Effective - constant amounts of amortization and interest...

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Effective-Interest Amortization To follow the matching principle, companies allocate bond discount to expense in each period in which the bonds are outstanding. However, to completely comply with the matching principle, interest expense as a percentage of carrying value should not change over the life of the bonds. This percentage, referred to as the effective-interest rate , is established when the bonds are issued and remains constant in each interest period. Unlike the straight-line method, the effective- interest method of amortization accomplishes this result. Under the effective-interest method , the amortization of bond discount or bond premium results in periodic interest expense equal to a constant percentage of the carrying value of the bonds. The effective-interest method results in varying amounts of amortization and interest expense per period but a constant percentage rate. In contrast, the straight-line method results in
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Unformatted text preview: constant amounts of amortization and interest expense per period but a varying percentage rate. Companies follow three steps under the effective-interest method: 1. Compute the multiplying the c the beginning of effective-interest 2. Compute the bond interest paid (or accrued) by multiplying by the contractual interest rate. 3. Compute the amortization amount by determining the diffe computed in steps (1) and (2). Illustration 10B-1 depicts these steps. Computation of amortization using effective-interest method Both the straight-line and effective-interest methods of amortization result in the same total amount of interest expense over the term of the bonds. Furthermore, interest expense each interest period is generally comparable in amount. However, when the amounts are materially different , generally accepted accounting principles (GAAP) require use of the effective-interest method....
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