What Is an Amortizable Bond Premium? The amortizable bond premium is a tax term that refers to the excess price paid for a bond over and above its face value. Depending on the type of bond, the premium can be tax-deductible and amortized over the life of the bond on a pro-rata basis.

How do you calculate amortized bond premium?

First, calculate the bond premium by subtracting the face value of the bond from what you paid for it. Then, figure out how many months are left before the bond matures and divide the bond premium by the number of months remaining. That tells you how much to amortize on a monthly basis.

What is the effective interest amortization method?

The effective interest method is 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.

What is the effective interest rate of bond measured at amortized cost?

The effective interest rate is multiplied times the bond’s book value at the start of the accounting period to arrive at each period’s interest expense. The difference between Item 2 and Item 4 is the amount of amortization.

Why is bond premium amortized?

When interest rates go up, the market value of bonds goes down and vice versa. It leads to market premiums and discounts on the face value of bonds. The bond premium has to be amortized periodically, thus leading to a reduction in the cost basis. It facilitates the taxation of assets.

Which is the preferred method for amortizing bond premium?

In other words, the credit balance in the account Premium on Bonds Payable must be moved to the account Interest Expense thereby reducing interest expense in each of the accounting periods that the bond is outstanding. The preferred method for amortizing the bond premium is the effective interest rate method or the effective interest method.

Why is effective interest rate better than straight line amortization?

This means that when a bond’s book value decreases, the amount of interest expense will decrease. In short, the effective interest rate method is more logical than the straight-line method of amortizing bond premium.

When to amortize a 5 year 9% Bond?

Before we demonstrate the effective interest rate method for amortizing the bond premium pertaining to a 5-year 9% $100,000 bond issued in an 8% market for $104,100 on January 1, 2020, let’s outline a few concepts: The bond premium of $4,100 must be amortized to Interest Expense over the life of the bond.

How is the amortization of interest expense calculated?

Interest expense is calculated as the effective-interest rate times the bond’s carrying value for each period. The amount of amortization is the difference between the cash paid for interest and the calculated amount of bond interest expense. Premium Example