Amortization of bond premium is the mirror image of amortizing a bond discount: it is the process of systematically moving the balance in Premium on Bonds Payable out of bond interest expense over the remaining life of the bond. A bond sells at a premium, above its face value, when its stated coupon rate is higher than the market interest rate available on comparable bonds at the time of issuance, meaning investors are willing to pay extra upfront for the above-market coupon they will receive going forward.
Because the issuer received more cash upfront than it must eventually repay at maturity, the extra amount received effectively offsets part of the cash coupon interest it will pay over the bond's life. Amortizing the premium recognizes that offset gradually, period by period, rather than all at once, so that reported interest expense each period comes in below the cash coupon interest actually paid, with the gap equal to that period's premium amortization.
How the amortization is recorded
Each period, the journal entry debits Premium on Bonds Payable and credits Bond Interest Expense, reducing both the premium balance and the amount of interest expense reported for the period. Since the premium is added to the face amount of Bonds Payable to determine the bond's carrying value, amortizing the premium also gradually reduces the bond's carrying value back down toward its face amount, reaching exactly the face amount by maturity.
Straight-line versus effective interest method
As with discount amortization, a straight-line approach amortizes an equal dollar amount of premium each period, while the effective interest rate method applies a constant rate to the bond's declining carrying value, producing an amortization pattern that more accurately reflects the bond's true economics and is the method GAAP requires when the difference is material.
Why investors and analysts track it
A bond issued at a premium effectively returns part of the investor's own money back to them disguised as above-market coupon payments, which is why sophisticated bond investors look past the stated coupon rate to the bond's yield to maturity, which already accounts for premium amortization, rather than judging a bond's attractiveness from its coupon alone. On the issuer's side, premium amortization is one of the reasons a company's reported interest expense on its income statement can differ meaningfully from the cash interest actually disbursed in the same period.
A simple worked example
A company issuing $1,000,000 face value of bonds for $1,050,000 records a $50,000 premium. Amortizing that premium evenly over a 10-year term reduces reported bond interest expense by $5,000 each year below the cash coupon actually paid, and by maturity the premium has been fully amortized away, leaving the bond's carrying value exactly equal to the $1,000,000 that must be repaid.
A bond sells at a premium when its coupon rate is higher than the market interest rate available on comparable bonds at the time it is issued or resold. Investors are willing to pay more than face value precisely because the above-market coupon payments they will receive make up for the extra amount paid upfront; the premium amortization simply recognizes, period by period, that part of each cash interest payment is really a return of the investor's own excess purchase price rather than pure interest income. This is also why bond premium amortization is tracked separately for tax purposes, since a bondholder, not just the issuer, generally amortizes a purchased premium against their own taxable interest income over the bond's remaining term.