Explain the difference between the straight-line method and the effective interest method when amortizing bond discounts and premiums.
What will be an ideal response?
The straight-line method involves dividing the total premium or discount by the number of interest payment periods. While the amount of amortization is the same each period, the effective interest changes each period because the carrying value of the bond issue changes. The effective interest method, though more complex, applies a constant interest rate to the carrying value. The interest expense is first computed by multiplying the carrying amount of the bond issue by the effective rate of interest. The amount to be amortized is computed by comparing the interest expense to the cash interest. Accordingly, the interest expense and the amount of discount or premium to be amortized change each time.
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