How to Amortize a Bond Premium
Get the yield of the bond at the time you purchased it., Calculate the bond premium., Calculate the amount of interest you'll earn per payment., Record the book value., Calculate the current interest expense based on the book value., Debit cash the...
Step-by-Step Guide
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Step 1: Get the yield of the bond at the time you purchased it.
The yield is effectively the total return that you'll receive on the bond, based on the price you paid, if you hold it until maturity.This will be easy to retrieve because you'll be given the yield at time of purchase.
You can also calculate current yield by dividing the annual cash flows earned by the bond (coupon payments) by the market price. -
Step 2: Calculate the bond premium.
This is also easy to retrieve because it's the price you paid for the bond minus the bond's face value.
For example, if the you bought a bond for $104,100 with a face value of $100,000, then the premium is $4,100 or $104,100
- $100,000.
The bond premium is the amount you'll amortize over the life of the bond. , You'll need to know how much money you'll receive with every interest during the life of the bond.
Remember, though, you'll use the face value of the bond to calculate the interest payments, not the amount that you paid for the bond.For example, if you bought a bond for $104,100 with a face value of $100,000 and a 9% interest rate, you'll use the face value to calculate the interest rate.
In this case, the annual interest rate is $9,000 or $100,000 x 9%.
However, that's the annual interest rate and interest payments are typically paid twice a year, so each interest payment is $4,500 or $9,000 /
2. , When you first purchase the bond, the book value is the same as the amount you paid for it.
For example, if you purchased a bond for $104,100, then the book value is $104,100.
The book value will decrease (or amortize) every time you receive an interest payment.
If you hold the bond until maturity, the book value will be the same as the face value when you receive your final interest payment. , To get the current interest expense, you'll use the yield at the time you purchased the bond and the book value.
For example, if you purchased a bond for $104,100 at an 8% yield, then the interest expense is $8,328 ($104,100 x 8%).
Remember, though, that interest is paid twice per year so you need to divide that number by two, giving you $4,164. , For example, if you buy a bond for $104,100, credit the cash account for $104,100. , For example, if you bought a bond for $104,100 that has a face value of $100,000, you would credit the bonds payable account for $100,000. , That's the amount you calculated in Step 2 above.
In this case, you'll credit bond premium account for $4,100.
Note that the complete accounting from this step and the previous step keeps your books in balance.
You've debited cash for $104,100 and you've credited two accounts for $104,100 ($100,000 + $4,100). , For your interest payment, you'll credit cash because you're receiving an increase in cash.
That's the amount you calculated from Step 3 above, or $4,500. , Calculate the interest expense based on the book value of the bond.
That's the amount you calculated in Step 5 above, or $4,164. , In this example, that difference is $336 or $4,500
- $4,164. , In this case, you'll debit the bond premium account $336.
After the first interest payment, the bond premium account value should be $3,764 or $4,100
- $336.
Remember, you credited the bond premium account $4,100 when you bought the bond. , The new book value of the bond is the previous book value minus the debit to the bond premium account.
So, for your first interest payment, the previous book value of the bond was $104,100 in the current example.
The new book value is $103,764 or $104,100
- $336.
The new book value is what you'll use to calculate the interest expense the next time that you receive an interest payment. -
Step 3: Calculate the amount of interest you'll earn per payment.
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Step 4: Record the book value.
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Step 5: Calculate the current interest expense based on the book value.
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Step 6: Debit cash the amount you paid for the bond when you buy it.
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Step 7: Credit the bonds payable account the face value of the bond.
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Step 8: Credit the bond premium account the value of the bond premium.
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Step 9: Credit cash when you receive your interest payment.
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Step 10: Debit interest expense.
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Step 11: Calculate the difference between the interest you received and the interest expense.
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Step 12: Debit the bond premium account the amount of the difference.
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Step 13: Recalculate the book value of the bond for the next interest payment.
Detailed Guide
The yield is effectively the total return that you'll receive on the bond, based on the price you paid, if you hold it until maturity.This will be easy to retrieve because you'll be given the yield at time of purchase.
You can also calculate current yield by dividing the annual cash flows earned by the bond (coupon payments) by the market price.
This is also easy to retrieve because it's the price you paid for the bond minus the bond's face value.
For example, if the you bought a bond for $104,100 with a face value of $100,000, then the premium is $4,100 or $104,100
- $100,000.
The bond premium is the amount you'll amortize over the life of the bond. , You'll need to know how much money you'll receive with every interest during the life of the bond.
Remember, though, you'll use the face value of the bond to calculate the interest payments, not the amount that you paid for the bond.For example, if you bought a bond for $104,100 with a face value of $100,000 and a 9% interest rate, you'll use the face value to calculate the interest rate.
In this case, the annual interest rate is $9,000 or $100,000 x 9%.
However, that's the annual interest rate and interest payments are typically paid twice a year, so each interest payment is $4,500 or $9,000 /
2. , When you first purchase the bond, the book value is the same as the amount you paid for it.
For example, if you purchased a bond for $104,100, then the book value is $104,100.
The book value will decrease (or amortize) every time you receive an interest payment.
If you hold the bond until maturity, the book value will be the same as the face value when you receive your final interest payment. , To get the current interest expense, you'll use the yield at the time you purchased the bond and the book value.
For example, if you purchased a bond for $104,100 at an 8% yield, then the interest expense is $8,328 ($104,100 x 8%).
Remember, though, that interest is paid twice per year so you need to divide that number by two, giving you $4,164. , For example, if you buy a bond for $104,100, credit the cash account for $104,100. , For example, if you bought a bond for $104,100 that has a face value of $100,000, you would credit the bonds payable account for $100,000. , That's the amount you calculated in Step 2 above.
In this case, you'll credit bond premium account for $4,100.
Note that the complete accounting from this step and the previous step keeps your books in balance.
You've debited cash for $104,100 and you've credited two accounts for $104,100 ($100,000 + $4,100). , For your interest payment, you'll credit cash because you're receiving an increase in cash.
That's the amount you calculated from Step 3 above, or $4,500. , Calculate the interest expense based on the book value of the bond.
That's the amount you calculated in Step 5 above, or $4,164. , In this example, that difference is $336 or $4,500
- $4,164. , In this case, you'll debit the bond premium account $336.
After the first interest payment, the bond premium account value should be $3,764 or $4,100
- $336.
Remember, you credited the bond premium account $4,100 when you bought the bond. , The new book value of the bond is the previous book value minus the debit to the bond premium account.
So, for your first interest payment, the previous book value of the bond was $104,100 in the current example.
The new book value is $103,764 or $104,100
- $336.
The new book value is what you'll use to calculate the interest expense the next time that you receive an interest payment.
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Michael Hart
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