Amortizing Bond Discount with Effective Interest Rate Examples, Concepts, Illustrations, Sample Help Online
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Understanding the concept of Amortizing Bond Discount with Effective Interest Rate Examples
Amortizing Bond Discount occurs when a bond is sold at a discount. The discount on bond is amortized to interest expense over the lifetime of bond. Since the debit amount in the account Discount on Bonds Payable will be moved to the account Interest Expense. This increases each period’s interest expense to be greater than the amount of interest paid during each of the years that the bond is outstanding.The preferred method for amortizing the bond discount is the effective interest rate method or the effective interest method.The amount of a bond’s book value at the beginning of the accounting period is correlated to the amount of interest expense in a given accounting period. This means that as a bond’s book value increases, the amount of interest expense will increase.
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Amortizing Bond Discount with Effective Interest Rate Examples Explanation
Let’s understand the concept with the help of an example.
Example 1: suppose, a 10-year $100,000 bond is issued with a 6% semi-annual coupon in a 10% market. The bond is sold at a discount for $95,000 on Jan. 1, 2015.The bond discount of $5,000, or $100,000 less $95,000, is amortized to the interest expense account over the life of the bond. The effective interest method of amortization causes the bond’s book value to increase from $95,000 on Jan. 1, 2015 to $100,000 prior to the bond’s maturity. An amount of $3,000 interest payment is made every six months the bond is outstanding. The cash account is then credited $3,000 on June 30 and Dec.
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