What is the Amortized Cost?

Amortized cost is an accounting method in which all financial assets must be reported on a balance sheet at their amortized value which is equal to their acquisition total minus their principal repayments and any discounts or premiums minus any impairment losses and exchange differences.

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How Does the Amortized Costs Work? 

Amortized cost is one category by the IFRS 9. Others are fair value, fair value through comprehensive income, also known as FVOCI, and fair value through profit and loss, also known as FVTPL. Amortized cost applies to debts that meet the following criteria:

• A contractual cash flow of financial assets which are on repayment plans of principals and interests that occur on scheduled dates.
• A business model of companies that own assets to collect their contractual cash flows instead of selling.

Effective interest rate method

Financial assets which meet the criteria and definition of amortized costs such as a bond, which carries a cash flow stream defined by their coupon rate. But over the bond's term period, the interest rate can differ as the market differs. If the market rate goes up and is higher than the noted rate, the bond price in the market is lower than its overall maturity value. The only example in which the market price and the bond's price would be the same is when the interest rate in the market and the face value rate are the same, but this is a rare occasion that this occurs. There are a few requirements any discount or premiums arise when a financial assets carry amortized costs using an interest rate method. Under these methods the interest rates is calculated by adding in the market rate to the bonds carry rate. The difference between the income interest should be recognized as the interest income being paid. This can be used to write off any discounts and premiums so there is a zero balance at the end of the bonds term period.

Example of Amortized Costs

The following is an example that shows how the application of this interest rate method can work: On January 1st, 2015, the company Drive. Inc invests 20,000 company bonds whose value is $100 and their coupon rate is 6% which is payable each year until it matures in 10 years. If the market rate was 6.5% Drive. Inc would then pay $1,928.112 for all the bonds. This is using the discounted bond and cash flow method using the market interest rate. PV(6.5%, 10,-120000-2000000). Drive Inc would then record the acquisition of the bond: Investments are held at an amortized cost of Company X bonds- $2,000,000. Cash(This is the present value of the bond's current cash flow) $1,928,112 Discount on the Company's X bonds $71,888 Drive, Inc reports that the bonds were purchased at $1,928,112 on their balance sheet (this is face value minus any discounts). The discount on the Company X bonds is a subsidiary to the Company X bond assets. The first payment on the interest is due on December 31, 2015, which will total $120,000 (This is =$2,000,000*6%). However, Drive, Inc is unable to record this $120,000 as their interest income because according to the interest method, they also need to account for the discount which was given initially on the bonds. Therefore their record of receipt should depict the following: Cash ($2,000,000* 6%) $120,000 Discount on the Company X Bonds $5,327 Interest income reported($1,928,112*6.5%) $125,327 After the very first payment, the value of the Company X bonds recorded of Drive, Inc shall be shown as follows: Face value of the Company X bonds: $2,000,000 Minus the discount on the Company X bonds on December 31, 2015 ($71,88-$5,327) -$66,561 Total amortized cost of the Company X bonds on December 31, 2015 $1,933,439 The journal notation for the second total interest payment on December 31, 2016 will be as follows: Cash (2,000,000*6%) $120,000 Discount on the Company X Bonds $5,674 Interest Income total (1,933,439 * 6.5%) $125,674

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