## Effective interest rate method bonds

Effective interest rate - NET column Determine actual earnings of a purchased bond or cost of an issued bond NET = (Coupon interest - Discount accretion) or (Coupon interest + Premium amortization)

Effective interest rate - NET column Determine actual earnings of a purchased bond or cost of an issued bond NET = (Coupon interest - Discount accretion) or (Coupon interest + Premium amortization) The effective interest on rate - is 19. 56%. Let's complicate the task by adding the one-time commission loan at the amount of 1% of the sum of 150 000\$. In monetary terms – is 1500\$. The cash interest is calculated by taking the coupon rate of the bond (9%) and multiplying it by the bond's face value (\$100,000), resulting in \$9,000 of cash interest. This use of a constant interest rate is known as the ‘interest method’ (also referred to as the “effective interest method”, although the FASB does not use that terminology in the Codification), and is applied to a discount or premium realized upon issuance, and to debt issuance costs incurred on the transaction.

## The effective interest method uses the market interest rate of the bond. The market rate of interest refers to the actual interest rate paid based on the book value of

The accounting profession requires that significant amounts of bond discount or premium be amortized by using the effective interest rate. Under this method, the effective interest rate (at the time the bonds were issued) is multiplied times the bond's carrying value. The result is the amount of interest expense for each reporting period. The The bonds were issued at a premium, interest payments are \$45,000 annually and the first year’s interest expense, under the effective interest rate method, is \$56,209. C. The bonds were issued at a discount, interest payments are \$60,000 annually and the first year’s interest expense, under the effective interest rate method, is \$42,157. Before we demonstrate the effective interest rate method for a 5-year 9% \$100,000 bond issued in a 10% market for \$96,149, let's highlight a few points: The bond discount of \$3,851 must be amortized to Interest Expense over the life of the bond. Effective Interest Rate Formula First, calculate the amount of the discount by subtracting the bond’s price from its face value. Second, divide the result by the number of bond payments remaining before the bond matures. Third, add the interest received per bond payment by the result. Based on a payment of \$900 to buy the bond, three interest payments of \$50 each, and a principal payment of \$1,000 upon maturity, Muscle derives an effective interest rate of 8.95%. Using this rate, Muscle's controller creates the following amortization table for the bond discount: Interest expense is calculated as the effective-interest rate times the bond’s carrying value for each period. The amount of amortization is the difference between the cash paid for interest and the calculated amount of bond interest expense. The effective interest rate method is one method of amortizing the premium or discount on bonds payable over the term of the bond, the alternative simpler method is the straight line method. The advantage of the effective rate method and the bond amortization schedule, is that the interest expense for the period reflects the book value of the bonds, in the case of a bonds issued at a premium, as the bond book value reduces towards the its face value, the interest expense reduces, and in the