond. If the bond yields taxable interest, you can choose to amortize the premium. If the bond yields tax-exempt interest, you must amortize the premium. This amortized amount is not deductible in determining taxable income.