Straight Line Method of Bond Discount Premium Amortization

In later years, the situation reverses, with the bulk of the payments going toward paying down the debt. The reason for this arrangement is that lenders earn profit from interest and therefore collect it as quickly as possible.

Suppose a company issues $100,000 of 10-year bonds that pay an 8% annual coupon. The bonds are sold at a discount, and thus the company only receives $90,000 in proceeds from investors. The $10,000 difference between the face value and the carrying value of the bonds must be amortized over 10 years. Though straight-line amortization applies to bonds in the investment industry, the method can technically apply to any situation in which a person or a company must make uniform payments over a set period of time. The straight-line method of amortization gains its name from the uniform payments it creates. Using this formula allows accountants to develop a “straight line” of identical payments due at equally measured intervals over a predetermined period of time.

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All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. The result of this, as well as subsequent entries, is to reflect the increase in the carrying value of the bonds. Salvage ValueSalvage value or scrap value is the estimated value of an asset after its useful life is over. For example, if a company’s machinery has a 5-year life and is only valued $5000 at the end of that time, the salvage value is $5000. When the loan is to be repaid in equal installment, it is also referred to as Straight-line amortization.

Since the corporation is selling its 9% bond in a bond market which is demanding 10%, the corporation will receive less than the bond’s face amount. The straight-line method of amortization allocates the discount evenly over the life of the bond. The double-declining balance depreciation method is an accelerated method that multiplies an asset’s value by a depreciation rate. One method accountants use to determine this amount is the straight line basis method. In accounting, there are many differentconventionsthat are designed to match sales and expenses to the period in which they are incurred. One convention that companies embrace is referred to asdepreciation and amortization. Bench gives you a dedicated bookkeeper supported by a team of knowledgeable small business experts.

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Amortization is the systematic write-off of the cost of an intangible asset to expense. A portion of an intangible asset’s cost is allocated to each accounting period in the economic life of the asset. The finite useful life of such an asset is considered to be the length of time it is expected to contribute to the cash flows of the reporting entity. Pertinent factors that should be considered in estimating useful life include legal, regulatory, or contractual provisions that may limit the useful life. The method of amortization should be based upon the pattern in which the economic benefits are used up or consumed.

Amounts are prorated for the first period and the final period based on the number of days in each period. Subtract the estimated salvage value of the asset from the cost of the asset to get the total depreciable amount. The following T-account shows how the balance in Discount on Bonds Payable will be decreasing over the 5-year life of the bond. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.

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For example, there is always a risk that technological advancements could potentially render the asset obsolete earlier than expected. Moreover, the straight line basis does not factor in the accelerated loss of an asset’s value in the short-term, nor the likelihood that it will cost more to maintain as it gets older. The equipment has an expected life of 10 years and a salvage value of $500. Straight line basis is a method of calculating depreciation and amortization, the process of expensing an asset over a longer period of time than when it was purchased. Until the end of the life of the intangible asset or until maturity of bond respectively in the income statement of the company. Straight line amortization is the same as straight line depreciation, except that it applies to intangible assets, rather than tangible assets. To calculate the depreciation rate, divide the depreciation expense by the depreciable base.

For a more accelerated depreciation method see, for example, our Double Declining Balance Method Depreciation Calculator. This method divides the expense from the purchase amount evenly across all periods, even partial periods.

Straight-line Amortization

These things lose value as they expire or otherwise fail to produce dependable revenue streams. In this case, the company can make a lump sum payment rather than several smaller payments. This leads to saving in interest costs and also helps in making a smooth transition from one accounting period to another. Further, companies can pick up the coupon payments in advance and reduce their interest costs. Another way to calculate the $6,702 is to divide the total interest cost, $67,024, into the 10 interest periods of the bond’s life, as in the journal entry for 1 July 2020.

• Over time, the carrying amount of the bonds is slowly reduced to $100,000 due to the amortization of the premium each year.
• These things lose value as they expire or otherwise fail to produce dependable revenue streams.
• If rounding is required for amounts when using the Straight-line, prorate first & last period method, then the rounding difference is added to the next to the last period.
• This method is more mathematically complex, but can be done fairly quickly with the help of a finance calculator or Excel.
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• The journal entries for the remaining years will be similar if all of the bonds remain outstanding.

This allows the borrower to allocate more of the repayments to the principal when the borrower decides to increase the proportions of every repayment. The https://online-accounting.net/ equation to calculate straight line amortization is quite simple. You subtract the expected salvage value of the intangible asset from its book value, and then you divide that the resulting amount by the number of periods that the asset will be active. In using the declining balance method, a company reports larger depreciation expenses during the earlier years of an asset’s useful life. While the purchase price of an asset is known, one must make assumptions regarding the salvage value and useful life.

When is the straight-line method of amortization used in ensuring bondholders?

This is because we paid an amount lower than the face value of the bond at issue date but will get the full face value at maturity. The Excel equivalent function for Straight-Line Method is SLN will calculate the depreciation expense for any period.

If no pattern is apparent, the straight-line method of amortization should be used by the reporting entity. In the straight-line method of amortization of bond discount or premium, bond discount or premium is charged equally in each period of the bond’s life. When the coupon rate on a bond is lower than the market interest rate, the bond is issued at a discount to par value. When a straight line amortization corporation is preparing a bond to be issued/sold to investors, it may have to anticipate the interest rate to appear on the face of the bond and in its legal contract. Let’s assume that the corporation prepares a $100,000 bond with an interest rate of 9%. Just prior to issuing the bond, a financial crisis occurs and the market interest rate for this type of bond increases to 10%.

Straight-line depreciation

Such as patents, goodwill or intellectual property, etc., is charged over the useful life of that intangible asset in equal yearly amounts. Accounting Period Of The CompanyAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. The term can also be applied to the repayment of a loan via a series of periodic payments that are in the same amount. Early in the series of payments, the bulk of the payments are comprised of interest charges, with modest principal repayments. The first payment is determined by dividing the total owed amount by the number of months it needs to be paid off and adding the interest, after calculating it as a percentage of the total amount owed. The following month, the total owed amount is smaller, having paid off the first installment with interest, therefore the interest is now a percentage of a smaller amount.