# Bond (Fair Value Reporting) and interest expenses

Dear all,

I understand for effective interest rate, the interest expense is obtained by :

’ Bond’s YTM @ maturity ’ X ’ Beginning balance of bond ’

For firms that uses _ fair value reporting _ option, how is interest expense computed?

Thank you.

Cheers,

Ernest

I think interest expense would simply be the interest payment on the bond’s initial cost i.e. if the bond was issued for \$10m and the applicable interest rate at that date was 10% interest expense would be \$1m every year. However, the actual value of the bond would be subject to movements under fair value and any gains and losses would go through the income statement.

And by the way when calculating interest expense under the historical cost model I think it isn’t the YTM at maturity that is used, it is the interest rate at the time the bond was issued.

True that; under effective interest rate method, periodic interest expense calculated as follows:

’ Bond’s YTM @ issuance’ X ’ Beginning bond value’

Hi guys,

As mentioned above, interest expense using the fair value method is calculated based on the actual amount of interest payable

Hope this helps, Seth

Thanks Seth for the reply. Can you elaborate further what do you mean by “_ actual amount of interest payable _”. As far as I understand, if effective interest rate method has been used, interest is always based on the bond yield @ issuance mutiply by the beginning value of the bond liabilities.

However, if fair value reporting is used, the beginning value will be always last fair value used (previous closing), in this case I dont think it will be correct to use bond yield @issuance to mutiply the beginning value to obtain interest expense for the period.

Thanks again!

Cheers,

Ernest

Sorry my answer wasn’t very informative - interest expense is based on the interest paid +/- the amortization of the bond discont or premium, which is essentially the difference between FV/PV at inception of the bond versus the face value. The gain/loss from chages in FV are recognized as unrealized gains/losses separatley in P&L

My apologies if that sounded misleading!

Hi Seth,

Really thanks for your help! I understand from one of the charterholder here that for fair value reporting, there isn’t any amortization discounts/premiums.

In addition, I think the difference between FV/PV at inception of the bond vs face value of the bond (during the date of valuation) will give the difference = unrealized gain/losses in the P&L.

Ernest, there are no unrealized gains/losses at increption of any financial instrument, they arise due to changes in the yield vs market rate over time. The difference between PV/FV and face value is a discount or premium,

Yeah, I think I phrase it wrongly, haha.

What I’m trying to say is - Unrealized gains/losses will be recongised (under fair value reporting) from time to time by comparing between:

1. Bond liability value @ issuance AND
2. Fair value of the bond liability (during next financial close)

During bond issuance, the initial value to be recorded is the proceeds (obtained from bond issuance). Once again, it is dependent on the governing accounting standards if _ issuance costs _ are in consideration:

1. IFRS - proceeds obtained need to be deducted for issuance cost before it becomes the initial bond liability value
2. U.S. GAAP - proceeds obtained will be the initial bond liability value on the balance sheet, the issuance cost is considered seperately i.e. capitalized as deferred charges.

I’ve never seen an explicit statement about how interest expense is computed when bonds issued are reported at fair market value. If I had to guess, I’d say it’s just the annual coupon payments.

It’s safe to believe that it won’t appear on the exam.

Thanks S2000magician and Seth for all the help along the way in this threat.

Cheers,

Ernest