If a bond is issued at a premium or at a discount, the amount will be amortized over the years through to its maturity. On issuance, a premium bond will create a “premium on bonds payable” balance. At every coupon payment, interest expense will be incurred on the bond.

How bond premiums and discounts affect interest expense?

When bonds are sold at a discount or a premium, the interest rate is adjusted from the face rate to an effective rate that is close to the market rate when the bonds were issued. Therefore, bond discounts or premiums have the effect of increasing or decreasing the interest expense on the bonds over their life.

Does bond Premium reduce interest expense?

When a bond is issued at a price higher than its face value, the difference is called Bond Premium. The issuer has to amortize the Bond premium over the life of the Bond, which, in turn, reduces the amount charged to interest expense. When interest rates go up, the market value of bonds goes down and vice versa.

Does bond Premium reduce tax exempt interest?

If the bond yields tax-exempt interest, you must amortize the premium. Generally no reduction for premium amortization is allowed since the interest is not taxable, but if the bonds are taxable (out-of-state) bonds, the taxable income can be reduced by the amount of premium amortization.

How is the premium or discount of a bond amortized?

If the bond is issued at a premium or discount, the premium or discount is amortized systematically over the life of the bonds as a component of interest expense. There are two methods for amortizing the premium or discount of bonds that are issued at a price other than par: (i) the effective interest rate method, and (ii) the straight-line method.

What was the interest rate on 4.50% coupon bonds?

At the time of issue of 4.50% coupon bonds, the effective interest rate was 5.00%. The bonds were most likely issued at: B. a discount. C. a premium.

What is the effective interest rate on bonds?

The effective interest rate is the market interest rate on the date that the bonds were issued. In our example the market interest rate on January 1, 2018 was 5% per semiannual period for 10 semiannual periods.

What does it mean when company offers discount on bonds?

Due to the market rate and coupon rate, company may issue the bonds and provide a discount to the investor. It means that company sells bonds at a price that is lower than the par value. Company will discount to attract investors when the coupon rate is lower than the market rate.