Amortisation occurs on a bond when someone sells a bond on a premium or discount. A premium is when the market's interest rate is lower than the stated interest rate on the bond. A discount is when the market's interest rate is higher than the stated interest rate on the bond. There are two methods to compute the bond amortisation--the straight-line method and the effective interest rate method. Amortisation of the premium decreases interest expense each month. Amortisation of the discount increases interest expense each month.
- Skill level:
Determine the premium or discount and the number of months left outstanding on the bond.
Divide the premium or discount by the number of months left outstanding on the bond to arrive at bond amortisation.
Multiply the bond's face value by the stated interest rate on the bond, and then subtract the premium amortisation, or add the discount amortisation to arrive at interest expense.
Multiply the beginning carrying value of the bond by the effective interest rate to arrive at interest expense.
Subtract the cash paid from the interest rate to determine the amortisation of the discount, if purchasing the bond at a discount.
Subtract the interest rate from the cash paid to determine the amortisation of the premium, if purchasing the bond at a premium.
Effective Interest Rate Method
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