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Below, you’ll learn more about bond premium amortization and one method of calculating it known as the straight-line method. Here’s a bit more discussion, excerpted from a page at the IRS. If you pay a premium to buy a bond, the premium is part of your cost basis in the bond. If the bond yields taxable interest, you can choose to amortize the premium.
Therefore, the bond premium allocable to the accrual period is $2,420.55 ($9,000−$6,579.45). Based on the remaining payment schedule of the bond and A’s basis in the bond, A’s yield is 8.07 percent, compounded annually. Therefore, the bond premium allocable to the accrual period is $1,118.17 ($10,000−$8,881.83). If you issue a bond at other than its face, or par, value, you must amortize the difference between the issue price and par. A premium bond sells for more than par; discount bonds sell below par. Amortization is an accounting technique to adjust interest expenses over time for bond premiums and discounts. You can choose either the straight-line amortization — SLA — or the effective interest rate amortization method — EIRA.
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Below we walk through how we calculate each methodology and why we support these two methodologies specifically. Collaborate easily in the cloud with internal teams and external partners. Manage your debt and lease amortizing bond premium obligations in a centralized collaborative environment. Stay up to date with the latest releases in debt and lease management. Experience debt and lease data you can really trust to keep your clients safe.
A new accounting rule that changes the calculation of bond premium amortization on certain callable debt securities could create tracking headaches due to the book-to-tax differences https://www.bookstime.com/ that might result. Once the bond premium is calculated, you need to decide how the bond premium shall be amortized. There are two methods for the same, which are discussed below.
Definition of Amortization of Bond Premium
Calculating bond premium amortization using the straight-line method couldn’t be simpler. First, calculate the bond premium by subtracting the face value of the bond from what you paid for it.
- When entering yield at purchase in the opening transaction, enter the annual yield.
- You plug the $41,000 difference by crediting the adjunct liability account “premium on bonds payable.” SLA reduces the premium amount equally over the life of the bond.
- Bond Premiums –Bonds that are issued at a price that is greater than its par value will be considered bonds issued at a premium.
- 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.
- Explain the difference between the percentage-of-sales method and the aging method for calculating the journal entry to adjust the allowance for uncollectible accounts.
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Comparison of Amortization Methods
Calculate the current interest expense based on the book value. To get the current interest expense, you’ll use the yield at the time you purchased the bond and the book value. For example, if you purchased a bond for $104,100 at an 8% yield, then the interest expense is $8,328 ($104,100 x 8%). Remember, though, that interest is paid twice per year so you need to divide that number by two, giving you $4,164.
- The straight line method can only be used for bonds issued before 1985.
- Valley collected $5,000 from the bondholders on May 31 as accrued interest and is now returning it to them.
- Explain how stocks and bonds impact the calculation of the debt-to-equity ratio.
- In other words, it reflects what the change in the bond price would be if we assumed that the market discount rate doesn’t change.