When using the effective-interest method of amortizing a discount or premium, interest expense is calculated by multiplying the:
A) contract interest rate by the face value of the bonds
B) effective-interest rate by the carrying value of the bonds
C) effective-interest rate by the face value of the bonds
D) contract interest rate by the carrying value of the bonds

Question

Quizplus · Accepted Answer

The effective-interest method of amortizing a discount or premium involves calculating interest expense based on the carrying value of the bonds multiplied by the effective-interest rate. This method takes into account the changing carrying value of the bonds over time as the discount or premium is amortized, and results in a more accurate reflection of the cost of borrowing for the company. Therefore, choice B is the correct answer. 
 
The effective-interest method, also known as the interest method or effective rate method, is a way of amortizing the bond discount or premium that results in a constant rate of interest over the life of the bond. The interest expense for each period is determined by applying the effective interest rate (which is the market rate at the time the bonds were issued) to the carrying value (book value) of the bonds at the beginning of the period. The carrying value is the face value adjusted for any unamortized premium or discount and any unamortized bond issuance costs.

When Using the Effective-Interest Method of Amortizing a Discount or Premium