Amortization occurs on a bond when someone sells a bond on a premium or discount. A premium is when the market‘s interest rate is lower than the stated interest rate on the bond. A discount is when the market’s interest rate is higher than the stated interest rate on the bond. There are two methods to compute the bond amortization--the straight-line method and the effective interest rate method. Amortization of the premium decreases interest expense each month. Amortization of the discount increases interest expense each month.
Determine the premium or discount and the number of months left outstanding on the bond.
Divide the premium or discount by the number of months left outstanding on the bond to arrive at bond amortization.
Multiply the bond's face value by the stated interest rate on the bond, and then subtract the premium amortization, or add the discount amortization to arrive at interest expense.
Effective Interest Rate Method
Multiply the beginning carrying value of the bond by the effective interest rate to arrive at interest expense.
Subtract the cash paid from the interest rate to determine the amortization of the discount, if purchasing the bond at a discount.
Subtract the interest rate from the cash paid to determine the amortization of the premium, if purchasing the bond at a premium.