Amortization and Accretion

amortizing bond premium

In this case, you’ll debit the bond premium account $410.After the first interest payment, the bond premium account value should be $3,690 or $4,100 – $410. Remember, you credited the bond premium account $4,100 when you bought the bond. In this case, you’ll debit the bond premium account $336.After the first interest payment, the bond premium account value should be $3,764 or $4,100 – $336. Credit the bonds payable account the face value of the bond. For example, if you bought a bond for $104,100 that has a face value of $100,000, you would credit the bonds payable account for $100,000. This will be easy to retrieve because you’ll be given the yield at time of purchase.You can also calculate current yield by dividing the annual cash flows earned by the bond by the market price.

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If the acquisition premium is amortized to its seven-year maturity, the yield is 8.074 percent; if amortized to the two-year call date, with the $5,000 call premium paid, the yield is only 6.894 percent. But if the call premium were $8,000, the yield would be 8.218 percent when amortized to the call date. The constant yield method calculates an adjustment schedule from the acquisition date to the redemption date, extracting the per period amounts from this schedule. The premium amount is adjusted across the life of the bond using the Yield at Purchase rate. The remaining amounts of qualified stated interest and bond premium allocable to the accrual period ending on February 1, 2000, are taken into account for the taxable year ending on December 31, 2000. Credit the bond premium account the value of the bond premium. In this case, you’ll credit bond premium account for $4,100.Note that the complete accounting from this step and the previous one keeps your books in balance.

New Investing Tips

Amortizable Bond Premium refers to the cost of premium paid above the face value of a bond. The face value of a bond is also called “par value”, it is the original cost of a stock or the amount paid to the holder of a bond. Amortizable Bond Premium is the difference between the amount a bond is purchased and the face value/par value of the bond. Any excess amount paid for a bond which is over and above its face value is amortizable bond premium. In simple words, expenses decrease with a decrease in book value under the Effective Interest rate method. This logic seems practical, but the straight-line method is easier to calculate.

  • Explain the difference between a bond issued at a premium versus one issued at a discount.
  • A bond is a fixed income investment that allows an investor to take a loan and borrow the funds for a defined period of time at either a variable or a fixed rate.
  • First, calculate the bond premium by subtracting the face value of the bond from what you paid for it.
  • The price paid is called the bond’s face (or “par”) value.

Governments, corporations and other entities sometimes issue bonds to raise money for capital projects or public activities. It’s a loan made by an investor to the issuer of the bond. The price paid is called the bond’s face (or “par”) value. The investor is paid interest, typically twice a year, that’s called the bond’s coupon rate. At the end of a pre-determined period of time, the bond is said to mature, and the issuer is then required to pay back the bondholder the original amount of the loan. Under IRS rules, investors and businesses have the option to amortize bond premium, but are not required to (unless they are tax-exempt organizations).

Recording Adoption of the New Method

Let’s modify our example so that the prevailing market rate is 10 percent and the bond’s sale proceeds are $961,500, which you debit to cash at issuance. Under this method, the amount of bond premium is equally amortized each year or accounting period.

amortizing bond premium

For example, if you pay $1,025 for a $1,000 maturity bond, your premium is $25. Is the cost basis as of the beginning date of the accrual period. Is calculated as the annual interest amount by multiplying the face value of the bond on the payment date by the Interest Rate. Then this number is converted into a value relative to the payment periods.

What is the Amortization of Premium on Bonds Payable?

If the primary consideration is to defer current income, the Effective Interest rate method should be chosen to amortize the premium on bonds. The Straight Method is preferable when the premium amount is very less or insignificant. Premium BondsA premium bond refers to a financial instrument that trades in the secondary market amortizing bond premium at a price exceeding its face value. This occurs when a bond’s coupon rate surpasses its prevailing market rate of interest. For instance, a bond with a face value of $750, trading at $780, will reflect that the bond is trading at a premium of $30 ($ ). Let us consider an investor that purchased a bond for $20,500.

And the difference between them is the amortization of premium. Volatility profiles based on trailing-three-year calculations of the standard deviation of service investment returns. If you paid more for a bond than its face value, you need to amortize it. Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.

When rates go up, bond market values goes down, and vice versa. To record these amounts, bondholders should understand how to amortize a bond premium. In the EIRA, you figure each amortization payment by reducing the balance in the premium on bonds payable account by the difference between two terms. The first term is the fixed interest payment, which in the example is $45,000. The second term is the prevailing semi-annual rate at the time of issue, which is 4 percent in the example, times the previous period’s book value of the bonds. The initial book value is equal to the bond premium balance of $41,000 plus the bond’s payable amount of $1 million. After six months, you make the first interest payment of $45,000.The semi-annual interest expense is 4 percent of $1.041 million, or $41,640.

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