Definition:

Amortization of premium is the process of systematically reducing the carrying value of a bond that was purchased at a premium. A premium occurs when a bond is purchased for a price higher than its face value.

Key points about amortization of premium:

  • Bond premium: A bond premium is the difference between the purchase price of a bond and its face value.
  • Interest expense: Amortization of premium reduces the interest expense recognized on the bond.
  • Carrying value: The carrying value of a bond is its face value minus the unamortized premium.
  • Straight-line method: The straight-line method is a common method for amortizing premium.

Why is amortization of premium important?

  • Interest expense: Amortization of premium reduces the interest expense recognized on the bond, which can improve a company’s profitability.
  • Bond valuation: Amortization of premium affects the carrying value of the bond, which is used to calculate its fair value.
  • Tax implications: Amortization of premium can affect a company’s tax liability.

In essence, amortization of premium is the process of systematically reducing the carrying value of a bond purchased at a premium, which can have a positive impact on a company’s financial statements.