Accounting for deferred financing costs

2.2. Straight-line method for deferred financing cost amortization

Letís look at the amortization of deferred financing costs using the straight-line method:

Straight-line Method

Year

Debt Issue
Cost ($)

Debt Issue
Cost (%)

1

7,500

0.8%

2

7,500

0.8%

3

7,500

0.9%

4

7,500

1.0%

5

7,500

1.1%

6

7,500

1.3%

7

7,500

1.6%

8

7,500

2.1%

9

7,500

3.1%

10

7,500

6.1%

Total

75,000

 

Amortization calculations under the straight-line method are simpler. Each year 1/10th of the deferred financing cost balance is amortized: $7,500 = $75,000 ų 10 and this amount is amortized to expense each year. The deferred financing cost amortization as a percentage of debt balance increases over time because the debt balance decreases while the amortization charge remains the same ($7,500).

In our example, does it matter which method is used by the company? Letís compare results of amortization under the two methods:

Year

Effective Interest
Rate Method
Amortization

Straight-line
Method
Amortization

Difference

1

12,710

7,500

5,210

2

11,699

7,500

4,199

3

10,638

7,500

3,138

4

9,524

7,500

2,024

5

8,355

7,500

855

6

7,126

7,500

(374)

7

5,837

7,500

(1,663)

8

4,482

7,500

(3,018)

9

3,061

7,500

(4,439)

10

1,568

7,500

(5,932)

Total

75,000

75,000

0

The differences donít appear significant; however, the companyís management needs to decide whether these differences are material and then choose either the straight-line method (i.e., allowed alternative method) or the effective interest rate method (i.e., default required method).

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