Effective Interest Amortization of a Premium Bond

Exhibit 14B.2 shows the amortization table using the effective interest method for the Adidas bonds (as described in Exhibit 14.8). Column A lists the semiannual cash payments. Column B shows the amount of bond interest expense, computed as the 5% semiannual market rate at issuance multiplied by the beginning-of-period carrying value. The amount of cash paid in column A is larger than the bond interest expense because the cash payment is based on the higher 6% semiannual contract rate.

The excess cash payment over the interest expense reduces the principal. These amounts are shown in column C. Column E shows the carrying value after deducting the amortized premium in column C from the prior period’s carrying value. Column D shows the premium’s reduction by periodic amortization. When the issuer makes the first semiannual interest payment, the effect of premium amortization on bond interest expense and bond liability is recorded as follows:

EXHIBIT 14B.2 Effective Interest Amortization of Bond Premium

Similar entries with different amounts are recorded at each payment date until the bond matures at the end of 2013. The effective interest method yields decreasing amounts of bond interest expense and increasing amounts of premium amortization over the bonds’ life.