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. Financial Advisor

    Using Excel PV Function to compute Bonds PV

    To determine the value of a bond today - for a fixed principal (par value) to be repaid in the future at any predetermined time - we can use an Excel spreadsheet.
  5. Investing

    Are Bonds Selling At A Premium A Good Investment?

    A bond with a par value – or face value -- of $1,000 is selling at a premium when its price exceeds par.
  6. Investing

    Explaining Amortization In The Balance Sheet

    Amortization occurs when an asset’s value decreases over time, usually over its estimated useful life.
  7. Personal Finance

    Mortgage Amortization Strategies

    Should you get a 30-year mortgage? A 15-year one? Ways to decide which mortgage is the best fit.
  8. Investing

    Risks To Consider Before Investing In Bonds

    Make sure you understand the risks associated with bonds before making an investment decision.
  9. Investing

    What is a "Coupon"?

    In the financial world, “coupon” represents the interest rate on a bond.
Frequently Asked Questions
  1. Where else can I save for retirement after I max out my Roth IRA?

    The first option to explore is to determine if you can contribute to a 401(k), 403(b), or 457 plan at work. If your employer ...
  2. How did George Soros "break the Bank of England"?

    In Britain, Black Wednesday (September 16, 1992) is known as the day that speculators broke the pound. They didn't actually ...
  3. What counts as "debts" and "income" when calculating my debt-to-income (DTI) ratio?

    It's important to know your debt-to-income ratio because it's the figure lenders use to measure your ability to repay the ...
  4. Who are Monsanto's main competitors?

    Learn about Monsanto Company's two main operating divisions and its main competitors within each sector, including The Mosaic ...
Trading Center