CAN YOU EXPLAIN THE AMORTIZATION OF BOND PREMIUMS WHEN BONDSARE SOLD - ProProfs Discuss
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Can you explain the amortization of bond premiums when bondsare sold for higher than PAR?



Asked by WARD, Last updated: May 15, 2021

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John Smith

John Smith

John Smith
John Smith

Answered Sep 08, 2016

The notion of amortizing a bond premium goes well beyond what is discussed in thecsc text. rest assured that you wouldnt be tested on such things.for information purposes only: when a bond is issued at a premium the companyneeds to account for this extra amount each year. for example, lets say a companyissues bonds with a face value of $100 million dollars and have a term of 10 years.this means that in 10 years, the bonds mature or come due and the company needs tomake a payout of $100 million to the bondholders. this amount comes out of cash.when the bonds are issued at a premium, the company initially got more than they willneed to pay back when the bonds matured. if the $100 million of bonds were issued ata premium and the company received $110 million, they still need to make the regularcoupon payments but will only need to pay back $100m at maturity.for accounting purposes, the company needs to recognize this extra $10 million theyreceive on the issue of the bonds. in very, very simple terms, they need do this byreducing the amount of the premium each year - amortizing it. so the companyrecords the $110 that it initially receives, and the $10m premium is also recorded.each year the company reduces this premium - again very simplistically, lets say itsreduced by $1m each year over the 10-year term of the bond. this is an accountingentry to better show the relationship or matching between the earnings statement andthe balance sheet.the trickier part is that the company must also include an interest expense amount forthe bond each year. since it starts at an amount of $110 and slowly reduces to $100by the maturity of the bond, the total interest expense declines each year.
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