 When bonds are issued at premium or discount prices, the premium or discount balance must be amortized over the life of the bond. This means that the balance in those types of accounts must be written off to interest expense over the life of the bond. There are two methods of amortizing premium and discounts. The effective interest rate method and the straight line method, which is not GAP approved, unless the results are similar to the effective interest rate method. The funny thing is, because interest rates in the U.S. have been so low for over 30 years, many companies do use the straight line method. The low and minimal fluctuation in interest rates have caused the results of the two methods to be similar enough that many companies are choosing the straight line method. Recall how to calculate interest. It is principal times rate times time. However, bond interest is more complicated because we have two rates and most bonds pay interest semi-annually, so does that impact time? Well, let's find out. The stated rate is the interest rate we use to calculate the amount of interest paid to the bondholders. That is the interest rate stated on the face of the bond, and really it's its only purpose. Since most bonds pay interest semi-annually, time is six months. When companies issue bonds at premiums or discounts, the amount of interest expense and the amount of interest payable, or cash, are going to be different. This is due to the premium or discount amortization that occurs each time an interest payment is made. The straight line method amortizes premiums and discounts evenly over the life of the bond, whereas the effective interest rate method matches interest expense more closely to the bond carrying value. This is why it is the method approved by GAP, by the way. This video will focus on recording interest using the straight line method. The formula to amortize a premium or discount is the balance divided by the number of interest payment periods. Now make sure you don't confuse that with years. If it's a five-year bond, but it pays interest semi-annually, then the number of interest payment periods is ten, not five. So let's look at a typical example and pull out the key information needed to record interest expense. Yazoo issues $100,000 five percent three-year bonds payable at 98. The bonds pay interest semi-annually. So the issue price is $98,000, meaning the discount balance is $2,000. The interest payment using the formula principle times rate times time is $2,500 every six months. The amount of discount amortization will be $333 every time we make an interest payment. The journal entry is as follows. We debit interest expense for $2,833, but this number is a plug number. So just enter the account name initially and then we'll move on to the credits. The discount on bonds payable has a normal debit balance, so we need to credit the amount for the amount of amortization, which is $333. The cash is credited for the amount of interest payment to the bondholders, which is $2,500. Since the total credits equal $2,833, this is the amount that we would debit interest expense. Since this is the straight line method, this exact journal entry would be made every six months over the next three years. Even though the journal entry repeats with the straight line method, some companies still prepare an amortization schedule. Here you can see the amounts of interest payment, interest expense, discount amortization, the discount balance, and the bond carrying amount. Using the table makes recording the journal entries really easy. And it's also helpful to verify the account balances are correct, like we could do here after interest payment number three. And here is the balance sheet presentation of this example. Okay, so let's quickly look at a premium example. Yazu issues 100,005% three-year bonds payable at $103, the bonds pay interest semi-annually. So the issue price is $103, meaning the premium balance is $3,000. The interest payment used in the formula is principal times rate times time, and that's $2,500 every six months. The amount of premium amortization will be $500 each time we make an interest payment. The journal entry then is followed. Interest expense is debited for $2,000. Again, this number is just plugged, so you may want to just put the account name there and then move on to the credits initially. The premium on the bonds payable has a normal credit balance, so we need to debit the amount for the amount of amortization, which is $500. Then cash is credited for the amount of interest payment to the bondholders, which is $2,500. In order to make this journal entry balance, we would debit interest expense for $2,000. Here is the amortization table. Again, we would use this to get data for the journal entry and to verify the balance sheet reporting, which you can see here.