Definition§
Unamortized premiums on investments refer to the portion of the amount paid over the par value (for bonds or preferred stock) or the market value (for common stock) of a security that has not yet been expensed. When an investor pays more than the face or market value of a security, the excess amount is considered a premium. This premium is amortized over the life of the security, reducing the investor’s interest income over that period.
Key Points§
- Bonds and Preferred Stock:
- Premiums are amortized over the remaining life of the bond/preferred stock.
- This reduces the amount of interest income the investor recognizes each period.
- Common Stock:
- The premium represents the amount paid over the current market value.
- Typically associated with acquiring stocks at a premium due to perceived future value.
Examples§
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Bond Purchase at a Premium: An investor buys a $1,000 bond at $1,100. The additional $100 is a premium. If the bond has a 10-year maturity, the $100 premium is amortized over 10 years, reducing the investor’s interest income by $10 annually.
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Preferred Stock Purchase: If preferred stock with a par value of $50 is purchased at $60, the $10 premium will be amortized over its life, diminishing the dividend income recognized.
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Common Stock Purchase: An investor might buy common stock with a current market value of $80 at $100 due to the anticipated growth of the company. The additional $20 is not immediately expensed but recognized as part of the cost basis for the stock.
Frequently Asked Questions§
Q1: Why are premiums on bonds amortized?
A1: Amortizing the premium on bonds helps to spread out the cost over the period the bond is held, ensuring a more accurate reflection of income from the investment.
Q2: How does amortization affect financial statements?
A2: Amortization of the premium reduces interest income reported on the income statement and the carrying amount of the investment on the balance sheet.
Q3: Is the amortization of premiums mandatory?
A3: Yes, under generally accepted accounting principles (GAAP), premium amortization is required for bonds to provide a true picture of the investment’s earning over time.
Related Terms§
- Par Value: The face value of a bond or stock.
- Market Value: The current price at which a security can be bought or sold.
- Amortization: The process of gradually writing off the initial cost of an asset.
- Bond Premium: The amount paid over the par value of a bond.
- Cost Basis: The original value of an investment for tax purposes.
Online Resources§
Suggested Books for Further Studies§
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“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- An in-depth guide on various accounting principles including investment premiums.
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“Accounting for Investments” by R.V.Rao
- Key insights into the complexities of investment accounting including amortization and premiums.
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“Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
- Covers fundamental concepts of finance including how premiums on investments affect corporate finance.
Fundamentals of Unamortized Premiums on Investments: Financial Accounting Basics Quiz§
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