What is amortization of discount?

The systematic allocation of the discount on bonds payable (reported as a debit in a contra-liability account) to Bond Interest Expense over the life of the bonds.

What is amortized discount?

A bond is sold at a discount when a company sells it for less than its face value and sold at a premium when the price received is greater than face value. … Under this method of accounting, the bond discount that is amortized each year is equal over the life of the bond.

How do you calculate amortized discount?

Divide the total discount or premium by the number of remaining periods in order to determine the amount to amortize in the current period. Multiply the face value of the bond by its stated interest rate to arrive at the interest payment to be made on the bond in the period.

What is the amortization of premium?

A tax term, the amortizable bond premium refers to the excess price (the premium) paid for a bond, over and above its face value. The premium paid for a bond represents part of the cost basis of the bond, and so can be tax-deductible, at a rate spread out (amortized) over the bond’s lifespan.

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Why is there a need to amortize discount or premium?

Therefore, bond discounts or premiums have the effect of increasing or decreasing the interest expense on the bonds over their life. Under these conditions,it is necessary to amortize the discount or premium over the life of the bonds by using either the straight-line method or the effective interest method.

What is the purpose of amortization?

First, amortization is used in the process of paying off debt through regular principal and interest payments over time. An amortization schedule is used to reduce the current balance on a loan—for example, a mortgage or a car loan—through installment payments.

What is the amortization rate?

In an amortization schedule, the percentage of each payment that goes toward interest diminishes a bit with each payment and the percentage that goes toward principal increases. Take, for example, an amortization schedule for a $250,000, 30-year fixed-rate mortgage with a 4.5% interest rate.

Is discount on bonds payable an asset?

If the contractual interest rate is less than the market rate, bonds sell at a discount or at a price less than 100% of face value. Although Discount on Bonds Payable has a debit balance, it is not an asset; it is a contra account, which is deducted from bonds payable on the balance sheet.

Why are bond discounts amortized?

A bond discount occurs when an issuer sells a bond and receives proceeds from investors for less than the face value of the bond. By amortizing a bond discount, the amount of amortization for each period can be used to determine periodic interest expense, as well as the changing bond carrying value over time.

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Why are bond premiums 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.

Do I have to amortize bond premium?

If the bond yields tax-exempt interest, you must amortize the premium. … As long as the bond is held to maturity, there will be no capital gain or loss associated with the bond. If the bond is sold before maturity, you may have capital gain or loss based is the portion of the premium which has not yet been amortized.

What is the rate of interest actually incurred?

The rate of interest that is actually incurred on a bond payable is called the: Effective rate. An investor purchases a 20-year, $1,000 par value bond that pays semiannual interest of $40.

Is a premium a debit or credit?

An option’s premium is simply – the price of an option. If you are buying an option, you are paying a premium for it – called a debit (more on this later). If you are selling an option, you are receiving premium for the option – called a credit.

What is effective interest 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.

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What is the relationship between premium and bond issue cost?

A premium bond is a bond trading above its face value or costs more than the face amount on the bond. A bond might trade at a premium because its interest rate is higher than the current market interest rates. The company’s credit rating and the bond’s credit rating can also push the bond’s price higher.

What is the difference between bond premium and acquisition premium?

The bond premium rules apply to OID Bonds in the same manner as they apply to Bonds without OID. … The purchase of an OID Bond carries acquisition premium if the purchase price is (a) greater than the Bond’s adjusted issue price, but (b) less than or equal to the sum of all remaining payments excluding QSI.

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