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How do you amortize using effective interest method?

As per IFRS 9 (IAS 39) some financial assets are required to be measured at amortized cost using effective interest method. Can anyone tell me what this in fact is & how it is calculated?

asked Jan 27, 2013 in IFRS 9 - Financial Instruments by Russie (2,930 points)
retagged Feb 16, 2013 by Mysio


1 Answer

+1 vote

Before moving into effective interest method (also called "present value amortization"), it is good to know what "effective interest rate" means.

Effective interest rate is the interest rate that can be applied on the carrying amount of a financial asset to create a constant yield up to the maturity date.

For example, let's assume a bond which costs $100,000 now with a maturity value $121,000 in two years time. the effective interest rate of this bond's yeild would be 10%. This would be found as follows:
$100,000 x (1 + 0.1) = $110,000
$110,000 x (1 + 0.1) = $121,000

This means, if you use a discount rate of 10%, the NPV of a cash flow of $121,000 due in 2 years' time is equal to the initial cost of $100,000.

However, in some complicated cases an exact algebraic solution is not easy to find, and various approximation methods can be applied. Practically, most people use MS Excel IRR funtion (internal rate of return) to calculate the effective interest rate (you can find many example calculations on the internet)

Then, the carrying amount of the bond x effective interest rate = amortization

Was this answer helpful? then please share it with others.

answered Feb 2, 2013 by Rimos (1,520 points)
edited Nov 26, 2013 by Mysio

Frequently asked questions about International Financial Reporting Standards (IFRS)

What is IFRS? - IFRS is a set of Accounting standards developed by the IFRS Foundation which is an independent, not-for-profit organization working in the public interest.

What is IASB? - IASB means the International Accounting Standards Board, which is the independent, accounting standard-setting body of the IFRS Foundation. IASB has 14 Board members who are selected as a group of experts with a mix of experience of standard-setting, preparing and using financial statements together with academic excellence. The IASB was founded on April 1, 2001 as the successor to the International Accounting Standards Committee (IASC). 

What is the difference between IFRS & IAS? - International Accounting Standards Committee (IASC) was responsible for developing International Accounting Standards (IAS) before 2001. IASC was renamed as The International Accounting Standards Board (IASB) in 2001. Consequently the standards issued thereafter are known as IFRS. Therefore all the standards issued after 2001 are IFRS. The previous IAS are still valid but are being gradually superseded by new IFRS.

What is the difference between IFRS Interpretations Committee & Standing Interpretations Committee? - IFRS Interpretations Committee is the committee which makes interpretations on both IAS and IFRS issues. Standing Interpretations Committee (SIC) was the committee which made interpretations on IAS. IFRS Interpretations Committee replaced the former Standing Interpretations Committee (SIC) in March 2002. Interpretations of IFRS Interpretations Committee are known as IFRIC while the Interpretations of the Standing Interpretations Committee (SIC) were known as SIC.

Which countries are using IFRS? - IFRS is used in more than 120 countries including the European Union, India, Australia, Malaysia, Pakistan, Russia, South Africa and Japan. However USA has not yet adopted IFRS.

What are the advantages of IFRS? - Global application of IFRS will make the comparison of financial statements easier for foreign investors which is advantageous for companies to attract investors.

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