Corporations issue bonds to individual investors and mutual fund managers. Mutual fund managers and investors purchase bonds to provide a stable income while minimizing the risk to the fund. Bond issuers make regular interest payments to the investor and repay the face value of the bond when it matures. When a company issues a bond, it negotiates the selling price with the purchaser. If the company sells the bond for more than the selling price, it records a premium. If the company sells the bond for less than the selling price, it records a discount. The company amortizes the premium or discount over the life of the bond. Many companies use the straight line method for amortizing the premium or discount.
Read the bond agreement to find the face value of the bond. Review the sales contract and locate the selling price of the bond.
Subtract the face value of the bond from the selling price. If the answer is a positive number, it represents the amount of premium resulting from the sale. If the answer is a negative number, it represents the amount of discount.
Read the bond agreement. Locate the redemption date of the bond. Subtract today’s date from the redemption date of the bond. This calculates the remaining life of the bond.
Divide the total premium or total discount by the number of years remaining on the bond. This number equals the annual amortization of the bond.
- When an accountant uses the straight line method to amortize the bond premium or discount, the amount remains the same each year. Many accounting systems allow the user to enter recurring journal entries. A recurring journal entry only needs to be entered one time. The system automatically repeats the same entry at the end of each period. This saves the accountant time each period.
- When a company amortizes a bond premium, the journal entry reduces interest expense and increases net income. When a company amortizes a bond discount, the journal entry increases interest expense and decreases net income.
- At the end of the bond term, the discount or premium should be fully amortized and have a zero balance.
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