Question

What are the two methods of amortizing discount and premium on bonds payable? Explain each.

Short answer

The two methods of amortizing discounts and premiums on bonds payable include the effective-interest method and the straight-line method.

Step-by-step solution

Meaning of Bonds Payable

Bonds payable represent the liability account that is listed when a company issues bonds for producing cash. Being a bond issuer, the company is regarded as the lender. Therefore, the action of issuing the bonds produces liability. Hence, bonds payable appear on the liability side of the firm’s balance sheet—usually, bonds payable lie in the non-current section of liabilities.

Two methods of amortizing discount and premium on bonds payable

Bonds discount or premium may be amortized on a straight-line method or an effective interest method. The profession suggests the effective-interest method but allows the straight-line method when the outcomes attained do not vary significantly from the effective-interest method. The straight-line method leads to a uniform allotment of the full interest over the duration of bonds. The effective-interest method leads to an increase or decrease in interest value for each period. It is because the interest is dependent on the book value of the bond issued at the start of every period. The straight-line method leads to a uniform dollar amount of interest as well as an increasing or decreasing interest rate over the duration of the bonds. The effective-interest method leads to an increase or decrease in the dollar amount of interest and a uniform rate of interest over the duration of the bonds.