EFFECTIVE INTEREST METHOD: Amortized Cost, FVOCI & FVPL

Two kinds of interest rate:

1. Nominal Rate – coupon rate/stated rate
2. Effective rate – yield rate/market rate which is the actual or true rate of interest
EFFECTIVE INTEREST METHOD
- Simply requires the comparison between interest earned/interest income & interest
received
 IE/II IR = Premium amort. or Discount amort.
 IE/II = effective rate x carrying amount
 IR = nominal rate x face amount
Effective rate vs Nominal Rate

Cost = Face Value ER=NR

Because premium is a loss on the part of the

Bond Premium ER<NR
bondholder
Because discount is a gain on the part of the
Bond Discount ER>NR bondholder

Bond Investment FVOCI

- when the business model includes selling the financial asset in addition to collecting
contractual cash flows.
NOTE: Discount amortization must still be in accordance with the effective interest table of
amortization regardless of the change in market value.
NOTE: The cumulative gain or loss previously recognized in OCI is reclassified to profit or loss on
disposal of the investment
Fair value option
- Investment in bonds can be designated without revocation as measured at fair value
through profit or loss even if the bonds are held for collection as a business model
- All changes in fair value are recognized in profit or loss. Accordingly, any transaction cost
incurred is an outright expense.
- The interest income is based on the nominal interest rate rather than effective interest
rate.