How to Amortize a Bond Premium

Amortizing a bond premium involves gradually reducing the premium paid on a bond over its life. Bond premium is the amount paid for a bond that exceeds its face value, or par value. This premium can be amortized over the life of the bond, reducing the effective interest rate paid by the bondholder.

Here are the steps to amortize a bond premium:

1. Calculate the premium: Determine the premium paid for the bond by subtracting its face value from the purchase price. For example, if a bond has a face value of $1,000 and was purchased for $1,050, the premium is $50.

2. Determine the bond's term: Determine the length of time until the bond matures, which will be used to calculate the number of periods over which to amortize the premium.

3. Calculate the periodic amortization amount: Divide the bond's premium by the number of periods until maturity. For example, if the bond premium is $50 and the bond has five years until maturity, the periodic amortization amount would be $10 per year.

4. Adjust the bond's carrying value: Subtract the periodic amortization amount from the bond's carrying value each period. The carrying value is the bond's original purchase price plus any accrued interest, minus any amortized premium or discounts. For example, if the bond was purchased for $1,050 and the periodic amortization amount is $10, the carrying value after the first period would be $1,040.

5. Calculate interest expense: Calculate interest expense for each period based on the carrying value of the bond. This is the amount of interest that will be paid to the bondholder.

6. Record amortization and interest expense: Record the periodic amortization amount and interest expense on the company's financial statements each period. This will reflect the reduced effective interest rate paid by the bondholder over the life of the bond.

By following these steps, the bond premium can be gradually amortized over the life of the bond, reducing the effective interest rate paid by the bondholder.