The initial journal entry to record the issuance of the bonds and the final journal entry to record repayment at maturity would be identical to those demonstrated for the straight line method. However, each journal entry to record the periodic interest expense when the effective interest rate method is used, the amortization of the bond premium recognition would vary and can be determined by reference to the preceding amortization table. When the effective-interest method is used to amortize bond premium or discount, the periodic amortization will increase the bonds were issued at a discount.
- If the straight-line method is used to amortize the $40,000 premium, you would divide the premium of $40,000 by the number of payments, in this case four, giving a $10,000 per year amortization of the premium.
- The rate takes into account the effect of compounding interest along with all the other costs that the borrower assumes for the loan.
- In the next interest period, this rate falls to 7.15% because the interest expense for the period remains at $6,702.
- This can help optimize bond portfolios, minimize tax liabilities, and achieve better overall returns.
- Investors can incorporate amortizable bond premium management into their wealth management strategies by diversifying their bond portfolios, considering the tax implications of their investments, and managing interest rate risk.
- In lending, the effective annual interest rate might refer to an interest calculation wherein compounding occurs more than once a year.
For example, Valenzuela bonds issued at a discount had a carrying value of $92,976 at the date of their issue. For example, under this method, each period’s dollar interest expense is the same. However, as the carrying value of the bond increases or decreases, the actual percentage interest rate correspondingly decreases or increases. The following table summarizes the effect of the change in the market interest rate on an existing $100,000 bond with a stated interest rate of 9% and maturing in 5 years.
How do you calculate the amortizable bond premium using the straight-line method?
This can help optimize bond portfolios, minimize tax liabilities, and achieve better overall returns. Understanding amortizable bond premium is crucial in wealth management, as it significantly influences bond yields, tax implications, and overall investment strategies. Investors must report bond interest income and bond premium amortization on their annual tax returns.
Over the life of the bond, this percentage interest rate continues to decrease until 2 January 2025, when it reaches 6.7% (or $6,702 / $99,294). Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.