1. CHAPTER TWENTY-FOUR APPENDIX
CORPORATIONS: BONDS--EFFECTIVE INTEREST METHOD

2. EFFECTIVE INTEREST METHOD
Method of amortizing premiums and discounts on bonds payable
Effective interest rate
market rate of interest on the date the bonds are issued
used to determine the amount of interest expense and premium or discount amortization for the period

3. Market Rate of 8% for 1/2 year
PREMIUM AMORTIZATION
EXAMPLE: On April 1, 20-1 the stated rate of 9% is GREATER than the current market rate of 8%, so Watkin Corp. will sell the $400,000, 10-year bonds for $427,181.
FORMULA:
Carrying Value x
Semiannual Effective Interest rate
$427,181 4% x
Market Rate of 8% for 1/2 year

4. PREMIUM AMORTIZATION $427,181 4%
EXAMPLE: On April 1, 20-1 the stated rate of 9% is GREATER than the current market rate of 8%, so Watkin Corp. will sell the $400,000, 10-year bonds for $427,181.
FORMULA:
Carrying Value x
Semiannual Effective Interest rate
$427,181 4% x
Interest Expense is $17,087

5. interest payment is computed
GENERAL JOURNAL
DATE
DESCRIPTION
DEBIT PR
CREDIT 1
Oct. 1
Bond Interest Expense
17,087 2
Premium on Bonds Pay. 3 4
Will be determined after Cash
interest payment is computed 5 6 7 8 9 10 11

6. GENERAL JOURNAL Oct. 1 Bond Interest Expense Premium on Bonds Pay.
DATE
DESCRIPTION
DEBIT PR
CREDIT 1
Oct. 1
Bond Interest Expense
17,087 2
Premium on Bonds Pay. 3
Cash
18,000 4
$400,000 x 9% stated rate x 1/2 year 5 6 7 8 9 10 11

7. GENERAL JOURNAL Oct. 1 Bond Interest Expense Premium on Bonds Pay.
DATE
DESCRIPTION
DEBIT PR
CREDIT 1
Oct. 1
Bond Interest Expense
17,087 2
Premium on Bonds Pay.
913 3
Cash
18,000 4
$18,000 - $17,087 5 6 7 8 9 10 11

8. Carrying Value of Bonds
PREMIUM AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Premium Amortization
Unamortized Premium
Date
4/1/-1
$27,181
$427,181
10/1/-1
$18,000
$17,087
$ 913
26,269
$27,181 - $913

9. PREMIUM AMORTIZATION $400,000 face value + $26,269 unamortized premium
Carrying Value of Bonds
Cash Payment
Interest Expense
Premium Amortization
Unamortized Premium
Date
4/1/-1
$27,181
$427,181
10/1/-1
$18,000
$17,087
$ 913
26,269
426,269
$400,000 face value + $26,269 unamortized premium

10. Carrying Value of Bonds
PREMIUM AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Premium Amortization
Unamortized Premium
Date
4/1/-1
$27,181
$427,181
10/1/-1
$18,000
$17,087
$ 913
26,269
426,269
4/1/-2
18,000
17,051
$426,269 x 4%

11. Carrying Value of Bonds
PREMIUM AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Premium Amortization
Unamortized Premium
Date
4/1/-1
$27,181
$427,181
10/1/-1
$18,000
$17,087
$ 913
26,269
426,269
4/1/-2
18,000
17,051
949
$18,000 - $17,051

12. Carrying Value of Bonds
PREMIUM AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Premium Amortization
Unamortized Premium
Date
4/1/-1
$27,181
$427,181
10/1/-1
$18,000
$17,087
$ 913
26,269
426,269
4/1/-2
18,000
17,051
949
25,319
$26,269 - $949

13. Carrying Value of Bonds
PREMIUM AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Premium Amortization
Unamortized Premium
Date
4/1/-1
$27,181
$427,181
10/1/-1
$18,000
$17,087
$ 913
26,269
426,269
4/1/-2
18,000
17,051
949
25,319
425,319
$400,000 + $25,319

14. PREMIUM AMORTIZATION The amortization of the premium
Carrying Value of Bonds
Cash Payment
Interest Expense
Premium Amortization
Unamortized Premium
Date
4/1/-1
$27,181
$427,181
10/1/-1
$18,000
$17,087
$ 913
26,269
426,269
4/1/-2
18,000
17,051
949
25,319
425,319
The amortization of the premium
continues in the same manner
throughout the remaining life of the bond.

15. Carrying Value of Bonds
PREMIUM AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Premium Amortization
Unamortized Premium
Date
4/1/-1
$27,181
$427,181
10/1/-1
$18,000
$17,087
$ 913
26,269
426,269
4/1/-2
18,000
17,051
949
25,319
425,319
10/1/-2
18,000
17,013
987
24,332
424,332
4/1/10
18,000
16,222
1,778
3,773
403,773
10/1/10
18,000
16,151
1,849
1,924
401,924
3/31/11
18,000
16,076
1,924
400,000

16. DISCOUNT AMORTIZATION
EXAMPLE: On April 1, 20-1 the stated rate of 9% is LESS than the current market rate of 10%, so Watkin Corp. will sell the $400,000, 10-year bonds for $375,076.
FORMULA:
Carrying Value x
Semiannual Effective Interest rate
$375,076 5% x
Market Rate of 10% for 1/2 year

17. DISCOUNT AMORTIZATION
EXAMPLE: On April 1, 20-1 the stated rate of 9% is LESS than the current market rate of 10%, so Watkin Corp. will sell the $400,000, 10-year bonds for $375,076.
FORMULA:
Carrying Value x
Semiannual Effective Interest rate
$375,076 5% x
Interest Expense is $18,754

18. interest payment is computed
GENERAL JOURNAL
DATE
DESCRIPTION
DEBIT PR
CREDIT 1
Oct. 1
Bond Interest Expense
18,754 2
Discount on Bonds Pay. 3 4
Will be determined after Cash
interest payment is computed 5 6 7 8 9 10 11

19. GENERAL JOURNAL Oct. 1 Bond Interest Expense Discount on Bonds Pay.
DATE
DESCRIPTION
DEBIT PR
CREDIT 1
Oct. 1
Bond Interest Expense
18,754 2
Discount on Bonds Pay. 3
Cash
18,000 4
$400,000 x 9% stated rate x 1/2 year 5 6 7 8 9 10 11

20. GENERAL JOURNAL Oct. 1 Bond Interest Expense Discount on Bonds Pay.
DATE
DESCRIPTION
DEBIT PR
CREDIT 1
Oct. 1
Bond Interest Expense
18,754 2
Discount on Bonds Pay.
754 3
Cash
18,000 4
$18,754 - $18,000 5 6 7 8 9 10 11

21. DISCOUNT AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Discount Amortization
Unamortized Discount
Date
4/1/-1
$24,924
$375,076
10/1/-1
$18,000
$18,754
$ 754
24,170
$24,170 - $754

22. DISCOUNT AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Discount Amortization
Unamortized Discount
Date
4/1/-1
$24,924
$375,076
10/1/-1
$18,000
$18,754
$ 754
24,170
375,830
$400,000 - $24,170

23. DISCOUNT AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Discount Amortization
Unamortized Discount
Date
4/1/-1
$24,924
$375,076
10/1/-1
$18,000
$18,754
$ 754
24,170
375,830
4/1/-2
18,000
18,791
$375,830 x 5%

24. DISCOUNT AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Discount Amortization
Unamortized Discount
Date
4/1/-1
$24,924
$375,076
10/1/-1
$18,000
$18,754
$ 754
24,170
375,830
4/1/-2
18,000
18,791
791
$18,791 - $18,000

25. DISCOUNT AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Discount Amortization
Unamortized Discount
Date
4/1/-1
$24,924
$375,076
10/1/-1
$18,000
$18,754
$ 754
24,170
375,830
4/1/-2
$18,000
$18,791
791
23,379
$24,170 - $791

26. DISCOUNT AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Discount Amortization
Unamortized Discount
Date
4/1/-1
$24,924
$375,076
10/1/-1
$18,000
$18,754
$ 754
24,170
375,830
4/1/-2
$18,000
$18,791
791
23,379
376,621
$400,000 - $23,379

27. DISCOUNT AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Discount Amortization
Unamortized Discount
Date
4/1/-1
$24,924
$375,076
10/1/-1
$18,000
$18,754
$ 754
24,170
375,830
4/1/-2
$18,000
$18,791
791
23,379
376,621
The amortization of the discount
continues in the same manner
throughout the remaining life of the bond.

28. DISCOUNT AMORTIZATION
Carrying Value of Bonds
Cash Payment
Interest Expense
Discount Amortization
Unamortized Discount
Date
4/1/-1
$24,924
$375,076
10/1/-1
$18,000
$18,754
$ 754
24,170
375,830
4/1/-2
18,000
18,791
791
23,379
376,621
10/1/-2
18,000
18,831
831
22,547
377,453
4/1/10
18,000
19,728
1,728
3,717
396,283
10/1/10
18,000
19,814
1,814
1,903
398,097
3/31/11
18,000
19,903
1,903
400,000