Financial Accounting: An Integrated Statements Approach, 2nd Edition

The interest rate used in the interest method of amortization is the market rate on

the date the bonds are issued. The carrying amount of the bonds to which the interest

rate is applied is the face amount of the bonds minus any unamortized discount or

plus any unamortized premium. Under the interest method, the interest expense to be

reported on the income statement is computed by multiplying the effective interest

rate by the carrying amount of the bonds. The difference between the interest expense

computed in this way and the periodic interest payment is the amount of discount or

premium to be amortized for the period.

Amortization of Discount by the Interest Method

To illustrate the interest method for amortizing bond discounts, we assume the fol-

lowing data from the chapter illustration of issuing $100,000 bonds at a discount:

Face value of 12%, five-year bonds, interest compounded semiannually $100,000

Present value of bonds at effective (market) rate of interest of 13% 96,406

Discount on bonds payable $ 3,594

Applying the interest method to these data yields the amortization table in

Exhibit 17. You should note the following items in this table:

1. The interest paid (Column A) remains constant at 6% of $100,000, the face amount
   of the bonds.


2. The interest expense (Column B) is computed at 6–^12 % of the bond carrying amount
   at the beginning of each period. This results in an increasing interest expense each
   period.


3. The excess of the interest expense over the interest payment of $6,000 is the amount
   of discount to be amortized (Column C).


4. The unamortized discount (Column D) decreases from the initial balance, $3,594,
   to a zero balance at the maturity date of the bonds.


5. The carrying amount (Column E) increases from $96,406, the amount received for
   the bonds, to $100,000 at maturity.

468 Chapter 10 Liabilities

ABCDE

Interest Paid Interest Expense Discount Unamortized Bond Carrying

Interest (6% of (6–^12 % of Bond Amortization Discount Amount

Payment Face Amount) Carrying Amount) (B A) (D C) ($100,000 D)

$3,594 $ 96,406

1 $6,000 $6,266 (6^1 – 2 % of $96,406) $266 3,328 96,672

2 6,000 6,284 (6^1 – 2 % of $96,672) 284 3,044 96,956

3 6,000 6,302 (6^1 – 2 % of $96,956) 302 2,742 97,258

4 6,000 6,322 (6^1 – 2 % of $97,258) 322 2,420 97,580

5 6,000 6,343 (6^1 – 2 % of $97,580) 343 2,077 97,923

6 6,000 6,365 (6^1 – 2 % of $97,923) 365 1,712 98,288

7 6,000 6,389 (6^1 – 2 % of $98,288) 389 1,323 98,677

8 6,000 6,414 (6^1 – 2 % of $98,677) 414 909 99,091

9 6,000 6,441 (6^1 – 2 % of $99,091) 441 468 99,532

10 6,000 6,470 (6^1 – 2 % of $99,532) 468* — 100,000

* Cannot exceed unamortized discount.

Exhibit 17

Amortization of Discount on Bonds Payable