Total interest expense, which is reported on the income statement, includes the total coupon payment plus a portion of the underappreciated discount or premium for the specified accounting period.

U.S. GAAP allows companies to amortize premiums or discounts by utilizing a straight-line amortization or the effective interest rate method.

  • Straight-line Depreciation
Formula 9.2
Depreciation amount = premium or discount at issue
                  payment periods

Example
Company ABC issues a $1m bond that will pay a 11% semiannual (coupon) for five years and similar bonds are paying 10%. Bond premiums are amortized using straight-line depreciation. The company issues at $1,038,609 and face value is $1m.

Interest expense = coupon payments - unamortized portion of bond premium for the period

The carry value = total market value at time of issue - cumulative amortized premium or discount

Unamortized portion of bond premium for every period (six months in this example) = $38,609 / (10 payment periods) = $3,860.9

Result
Under this method the issuing company will recognize an equal amount of unamortized depreciation for every period.

  • Effective Interest Rate Method
    Effective interest rate method results in an interest expense that is a constant percentage of the carrying value of the bonds; thus interest expense varies from period to period. In contrast, the straight-line method results in a constant interest expense from period to period.
Formula 9.3
Interest expense = current interest rate at time of issue x carry value


The carry value = total market value at time of issue - cumulative amortized premium or discount
Formula 9.4
Amortized premium (discount) = coupon payment - interest expense


Example
Company ABC issues a $1m bond that will pay a 11% semiannual (coupon) for five years, and similar bonds are paying 10%. Bond premiums are amortized using the effective interest rate depreciation method. The company issues at $1,038,609 and face value is $1m.


Reporting The Retirement Or Conversion of Bonds

Related Articles
  1. Investing

    Premium Bonds: Problems And Opportunities

    Learn all about premium bonds and how you can make them work for you.
  2. Investing

    What is a Premium Bond?

    A premium bond is one that trades above its face or nominal amount.
  3. Investing

    Understanding Bond Prices and Yields

    Understanding this relationship can help an investor in any market.
  4. Investing

    Explaining Amortization In The Balance Sheet

    Amortization is important to account for intangible assets. Read to find out more about amortization.
  5. Investing

    Comparing Yield To Maturity And The Coupon Rate

    Investors base investing decisions and strategies on yield to maturity more so than coupon rates.
  6. Investing

    How Does A Bond’s Coupon Interest Rate Affect Its Price?

    All bonds come with a coupon interest rate, which is the fixed annual interest a bond pays.
  7. Investing

    Explaining the Coupon Rate

    Coupon rate is the stated interest rate on a fixed income security.
  8. Insurance

    Explaining Premiums

    Premium has a few different meanings in the financial world.
Frequently Asked Questions
  1. Why is social responsibility important to a business?

    Take social responsibility seriously, and your business could benefit from happier, more productive staff members while helping ...
  2. Which socially responsible retailers appeal most to ethical investors?

    Learn why ethical investors have many options in the retail sector, and discover which retail companies are most popular ...
  3. What are Some Examples of Free Market Economies?

    Learn which of the world's economies best resemble free market economies, marked by free trade, low government involvement, ...
  4. Who Decides When to Print money in India?

    Find out the role of the Reserve Bank of India, or RBI, and the amount of authority given to the government. Learn who is ...
Trading Center