Effective-Interest Method for Bonds: Worked Example
Worked Example · Intermediate Accounting
Bonds Payable: the Effective-Interest Method
A bond’s issue price is the present value of its cash flows at the market (yield) rate. When the market rate is above the coupon rate it sells at a discount that amortizes to par by maturity. Interest expense = carrying value × market rate — never the coupon. Bonds pay semi-annually, so halve both rates and double the periods.
Worked example (discount, effective interest)
Issue a $100,000, 8% bond, 2 years, interest semi-annual, when the market rate is 10%. Coupon = 100,000 × 8%/2 = $4,000; market rate = 5% per period; N = 4. Issue price = PV of four $4,000 coupons + $100,000 at 5% = $96,454 (a $3,546 discount).
| Period | Opening CV | Interest (5%) | Coupon | Amort. | Closing CV |
|---|---|---|---|---|---|
| 1 | 96,454 | 4,823 | 4,000 | 823 | 97,277 |
| 2 | 97,277 | 4,864 | 4,000 | 864 | 98,141 |
| 3 | 98,141 | 4,907 | 4,000 | 907 | 99,048 |
| 4 | 99,048 | 4,952 | 4,000 | 952 | 100,000 |
| Cash | 96,454 | |
| Discount on bonds payable | 3,546 | |
| Bonds payable | 100,000 |
Building a schedule for your own bond? A tutor can walk your own numbers — book a session.
The mistake that costs marks
Using the coupon rate for interest expense, or forgetting to halve the rate and double the periods for semi-annual bonds. Expense is always carrying value × market rate per period; the coupon only sets the cash paid.
Frequently asked questions
Discount vs premium?
Market rate above coupon → discount (price below par). Market rate below coupon → premium (price above par).
Effective-interest vs straight-line?
IFRS requires effective-interest; ASPE permits straight-line. Effective-interest gives a constant rate, not a constant dollar amount.
Why divide the rate and multiply the periods?
Semi-annual bonds pay twice a year, so each period carries half the annual rate and there are twice as many periods.
Amortization schedules on your exam?
Work discount and premium bonds 1-on-1 with a tutor.
Book a session →
