Can anyone please clarify why for a bond issued at a premium, interest expense decreases over time (and vice versa)? My logic is that because the bond is issued at a premium, the balance sheet value will decrease each period as the premium is amortized and the bond gets closer and closer to par value. Since interest expense is the market rate at issuance multiplied by the balance sheet value, the later variable in the formula is decreasing over time. Therefore interest expense will be lower and lower over time. I’m pretty sure thats it, but for some reason this concept will not stick with me. Thanks for viewing the thinking out loud. -Greg
Yeah, you pretty much got it right there.
by George he has it !
One question though - CFF is decreased by the amortized premium for premium AND discount bonds, right? Also, why is CFF being decreased at all by this - isn’t this a noncash expense? (Theoretically speaking)
Hi Brafique. I think the coupon payment is recorded in CFO (US GAAP) or CFO/CFF (IFRS). You are correct, amortization is a non cash expense and is therefore not included in cash flow. Please correct me if I am wrong… which I may be…
^ Ignore my earlier post, I was mistakenly thinking of leases rather then bonds. For a capital lease, the PRINCIPAL REPAYMENT lowers CFF, and it is calculated in much the same way as above. For some reason, I get the two mixed up, although I know they are totally different things!