Also, it leads to reducing the cost basis of the taxable bond for premium amortized in each period. The format of the journal entry for amortization of the bond premium is the same under either method of amortization – only the amounts change. Even though this example discusses only straight-line amortization of discount on a bond payable, amortization of bond premium only involves the same process. Under straight line method, amortization of bond discount do not vary over the term of the bond. In case of a discounted bond issue, the carrying amount equals face value minus the discount on bond; and in case of a premium issue, the carrying amount equals face value plus unamortized premium.
- To calculate the amount to be amortized for the tax year, the bond price is multiplied by the yield to maturity , the result of which is subtracted from the coupon rate of the bond.
- The bond is dated January 1, 2024 and requires interest payments on each June 30 and December 31 until the bond matures at the end of 5 years.
- Over the life of the bond, BizCorp will amortize the premium, which means it will gradually reduce the Premium on Bonds Payable account balance and record it as a reduction in interest expense.
- When we issue a bond at a premium, we are selling the bond for more than it is worth.
What is the Effective Interest Method of Amortization?
The market interest rate is used to discount both the bond’s future interest payments and the principal payment occurring on the maturity date. 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 table starts with the book value of the bond which is the face value (250,000) less the discount on bonds payable (8,663), which equals the amount of cash received from the bond issue (241,337). The discount on bonds payable account has a debit balance of 8,663 which needs to be amortized to the interest expense account over the lifetime of the bond.
AccountingTools
Premium on bonds payable is a contra account to bonds payable that increases its value and is added to bonds payable in the long‐term liability section of the balance sheet. As the discount is amortized, the discount on bonds payable account’s balance decreases and the carrying value of the bond increases. The amount of discount amortized for the last payment is equal to the balance in the discount on bonds payable account.
Bond Premium Amortization Schedule
- A second reason for bonds having a lower cost is that the bond interest paid by the issuing corporation is deductible on its U.S. income tax return, whereas dividends are not tax deductible.
- Double Entry Bookkeeping is here to provide you with free online information to help you learn and understand bookkeeping and introductory accounting.
- Second, we establish what area of the financial statements are impacted by issuing the bonds.
A bond is valued at the present value of its future cash flows (i.e. coupon payments and the par value) determined based on the market interest rate. Notice that the effect of this journal is to post the interest calculated in the bond amortization schedule (14,880) to the interest expense account. Notice that the effect of this journal is to post the interest calculated in the bond amortization schedule (10,363) to the interest expense account. This is because the carrying value of bonds payable equal bonds payable minus bonds discount or the bonds payable plus bond premium. Hence, once the balance of bond discount or bond premium becomes zero, the carrying value of the bonds payable will equal the balance of bonds payable itself which is the face value of the bonds.
When a bond is sold for less than its face amount, it is said to have been sold at a discount. The discount is the difference between the amount received (excluding accrued interest) and the bond’s face amount. The difference is known by the terms discount on bonds payable, bond discount, or discount. To illustrate the premium on bonds payable, let’s assume that in early December 2023, a corporation has prepared a $100,000 bond with a stated interest rate of 9% per annum (9% per year). The bond is dated as of January 1, 2024 and has a maturity date of December 31, 2028.
Amortization of Discount or Premium
In some jurisdictions, certain bonds may offer tax advantages, such as tax-exempt municipal bonds in the United States. These bonds often command a premium because the after-tax return for investors can be higher compared to taxable bonds with similar risk profiles. In this case, the bond holder essentially assumes the same role as a bank lending a 30-year mortgage to a home buyer. Much like the bank receiving regular payments over the life of the mortgage loan, the bond holder receives regular payments of both principal and interest until the bond reaches maturity.
Note that under either method, the interest expense and the carrying value of the bonds stays the same. Beyond FASB’s preferred method of interest amortization discussed here, there is another method, the straight-line method. This method is permitted under US GAAP if the results produced by its use would not be materially different than if the effective-interest method were used.
Are bonds payable amortized?
Premium on bonds payable is the excess amount by which bonds are issued over their face value. A premium occurs when the market interest rate is less than the stated interest rate on a bond. In this case, investors are willing to pay extra for the bond, the amortization of premium on bonds payable which creates a premium. They will pay more in order to create an effective interest rate that matches the market rate. These fees include payments to attorneys, accounting firms, and securities consultants. These costs are referred to as issue costs and are recorded in the account Bond Issue Costs.
In simple words, expenses decrease with a decrease in book value under the Effective Interest rate method. 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.
Over the life of the bond, this premium is amortized, and it reduces the amount of interest expense reported in the income statement. “Premium on Bonds Payable” is a concept in financial accounting that arises when the selling price of a bond is higher than its face value. This typically happens when the coupon rate (the interest rate stated on the bond) is higher than the prevailing market interest rates at the time of issue. The issuance cost incurred will be accounted for based on the jurisdiction of the organization issuing the bond. If a governmental entity accounting under GASB issues the bond, the issuance cost will be expensed as incurred on the statement of net activities. If an organization following FASB standards issues the bond, the total issuance cost will be deferred and amortized over the life of the bond.
To calculate the present value of the single maturity amount, you discount the $100,000 by the semiannual market interest rate. The second component of a bond’s present value is the present value of the principal payment occurring on the bond’s maturity date. The principal payment is also referred to as the bond’s maturity value or face value. 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.
In accounting, we may issue a bond at a discount or at a premium which results in the carrying value of the bonds payable recorded on the balance sheet being lower or higher than the face value of the bond. The accounting treatment of this premium is to amortize it over the life of the bond. Amortization reduces the bond’s book value on the balance sheet and is recognized as an adjustment to interest expense on the income statement. This process aligns the interest expense with the bond’s net carrying amount, reflecting a more accurate cost of borrowing over the period. For example, if a company issues a $1,000,000 bond at a 5% coupon rate when the market rate is 4%, and it sells for $1,050,000, the $50,000 premium is amortized until the bond matures.