When The Effective-Interest Method is Used to Amortize Bond Premium or Discount

When The Effective-Interest Method is Used to Amortize Bond Premium or Discount

Question:

When the effective-interest method is used to amortize bond premium or discount, the periodic amortization will:

  1. a) increase the bonds were issued at a discount.
  2. b) decrease if the bonds were issued at a premium.
  3. c) increase if the bonds were issued at a premium.
  4. d) increase the bonds were issued at either a discount or a premium.

Amortization:

Amortization is the process of reducing the book value of intangible assets over a predetermined period of time. It is the process of repaying a loan over time. Amortization is the same as depreciation when applied to assets.

Answer and Explanation:

Answer:

  1. d) increase the bonds were issued at either a discount or a premium.

Explanation:

A bookkeeping standard used to amortize or refund a bond is the effective interest method. This approach is utilized for rebated bonds, where the bond discount is amortized to interest expense during the bond’s tenure. When the effective-interest method is used to amortize bond premiums or discounts, the periodic amortization will significantly raise if the bonds were issued at a discount, lowering if the bonds were issued at a premium, increase if the bonds were issued at a premium, and decrease if the bonds were issued at a premium.

If the bonds were issued at a premium, this demonstrates that the effective yield or market interest rate reached the stated (nominal) percentage. The nominal interest rate was higher than the market rate. The market and nominal rates coincided, indicating that there is no required connection between the two values.

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