Amortization vs. Accrued Interest

When you examine a corporation’s financial report, you may encounter accounts on the balance sheet and income statement related to bonds and other debt. The income accounts record interest income and expenses as they accrue. They also record amortization adjustments for the period. Amortization accumulates on the balance sheet and affects the book value of bonds payable and bond investments.

Accrued Interest

A bond normally accumulates interest on a daily or monthly basis, but many bonds pay interest semi-annually. An individual investor recognizes interest income when it’s paid, but companies accrue interest each month. This is the interest that the bond generated but has yet to pay. When you buy a bond, you pay the accrued interest to the seller and then receive the full period interest on the next payment date. If a company issues bonds, it credits the amortized amount to interest payable -- an accrued liability -- each month and debits it to interest expense. Companies that invest in bonds debit interest receivable -- an accrued asset -- and credit interest income monthly. When the interest is paid, the corporation reverses the payable or receivable and adjusts the cash account.

Amortizing Premiums

Bond premium is the excess of market price over face value. The bond premium is a part of a bond’s cost basis and is amortized over the remaining life of the bond. The premium is a gain for the bond issuer and loss to the buyer. An individual bond buyer amortizes bond premium by applying the constant yield method. You subtract the annual amortized amount from interest income and deduct any excess amortized premium as an itemized expense. Corporations normally use straight-line amortization or the effective interest method to amortize bond premium. Bond issuers debit the amortized amount to the premium on bonds payable account and credit the interest income account monthly. Corporations holding bond investments credit the bond investment account -- a long-term asset -- and debit interest expense when they recognize amortization at month’s end.

Amortizing Discounts

The flip side of a bond premium is a discount -- the excess of face value over bond price. Since bond buyers will receive more at maturity than they paid at purchase, they treat bond discounts as gains. The discount is a loss to the bond issuer. Individuals amortize discounts using either the straight-line method or constant yield method. They must amortize original issue discounts but can choose not to amortize market discounts and instead recognize these as an ordinary gain at bond maturity or sale. Corporations amortize bond discounts using the straight-line method or the effective yield method. A corporation must amortize the discount as either a credit to discount on bonds payable or a debit to bond investments, with the corresponding entries to interest expense or interest income, respectively.

Debt Issue Costs

A corporation can spend a substantial sum when issuing debt. Normally, corporations hire syndicates of investment bankers to underwrite and distribute the bonds. The syndicate collects a fee that reduces the net proceeds from the sale. Other costs include printing and legal fees. The corporation must capitalize and amortize these costs. It debits a non-current asset called debt issue costs when it records the credit to the bonds payable account. The company uses straight-line amortization to recognize debt issue expense and reduce debt issue costs over the remaining lifetime of the bond.

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