What is an effective method of interest?
The effective interest method is a way to charge bonds that are sold with a discount. Such sales create the difference between the amount that the company receives in advance and the amount it must repay. The difference is the cost that the company will have to divide throughout the life of the bond for accounting purposes, which is a process known as amortization. An effective method of interest is a method based on a percentage for calculating this division. Bond costs are simply interest rate. For example, if it issues a USD bond (USD) to be repaid for one year for a 5% interest rate, its total cost will be $ 5,000, which will be mentioned as the cost of the company's accounts. If the bond has a lifetime of more years, the total costs over the years can be easily divided into accounting purposes. If the terms of bonds require an annual interest payment, there is no need for split: expenditures can be easily chased every year as they occur.
This simple situation may be more complicated if the bond interest rate is under average available in the whole market with similar bonds. In this case, the company will have to sell a bond under its nominal value to attract all buyers. In such a situation, interest payments are still based on the nominal value of the bond and are listed as an expenditure in a normal way. The problem with this situation is that the difference between the sale price and the nominal value of the bond represents a loss for the company and thus effectively additional costs of lending through the bond to be posted. Since the advantage associated with these costs, namely lending, lasts several years, the company usually wants to divide additional costs throughout the life of the bond.
Therey, the most common way of solving this situation is a method of effective interest. The company calculates the interest payment every yearEra would be payable on the bond if the prevailing market rate was carried from the date on which it was issued. The company then calculates the difference between this amount and the actual amount that pays in interest, which is of course based on the actual nominal value of the bond. This difference is then chalk as additional interest costs. During the life of the bond, these additional interest costs will increase to be equal to the total additional costs obtained by the company by issuing a discount.
The effective interest method should not be confused with the method of calculating the interest rate on the loan or credit agreement. In this context, references to effective rates may cover two elements of the calculation. One of them is to allow a fair comparison between different loans that composed interest at different intervals; This is done by calculating the total Internet in one year. Another importance for the annual comparison of the total amount payable per year, taking into account interest payments and any fees. Requirements and TerminThe oscillation of the calculations of effective interest varies depending on jurisdiction.