Expense 129
between the amount to be repaid at the end of the
contract and the amount originally borrowed is in-
terest, which on the accrual basis of recording must
be allocated over the reporting periods between the
beginning and end of the contract. Th e interest ac-
cruing in each period is recorded as if being paid
by the debtor and then borrowed as an additional
amount of the same liability. Th us, interest expense
and an increase in the liability are recorded in each
period. When more than one reporting period is
involved, there are a number of ways to allocate the
total amount of interest among the periods involved.
Th e most common and simple method is to assume
that the interest rate is constant throughout the con-
tract period. On the cash basis of recording, the full
amount of the diff erence between the amount to be
repaid at the end of the contract and the amount orig-
inally borrowed is recorded as interest when the pay-
ment is made—that is, at the end of the contract when
the liability matures.
6.72 A slightly more complicated case is a deep-
discount bond, which is a discounted instrument that
also requires periodic payments. In such cases, the
accrued interest expense is the amount of the cou-
pon payable periodically plus the amount of interest
accruing each period attributable to the diff erence
between the redemption price and the issue price.
Again, the most common assumption is that the inter-
est rate is constant over the entire period of the con-
tract. Th is interest rate is the one that makes the sum
of all future payments equal to the amount initially
borrowed when the future payments are discounted
by the interest rate.
6.73 In some cases, debt securities are issued at a
premium rather than at a discount. Th e method of
determining the accrued interest expense is identi-
cal to the case of a discounted instrument except that
the premium (the diff erence between the redemp-
tion price and the issue price—see paragraph 9.40)
is amortized over the life of the instrument and re-
duces (rather than increases) the amount of interest
accruing in each period. Th ese premiums are there-
fore recorded as an increase in cash receipts with a
corresponding entry in other accounts payable for
the unearned portion of the premium. A reduction in
interest expense, with a corresponding reduction in
the other accounts payable, is subsequently recorded
over the period of the contract. On the cash basis of
recording, the full amount of premiums will be recog-
nized as a reduction in interest expense at the time the
debt instrument is issued.
6.74 Loans are oft en structured with periodic
payments that incorporate both interest and prin-
cipal payments. Th e excess of the periodic payment
over the interest accrued reduces the original prin-
cipal. Over time, the share of the payment allocated
to the payment of accrued interest decreases and the
share allocated to reducing the original principal
increases.
6.75 Index-linked securities are instruments for
which either the coupon payments (interest) or the
principal or both are linked to another item, such as
a price index, an interest rate, or the price of a com-
modity (see paragraph 7.153). Th e item is one that
normally changes over time in response to market
pressures. Th e values of the indicators are not known
in advance. For debt securities with indexation of the
amount to be paid at maturity, these amounts may be
known only at the time of redemption. As a result,
total interest fl ows before redemption cannot be deter-
mined with certainty. To estimate interest accrued be-
fore the values of the reference indicators are known,
it is useful to distinguish various arrangements.Indexation of the coupon payments only
6.76 When only coupon payments are index-
linked, as with fl oating-rate notes, the full amount
resulting from indexation is recorded as interest ac-
cruing during the period covered by the coupon. To
the extent that data are compiled aft er the coupon
payment date, the value of the index is known and
can be used to estimate that payment. If the data are
compiled before the date for the coupon payment, the
movement in the index during that part of the report-
ing period covered by the coupon can be used to cal-
culate the interest accrued.Indexation of the amount to be paid at maturity
6.77 When the amount to be paid at maturity is
also index-linked, the amount of interest accrued
becomes uncertain because the redemption value is
unknown; in some cases, the maturity time may be
several years in the future. Th ere are two approaches,