Straight-Line Method of Amortization
The Straight-Line Method of Amortization – Definition
The straight-line method of amortization simply allocates the discount evenly over the life of the bond. There is a constant interest charge each period. An entry is usually made on every interest date, and if necessary, an adjusting journal entry is made at the end of each period to record the discount amortization.
Application of the Straight-Line Method
To demonstrate the application of the straight-line method, we will return to the Valenzuela Corporation example. In this case, the discount of $7,024 will be amortized over 10 interest periods at a rate of $702 per interest period ($7,024 / 10). The total interest expense for each period is $6,702, consisting of the $6,000 cash interest and the $702 amortized discount. Another way to calculate the $6,702 is to divide the total interest cost, $67,024, as shown above into the 10 interest periods of the bond’s life, journal entry at July 1, 2020, and each interest payment date thereafter is:
As the bonds approach maturity, their carrying value increases, and the result of this and subsequent entries is to reflect this increase in the carrying value of the bonds. This is because of the discount account, which is offset against bonds payable in arriving at the bonds’ carrying value, is decreased each time a credit entry is made to that account. To Illustrate, the relevant T accounts and a partial balance sheet as of July 1, 2020, are presented next:
In each interest period, the bond’s carrying value will be increased by $702, so that by the time the bond matures, the balance in the Discount on Bonds Payable account will be zero, and the bond’s carrying value will be $100,000. The below Exhibit ‘B’ presents an amortization schedule for this bond on the straight-line method. Thus, when the company repays the principal it makes the following entry: