2 It amortizes a bond premium by multiplying the adjusted basis by the yield at issuance and then subtracting the coupon interest. Or in formula form: Accrual = Purchase Basis x (YTM /Accrual periods per year) – Coupon Interest.
What does it mean to amortize a bond premium or discount?
With regards to bonds payable, the term amortize means to systematically allocate the discount on bonds payable, the premium on bonds payable, and the bond issue costs to Interest Expense over the remaining life of the bonds. (Bonds are likely to mature in 10 years or more.)
What are two methods of amortizing a bond discount or premium?
Effective-interest and straight-line amortization are the two options for amortizing bond premiums or discounts. The easiest way to account for an amortized bond is to use the straight-line method of amortization.
Are bond discounts amortized?
Amortizing Bond Discount with the Effective Interest Rate Method. When a bond is sold at a discount, the amount of the bond discount must be amortized to interest expense over the life of the bond. … This means that as a bond’s book value increases, the amount of interest expense will increase.
Why is it necessary to amortize a premium or discount on a bond investment?
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.
What do you do with bond premium on tax-exempt bonds?
If the bond is a tax-exempt municipal, you report the loss of premium value and subtract the loss from the cost basis of the bond, but you don’t subtract it from your taxable income. Tax-exempt bonds purchased for a price above par must be amortized.
How is bond premium treated on tax return?
If the bond yields tax-exempt interest, you must amortize the premium. This amortized amount is not deductible in determining taxable income. … As long as the bond is held to maturity, there will be no capital gain or loss associated with the bond.
What are the two methods of amortizing a bond discount or premium and which one is preferred by GAAP?
If the company uses the amortized cost approach to measure a long-term debt, it can use two methods to amortize the discount and the premium: the effective interest rate method, or. the straight-line method (allowed only under U.S. GAAP).
Which statement is correct when the effective interest method is used to amortize bond premium or discount?
The correct answer is d) increase the bonds were issued at either a discount or a premium. The effective interest method is used to discount on…
What will the use of the effective interest method in amortizing bond premiums and discounts result in?
held-to-maturity debt securities. … available-for-sale debt securities. Use of the effective-interest method in amortizing bond premiums and discounts results in. a greater amount of interest income over the life of the bond issue than would result from use of the straight-line method.
Why do you amortize bond discounts?
Discounted bonds’ amortization always leads to an effective interest expense that is higher than the payment of the bond interest coupon for each period. If a bond is sold at a discount, it means that the market interest rate is above the coupon rate.
When a taxable bond is issued at a discount taxpayers are required to amortize?
(T/F) When a taxable bond is issued at a discount, taxpayers are required to amortize the discount and reduce the amount of interest reported in the current year by the amount of current year original issue discount amortization.