Angeles University Foundation |Bachelor of Science in Accountancy EFFECTIVE INTEREST METHOD

The goal is to earn the title – CPA

Introduction PFRS 9 Interest paid
 Requires that Premium or Discount on bonds FA x semiannual nominal rate = periodic interest paid
payable should be amortized using the effective
interest method Interest expense
CA x semiannual effective rate = periodic interest
2 kinds of interest rate paid

Nominal Rate Discount amortization

 Coupon or stated rate Interest expense – Interest paid = periodic discount

Effective Rate Carrying amount

 Yield or market rate Preceding CA + discount amortization = periodic CA
Note: if discount add mo lang, if premium deduct mo no bakla?
 Rate that exactly discounts estimated cash
future payments through the expected life of
the bonds payable
Journal Entries:
Jan.1 Cash 964, 540
Discount 35,460
When bonds are sold at FA Bonds Payable 1,000,000
 Effective rate = nominal rate
June 30 Interest Expense 48,227
When bonds are sold at Premium Cash 40,000
 Effective rate < nominal rate Discount 8,227

When bonds are sold at Discount Dec. 31 Interest Expense 48,638

 Effective rate > nominal rate Cash 40,000
Discount 8,638
Effective interest method
 Multiply effective rate by the carrying amount Effective amortization of premium
of the bonds
 The carrying amount of the bonds changes Issue price : 1,049,740
every year because the amount of premium Life of Bonds : 3 years
or discount is amortized periodically Face amount : 1,000,000
Effective rate : 10%
Premium amortization Nominal rate : 12
Nominal interest (nominal rate x FA) xxx Annually : Dec. 31
Less: Effective interest (effective rate x FA) xxx
Premium amortization xxx Schedule of amortization
Date Interest paid Interest Exp Premium CA
Discount amortization 1/1/20 1,049,740
Effective interest xxx 12/31/20 120,000 104,974 15,026 1,034,714
Less: Nominal interest xxx 12/31/21 120,000 103,471 16,529 1,018,185
Discount amortization xxx 12/31/22 120,000 101,815 18,185 1,000,000

Effective amortization of discount Interest paid

FA x annual nominal rate = periodic interest paid
Issue price : 964,540
Life of Bonds : 2 years Interest expense
Face amount : 1,000,000 CA x annual effective rate = periodic interest paid
Effective rate : 10%
Nominal rate : 8% Discount amortization
Semiannually : June 30 & Dec. 31 Interest expense – Interest paid = periodic discount

Schedule of amortization Carrying amount

Date Interest paid Interest Exp Discount CA Preceding CA - premium amortization = periodic CA
1/1/20 964,540 Note: if premium deduct mo lang, if discount add mo no bakla?
6/30/20 40,000 48,227 8,227 972,767
12/31/20 40,000 48,638 8,638 981,405
6/30/21 40,000 49,070 9,070 990,475
12/31/21 40,000 49,525 9,525 1,000,000
VAM | Values - Attitude – Motivation Source: Valix 2019
Angeles University Foundation |Bachelor of Science in Accountancy EFFECTIVE INTEREST METHOD
The goal is to earn the title – CPA
Journal Entries: Date of issuance January 1, 2020
Jan.1 Cash 1,049,740 Maturity date January 1, 2023
Bonds Payable 1,000,000 Period Annually (Jan 1;Dec. 31)
Premium 49,740
PV of 1 at 5% for 6 periods .7426
PV of an ordinary annuity of 1 at 5% for 6 periods 5.0757

Dec. 31 Interest Expense 104,974 5,000,000 x .7426 = 3,731,000

Premium 15,026 300,000 x 5.0757 = 1,522,710
Cash 120,000 Total present value 5,253,710

Market price or issue price of bond payable 5,000,000 x 6% = 300,000

 Is equal to PV of the principal bond liability +
PV of future interest using effective rate or FA 5,000,000
market rate of interest Issue price 5,253,710
Premium 253,710
Present value of bonds payable
Table of amortization
 PV of 1 factor at the effective rate for a Date Interest paid Interest Exp Premium CA
number of interest periods 1/1/20 5,253,710
6/30/20 300,000 262,686 37,314 5,216,396
Present value of the total interest payments 12/31/20 300,000 260,820 39,180 5,177,216
 PV of an ordinary annuity of 1 factor at the 6/30/21 300,000 258,861 41,139 5,136,077
effective rate for a number of interest periods 12/31/21 300,000 256,804 43,196 5,092,881
times periodic nominal interest (kunin mo 6/30/22 300,000 254,644 45,356 5,047,525
interest using nominal rate? Yun, tapos times molang 12/31/22 300,000 252,475 47,525 5,000,000
dyan, keri?)
Illustration 3- Serial Bonds
Illustration 1 FA 3,000,000
FA 4,000,000 Nominal rate 12%
Nominal rate 6% Effective rate 10%
Effective rate 8% Date of issuance January 1, 2020
Date of issuance January 1, 2020 Installment 1,000,000(Dec. 31)
Maturity date January 1, 2024 Period Annually
Period Annually
Present value of 1 at 10%
PV of 1 at 8% for 4 periods .7350 1 period 0.9091
PV of an ordinary annuity of 1 at 8% for 4 periods 3.3121
2 period 0.8264
4,000,000 x .7350 = 2,940,000 3 period 0.7513
240,000 x 3.3121 = 794,904
Total present value 3,734,904 Present value of the bonds payable
Date Principal Interest Total PV PV
payment Payment Payment Factor
4,000,000 x 6% = 240,000
12/31/20 1,000,000 360,000 1,360,000 0.9091 1,236,276
FA 4,000,000 12/31/21 1,000,000 240,000 1,240,000 0.8264 1,024,736
12/31/22 1,000,000 120,000 1,120,000 0.7513 841,456
Issue price 3,734,904
Total PV 3,102,568
Discount 256,096 FA 3,000,000
Premium 102,568
Table of amortization
Date Interest paid Interest Exp Discount CA Interest payment
1/1/20 3,734,904 Dec. 31, 2020 (3,000,000 x 12%) 360,000
12/31/20 240,000 298,792 58,792 3,793,696
Dec. 31, 2021 (2,000,000 x 12%) 240,000
12/31/21 240,000 303,496 63,496 3,857,192
12/31/22 240,000 308,575 68,575 3,925,767 Dec. 31, 2022 (1,000,000 x 12%) 120,000
12/31/23 240,000 314,233 74,233 4,000,000
Table of amortization
Date Interest Interest Premium Principal CA
Illustration 1 Paid Expense Payment
FA 5,000,000 1/1/20 3,102,568
Nominal rate 12% 12/31/20 360,000 310,257 49,743 1M 2,052,825
Effective rate 10% 12/31/21 240,000 205,282 34,718 1M 1,018,107
12/31/22 120,000 101,893 18,107 1M
VAM | Values - Attitude – Motivation Source: Valix 2019
Angeles University Foundation |Bachelor of Science in Accountancy EFFECTIVE INTEREST METHOD
The goal is to earn the title – CPA
Decrease premium on bonds
December 31, 2020 Illustration 1 – Discount and Bond issue cost
Interest paid (3,000,000 x 12%) 360,000
Interest Expense (3,102,568 x 10%) 310,527 On January 1, 2020, an entity issued 3-year bonds
Premium 2020 49,743 with FA of 10,000,000 and 9% stated rate.
CA 1/1/20 3,102,568
The bonds mature on January 1, 2023 and interest
Premium 2020 (49,743)
payable annually on December 31.
Principal payment 12/31/20 (1,000,000)
CA 12/31/20 2,052,825
The bonds are issued at 9,751,210 with an effective
yield of 10% before considering the bond issue cost.
December 31, 2021
Interest paid (2,000,000 x 12%) 240,000
The entity paid bond issue cost of 239,880
Interest Expense (2,052,825 x 10%) 205,282
Premium 2021 34,718
FA 10,000,000
CA 12/31/20 2,052,825 Discount ( 248,790)
Premium 2021 (34,718) Issue Price 9,751,210
Principal payment 12/31/21 (1,000,000) Bond issue cost ( 239,880)
CA 12/31/21 1,018,107 Net proceeds 9, 511,330

Journal entries for 2020 The effective rate is 10% but because of bonds issue
Issuance of bonds: cost, the effective rate must be higher than 10%.
Cash 3,102,568
Bonds Payable 3,000,000 Maghahanap tayo nyan ng rate na kapag nag
Premium 102,568 compute tayo ng PV of 1 ng 10,000,000 for 3 periods
at PV of interest payment ng 900,000 for 3 periods ay
Payment of interest: makaka kuha tayo ng 9,511,330 or mas malapit dyan.
Interest expense 360,000
Cash 360,000 Try natin ang 11%, kase dapat mas mataas sa 10%,
trial and error tayo, interpolation bes.
Amortization of premium:
Premium on Bonds payable 49,743 PV of 1 at 11% for 3 periods .7312
PV of ordinary annuity of 1 at 11% for 3 periods 2.4437
Interest expense 49,743
10,000,000 x .7312 = 7,312,000
Payment of principal 900,000 x 2.4437 = 2,199,330
Bonds Payable 1,000,000 Total PV 9,511,330
Cash 1,000,000
So sakto? Ang bagong effective rate ay 11% 
Effective interest method-Bond issue cost
PFRS 9 Journal entries
 Transaction cost that are directly attributable Issuance of bonds:
to the issue of financial liability shall be Cash 9,511,330
included in the initial measurement of the Discount 488,670
financial liability Bonds Payable 10,000,000
Under the effective interest method, bond issue cost is added to
Transaction cost the discount
 Commission paid to agents
 Advisers Payment of annual interest payment:
 Brokers and dealers Interest expense 900,000
 Levies Cash 900,000
 Transfer taxes and duties
Amortization of discount:
Calculation of effective interest rate Interest expense 146,246
 Shall include all transaction costs, premium Discount 146,246
and discounts
Calculation of effective interest rate Interest expense (9,511,330 x 11%) 1,046,246
Increase discount on bonds Interest paid (10,000,000 x 9%) 900,000
Amortization of discount 146, 246
VAM | Values - Attitude – Motivation Source: Valix 2019
Angeles University Foundation |Bachelor of Science in Accountancy EFFECTIVE INTEREST METHOD
The goal is to earn the title – CPA

Illustration- Interpolation between the 2 The bonds mature on January 1, 2025 and interest
whole numbers for DISCOUNT payable annually on December 31.

On January 1, 2020, an entity issued 5-year bonds The entity paid bond issue cost of 200,000
with FA of 10,000,000 at 95 and 10% stated rate
payable annually. FA 10,000,000
Premium 500,000
The bonds mature on January 1, 2025 and interest Issue Price 10,500,000
payable annually on December 31. Bond issue cost ( 200,000)
Net proceeds 10,300,000
The entity paid bond issue cost of 200,000
Bond issue cost is “netted” against the premium on
FA 10,000,000 bonds payable
Discount ( 500,000)
Issue Price 9,500,000 Cash 10,300,000
Bond issue cost ( 200,000) Bonds payable 10,000,000
Net proceeds 9, 300,000 Premium 300,000

The nominal rate is 10% but because of bonds issue The nominal rate is 10% but because of bonds issue
cost, the effective rate must be higher than 10%. cost, the effective rate must be lower than 10%.

Interpolation of 11% Interpolation of 9%

PV of 1 .5935 PV of 1 .6499
PV of interest payments 3.6959 PV of interest payments 3.8897

10,000,000 x .5935 = 5,935,000 10,000,000 x .6499 = 6,499,000

1,000,000 x 3.6959 = 3,695,900 1,000,000 x 3.8897 = 3,889,700
Total PV 9,630,900 (lower) Total PV 10,388,700 (lower)

Interpolation of 12% Notice: Pag bumababa ang interpolation sa effective rate,

PV of 1 .5674 tumataas ang PV, sa 9% mataas ang PV natin sa 10,388,700. So
PV of interest payments 3.6048 in conclusion, dapat mataas sa 9% pero mababa sa 10%
NP – 9%
10,000,000 x .5674 = 5,674,000 10% - 9%
1,000,000 x 3.6048 = 3,604800
Total PV 9,278,800 (higher) 10,300,000 – 10,388,700
10,000,000 – 10,388,700
Notice: Pag tumataas ang interpolation sa effective rate,
bumababa ang value, sa 11% mataas ang PV natin sa 9,278,800 88,700
tapos sa 12% naman mababa ang PV natin sa 9, 278,800 so 388,700
para dito, ang conclusion is mas mataas sa 11% pero mas baba
sa 12%.
=.23 + 9% = 9.23%
NP – 11%
12% - 11%
9,300,000 – 9,630,900
9,278,000 – 9,630,900

330,900
352,100

=.94 + 11% = 11.94%

Illustration- Interpolation between the 2

whole numbers for PREMIUM

On January 1, 2020, an entity issued 5-year bonds

with FA of 10,000,000 at 105 and 10% stated rate
payable annually on Dec. 31
VAM | Values - Attitude – Motivation Source: Valix 2019