Certified Government Financial Manager (CGFM) Practice Exam

In financial reporting, bond premiums or discounts are amortized over the life of the bond. This treatment ensures that the financial statements accurately reflect the true cost of borrowing and the effective interest expense over time.

When a bond is issued at a premium, the issuer receives more cash than the face value of the bond. This premium is amortized as a reduction of interest expense, allowing the issuer to report a smaller interest expense than the cash interest paid to bondholders. Conversely, if a bond is issued at a discount, the issuer receives less cash than the face value, and the discount is amortized as an additional interest expense over time. This process aligns the actual cost of borrowing with the bond's issuance and allows for a more accurate reflection of the financial position and results of operations in the entity's financial statements.

Amortization of bond premiums and discounts is typically done using the effective interest method or straight-line method, depending on the entity's accounting policies. This systematic approach provides a clearer view of how interest affects financial performance across the bond's life, making it essential for accurate financial reporting.