Financial Accounting and Reporting CPA Practice Exam 2025 – Complete Prep Resource

The correct answer, which notes that the amortization of a bond premium is considered an advance payment of interest to bondholders, reflects the nature of how premiums are accounted for in bond transactions.

When bonds are issued at a premium, it means they are sold for more than their face value. This occurs because the stated interest rate on the bond is higher than the prevailing market interest rates. Consequently, the excess amount received (the premium) essentially represents additional interest that the bond issuer will not have to pay in future cash flows.

As the premium is amortized over the life of the bond, it effectively reduces the interest expense recognized by the issuer on the income statement. The premium is systematically allocated, thus lowering the bond’s effective interest expense to align it more closely with the market rates. This amortization reflects the advance interest received because the bondholder does not receive the full cash flow expected in an environment where they might receive lower interest payments elsewhere.

The other options do not accurately describe the nature of bond premium amortization. The statement regarding increases to interest expense is incorrect; the amortization actually decreases the reported interest expense. Marketable security valuation typically pertains to the market value of securities rather than the accounting treatment of bond premiums. Lastly, character