Accounting for deferred financing costs
2.1. Effective interest rate method for deferred financing cost amortization
The schedule of the deferred financing cost amortization using the effective interest rate method is presented below:
Effective Interest Rate Method |
||
Year |
Debt Issue |
Debt Issue |
1 |
12,710 |
1.27% |
2 |
11,699 |
1.27% |
3 |
10,638 |
1.27% |
4 |
9,524 |
1.27% |
5 |
8,355 |
1.27% |
6 |
7,126 |
1.27% |
7 |
5,837 |
1.27% |
8 |
4,482 |
1.27% |
9 |
3,061 |
1.27% |
10 |
1,568 |
1.27% |
Total |
75,000 |
As you can see, over the loan term, $75,000 of deferred financing costs is amortized. The rate of amortization of deferred financing costs in relation to the debt balance for respective years remains consistent, 1.27%. This rate can be calculated as the deferred financing costs amortization for a year divided by respective debt balance at the beginning of that year. For example, at the end of the first year, the deferred financing costs amounted to $12,710. The debt balance at the beginning of that year was $1,000,000. So, the rate was 1.27% = $12,710 ÷ $1,000,000.
For those who would like to know how the deferred financing cost amortization was calculated, read this paragraph. First, take the total of all debt balances over the loan term; $5,900,915. Then, for each year, divide the debt balance at the beginning of the year by the total of all debt balances. For example, for the first year, the result will be 0.16946 = $1,000,000 ÷ $5,900,915. For the second year, the result will be 0.15599 = $920,495 ÷ $5,900,915. And so forth. Finally, multiply the results from the preceding step by the total deferred financing costs. So, for the first year, the deferred financing cost amortization will be: $75,000 x 0.16946 = $12,710 (rounded). For the second year, the deferred financing cost amortization will be: $75,000 x 0.15599 = $11,699 (rounded). Same logic applies to years 3-10. Note: There may be other ways to calculate the amortization amounts under the effective interest rate method.