Financial Accounting and Reporting-CPA Practice Exam

What happens to interest expense in the reporting period when accounting for bond premiums?

1. It results in a lower recorded interest expense.

2. It remains unchanged from the coupon payment.

3. It increases due to additional interest payments.

4. It must be deferred until maturity.

The correct answer is: It results in a lower recorded interest expense.

When bonds are issued at a premium, the amount received is greater than the face value of the bonds. This premium affects the interest expense reported in the financial statements. The bond premium is amortized over the life of the bond, typically using the effective interest rate method or the straight-line method. As the premium is amortized, it serves to reduce the amount of interest expense recognized in the reporting period. This is because the total interest expense includes the cash paid for interest minus the amortization of the premium. Therefore, even though the cash interest payment (the coupon payment) remains the same, the recorded interest expense is lower than this payment due to the amortization of the bond premium. This means that the interest expense recognized in the financial statements will decrease as the premium is amortized over the bond's life, resulting in a lower recorded interest expense in the reporting period.