Browse Accounting Lessons Here Accounting Terms & Definitions Accounting for Merchandising Activities Debits and Credits (Double Entry Accounting) Business Valuation Formulas Time Value of Money & Present/Future Values Complex Debt & Equity Instruments Common Stock & Shareholder's Equity Accounting & Finance Ratios Valuing Common Stock Corporate Income Taxes Lower of Cost or Market (LCM) & Inventory Valuation Chart of Accounts & Bookkeeping Bonds Payable & Long Term Liabilities Capital Assets GAAP, Accrual & Cash Accounting, Information Commodity, Internal Controls & Materiality What category of browser are you on this website? Accounting student (homework help) Finance professor (university research) Accounting manager (at work) Other Explore Careers in Accounting and Finance Visit our section on Careers in Accounting & Finance to explore vast opportunities in this industry.

Chapter 2.91® - Amortizing a Bond Premium Interest Expense – Straight Line Method & Effective Interest Method Example

The straight line method of amortization allocates interest expense equally over the life of the bonds (over the 4 annual interest payment periods). To calculate this number, we divide \$54,090 by 4 giving us a total bond interest expense of \$13,522.50 per period (year).

 December 31st, 2009 Account Name Debit Credit Dr. Bond Interest Expense \$13,522.50 Dr. Premium on Bonds Payable \$1,477.50 Cr. Cash \$15,000 Entry to record payment of interest expense on bonds payable

This entry is made on December 31st of each year for 4 years. The \$1,477.50 debit to Premium on Bonds Payable reduces the carrying value of the bond payable because remember, bonds payable is a Credit account and any debit to it reduces its carrying value.

 A Period Ending B Cash Interest Paid (\$100,000 x 15%) C Period Interest (\$54,090 / 4 years) D Premium Amortization (\$5,910 / 4 periods) E Unamortized Premium (E – D) F Carrying Value \$100,000 + Unamortized Premium Jan 1st/09 \$5,910 \$105,910 Dec 31/2009 \$15,000 \$13,522.50 \$1,477.50 \$4,432.50 \$104,432.50 Dec 31/2010 \$15,000 \$13,522.50 \$1,477.50 \$2,955 \$102,955 Dec 31/2011 \$15,000 \$13,522.50 \$1,477.50 \$1,477.50 \$101,477.50 Dec 31/2012 \$15,000 \$13,522.50 \$1,477.50 \$0 \$100,000

Effective Interest Method for Amortization of Bonds Payable

In the straight line amortization method, the bond’s carrying value changes each period while the bond interest expense each period remains the same. This displays a changing interest rate when the carrying value fluctuates each period while interest remains the same. Thus, the accounting handbooks advise to only use this rule when the results do not differ significantly from the effective interest method. The effective interest method allocates bond interest expense over the life of the bonds in such a way that it yields a constant rate of interest, which in turn is the market rate of interest at the date of issue of bonds. With effective interest method, the bond payable and discount/premium is calculated using the effective market interest rate versus the coupon rate used in straight-line method. Below is the amortization schedule for this bond issue using effective interest.

 A Period Ending B Cash Interest Paid (\$100,000 x 15%) C Period Interest (F x 13%) D Premium Amortization (B - C) E Unamortized Premium F Carrying Value \$100,000 + Unamortized Premium Jan 1st/09 \$5,910 \$105,910 Dec 31/2009 \$15,000 \$13,768.30 \$1,231.70 \$4,678.30 \$104,678.30 Dec 31/2010 \$15,000 \$13,608.18 \$1,391.82 \$3,286.48 \$103,286.48 Dec 31/2011 \$15,000 \$13,427.20 \$1,572.80 \$1,713.68 \$101,713.68 Dec 31/2012 \$15,000 \$13,222.80 \$1,777.20 \$-63.52* \$100,000

*Notice the \$-63.52 of unamortized premium occurs due to rounding issues in these numbers but normally most companies would use automated amortization schedules that will take care of rounding issues leaving no variance.

The journal entry to record bond interest expense on December 31st, 2009 will be:

 December 31st, 2009 Account Name Debit Credit Dr. Bond Interest Expense \$13,768.30 Dr. Premium on Bonds Payable \$1,231.70 Cr. Cash \$15,000 Entry to record bond interest expense for 2009 and amortization for premium on bonds payable.