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.
