What are the two methods of amortization of bonds discount premium and how they are different from each other?

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).

What method is required in amortizing discount on bonds payable and premium on bonds payable?

Under the effective interest method, amortization of discount/premium and/or transaction cost on a financial asset/liability equals the difference between interest income/expense on the asset/liability at the effective interest rate and interest receipts/payments at the stated interest rate.

How do you amortize bond premium?

Amortizing the Bond

A method of amortizing a bond premium is with the constant yield method. The constant yield method amortizes the bond premium by multiplying the purchase price by the yield to maturity at issuance and then subtracting the coupon interest.

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How is the discount and premium amortized?

With regards to bonds payable, the term amortize means to systematically allocate the discount on bonds payable, the premium on bonds payable, and the bond issue costs to Interest Expense over the remaining life of the bonds. … The most precise way to amortize these is to use the effective interest rate method.

How do you amortize a bond discount?

Under the straight-line method, bond discount amortized in each period will equal total bond discount divided by total number of periods. In this case, it works out to $7,370 (=$147,409/20). Where BD is the total bond discount, n is the bond life in year and m is the total coupon periods per year.

How do you find the discount on a bonds payable?

It is the sum of the present value of the principal plus the present value of the interest payments. Calculate the bond discount. Compare the bond’s market price which you just calculated with the bond’s face value. In the example above, the bond’s market price is lower than the face value.

Is discount on bonds payable an asset?

If the contractual interest rate is less than the market rate, bonds sell at a discount or at a price less than 100% of face value. Although Discount on Bonds Payable has a debit balance, it is not an asset; it is a contra account, which is deducted from bonds payable on the balance sheet.

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.

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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.

How do you account for bond premium?

When the bond is issued, the company must debit the cash by the amount that the business receives, credit a bond payable liability account by an amount equal to the face value of the bonds, and credit a bond premium account by the difference between the sale price and the bond’s face value.

What is the effective interest rate 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.

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 relationship between premium and bond issue cost?

A premium bond is a bond trading above its face value or costs more than the face amount on the bond. A bond might trade at a premium because its interest rate is higher than the current market interest rates. The company’s credit rating and the bond’s credit rating can also push the bond’s price higher.

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How do you account for discounted bonds?

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

What is meant by amortization of bond discount?

Amortization is a process carried out to reduce the cost base of a bond for each period to reflect the economic reality of the bonds approaching maturity. The amortization is done at par. It is also done annually and has different tax implications for the different bond types. …

How do you prepare a bond amortization schedule?

Multiply the face value of the bond by its stated interest rate to arrive at the interest payment to be made on the bond in the period. Multiply the current balance of the bond by the effective interest rate to arrive at the interest expense to record for the period.

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