Page 604 - Accounting Principles (A Business Perspective)

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amortization.
By the maturity date, all of the premium would have been amortized.
The effective interest rate method APB Opinion No. 21 recommends an amortization procedure called the
effective interest rate method, or simply the interest method. Under the interest method, interest expense

for any interest period is equal to the effective (market) rate of interest on the date of issuance times the carrying
value of the bonds at the beginning of that interest period. Using the Carr example of 12 per cent bonds with a face
value of USD 100,000 sold to yield 14 per cent, the carrying value at the beginning of the first interest period is the
selling price of USD 95,233. Carr would record the interest expense for the first semiannual period as follows:
2010
Dec. 31 Bond interest expense ($95,233 x 0.14 x ½) (- 6,666
SE)
Cash ($100,000 x 0.12 x ½) (-A) 6,000
Discount on bonds payable (+L) 666
To record discount amortization and interest
payment.
Note that interest expense is the carrying value times the effective interest rate. The cash payment is the face
value times the contract rate. The discount amortized for the period is the difference between the two amounts.
After the preceding entry, the carrying value of the bonds is USD 95,899, or USD 95,233 + USD 666. Carr

reduced the balance in the Discount on Bonds Payable account by USD 666 to USD 4,101, or USD 4,767 - USD 666.
Assuming the accounting year ends on December 31, the entry to record the payment of interest for the second
semiannual period on 2011 June 30 is:
2011
June 30 Bond interest expense ($95,899 x 0.14 x ½) (-6,713
SE)
Cash ($100,000 x 0.12 x ½) (-A) 6,000
Discount on bonds payable (+L) 713
To record discount amortization and interest
payment.
Carr can also apply the effective interest rate method to premium amortization. If the Carr bonds had been
issued at USD 105,076 to yield 10 per cent, the premium would be USD 5,076. The firm calculates interest expense
in the same manner as for bonds sold at a discount. However, the entry would differ somewhat, showing a debit to
the premium account. The entry for the first interest period is:

2010
Dec. 31 Bond Interest Expense ($105,076 x 0.10 x ½) (-SE) 5,254
Premium on bonds payable (-L) 746
Cash ($100,000 x 0.12 x ½) (-A) 6,000
To record interest payment and premium amortization.
After the first entry, the carrying value of the bonds is USD 104,330, or USD 105,076 - USD 746. The premium

account now carries a balance of USD 4,330, or USD 5,076 - USD 746. The entry for the second interest period is:
2011
June 30 Bond interest expense ($104,330 x 0.10 x ½) (-SE) 5,216*
Premium on bonds payable (-L) 784
Cash ($100,000 x 0.12 x ½) (-A) 6,000
To record interest payment and premium amortization.
*Rounded down.

Accounting Principles: A Business Perspective 605 A Global Text