Then, figure out how many months are left before the bond matures and divide the bond premium by the number of months remaining. When a bond is issued at a price higher than its par value, the difference is called bond premium. The bond premium must be amortized over the life of the bond using the effective interest method or straight-line method. The effective interest method is Best Practice To Hire or Outsource for Nonprofit Accounting an accounting practice used to discount a bond. This method is used for bonds sold at a discount or premium; the amount of the bond discount or premium is amortized to interest expense over the bond’s life. The effective interest method of amortization is a process used to allocate the discount or premium on bonds, or other long-term debt, evenly over the life of the instrument.
When we issue a bond at a premium, we are selling the bond for more than it is worth. We always record Bond Payable at the amount we have to pay back which is the face value or principal amount of the bond. The difference between the price we sell it and the amount we have to pay back is recorded in a liability account called Premium on Bonds Payable.
Bond Amortization Calculator Download
As we amortize the premium/discount over the life of the bond, the book value is reduced back to its original par amount at the maturity date of the bond. 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. The combination of these two accounts is known as the book value or carrying value of the bonds.
In order to account for the bond properly, this premium or discount needs to be amortized over the lifetime of the bond. Notice that under both methods of amortization, the book value at the time the bonds were issued ($104,100) moves toward the bond’s maturity value of $100,000. The reason is that the bond premium of $4,100 is being amortized to interest expense over the life of the bond. When a bond is sold at a premium, the amount of the bond premium must be amortized to interest expense over the life of the bond.
Bond Amortization Schedule (Premium)
On January 1, 2022 the book value of this bond is $104,100 ($100,000 credit balance in Bonds Payable + $4,100 credit balance in Premium on Bonds Payable). By the time the loan is preparing to reach maturity (around year 28 or 29), the majority of the yearly payments will go toward reducing the remaining principal. By the 29th year, roughly $11,000 of the annual payments of $12,883 are now going toward https://business-accounting.net/what-is-legal-accounting-software-for-lawyers/ the principal rather than merely paying interest on the loan. The primary advantage of using the effective interest rate is simply that it is a more accurate figure of actual interest earned on a financial instrument or investment or of actual interest paid on a loan, such as a home mortgage. For example, Valenzuela bonds issued at a discount had a carrying value of $92,976 at the date of their issue.
If the bond matures after 30 years, for example, then the bond’s face value plus the interest due is paid off in monthly installments. An amortized bond is a bond with the principal amount – otherwise known as face value –regularly paid down over the life of the bond. The bond’s principal is divided up according to the security’s amortization schedule and paid off incrementally (often in one-month increments). In its simplest form, discount amortization is a process used to allocate the discount on bonds, or other long-term debt, evenly over the life of the instrument. The bond amortization schedule calculator is one type of tvm calculator used in time value of money calculations, discover another at the links below. Note that under the effective interest rate method the interest expense for each year is decreasing as the book value of the bond decreases.
Bond Amortization Schedule – Effective Interest Method
In this table, the effective periodic bond interest expense is calculated by multiplying the bond’s carrying value at the beginning of the period by the semiannual yield rate, determined at the time the bond was issued. When we issue a bond at a discount, remember we are selling the bond for less than it is worth or less than we are required to pay back. The difference between the price we sell it and the amount we have to pay back is recorded in a contra-liability account called Discount on Bonds Payable. This discount will be removed over the life of the bond by amortizing (which simply means dividing) it over the life of the bond. The discount will increase bond interest expense when we record the semiannual interest payment.