what is amortised cost

Amortised cost is a way of carrying a financial asset or liability — typically a bond or loan — on the balance sheet, where the value gradually moves from what you paid toward what it will eventually settle at. A bond bought below its face value is recorded at that lower price and written up over its life toward face value, while one bought above face is written down. The adjustment each period is driven by the effective interest method, so the carrying amount reflects the price paid plus the interest earned but not yet received in cash.

what is the effective interest method

The effective interest method recognises interest income or expense at a constant rate — the effective interest rate — applied to the carrying amount of the instrument, rather than simply booking the stated coupon. The effective rate is the yield that makes the present value of all future cash flows equal to the price paid, so it captures both the coupon and any discount or premium on purchase. As a result the interest reported in the accounts is the true economic yield, which can differ noticeably from the headline coupon.

amortised cost vs fair value

Amortised cost carries an instrument at its purchase price adjusted for interest, ignoring day-to-day market price moves, whereas fair value marks it to its current market price each reporting date. The choice matters most for banks and NBFCs: bonds held at amortised cost do not show gains or losses as interest rates move, so a rate spike can leave large unrealised losses invisible on the balance sheet, while the same bonds held at fair value would reveal them immediately. How a lender classifies its investments therefore shapes how rate risk appears — or does not — in its accounts.

why is a bond’s book value not its face value

Because a bond is rarely bought exactly at face value: if you pay less than face, you are compensated for a coupon lower than the market yield, and that discount is earned back gradually as the carrying value rises toward face by maturity. The book value at any point is the price paid plus the interest accrued under the effective interest method, so it sits between the purchase price and the face value and converges on face only at maturity. Face value is what it repays; amortised cost is what it is worth on the books along the way.

Amortised cost and the effective interest method explained

A company buys a bond that will repay ₹100 at maturity, but pays only ₹92 for it today because its coupon is below the going market rate. What value goes on the balance sheet — the ₹92 paid, or the ₹100 it will repay? The answer is neither, and both: it starts at ₹92 and drifts up to ₹100 over the bond’s life. That drift is amortised cost.

Why the interest booked is not the coupon

Under the effective interest method, the interest recognised each period is the effective yield times the current carrying amount — not simply the coupon the bond prints. On a bond bought at a discount, that means the accounts book more interest than the coupon actually pays in cash, with the extra representing the discount being earned back as the value climbs toward face. The reported interest reflects the true return on the price paid, which is why it can sit above or below the headline coupon.

Worked example

A discount bond, amortising up

Illustrative — ₹100 face bond bought at ₹92

Paidbelow face, because its coupon lags the market yield₹92

Effective ratethe yield that equates ₹92 to all future cash flowshigher than the coupon

Interest bookedmore than the cash coupon; the excess lifts the carrying valueeffective rate × ₹92

At maturitythe ₹8 discount fully earned back₹100

The bond’s book value rises from ₹92 toward ₹100 across its life as the discount is amortised, and each period’s reported interest exceeds the coupon by the amount of that write-up. The face value is only reached at the end — in between, amortised cost is the honest carrying figure, and the effective rate, not the coupon, is the true yield.

Check yourself

A bank holds government bonds at amortised cost. Interest rates jump sharply. What is the effect on its reported balance sheet?

Simple bhasha mein

Bond ki book value ≠ face value

Bond ₹100 pe repay hoga, par aaj ₹92 mein mila (coupon market rate se kam). Balance sheet pe kya — ₹92 ya ₹100? Dono: ₹92 se shuru, dheere-dheere ₹100 tak — yahi amortised cost. Effective interest method se interest book hota hai (asli yield × carrying amount), na ki sirf coupon — isliye discount bond pe accounts coupon se zyada interest dikhate hain, extra wahi discount jo wapas kamaaya ja raha hai. Kyun important: bank/NBFC bonds amortised cost pe rakhein toh rate badhne pe unrealised loss balance sheet pe dikhta hi nahi — fair value pe hota. Lender dekho toh check karo kitna amortised cost pe hai.

What to remember

Amortised cost carries a bond at the price paid, adjusted toward face value over its life.
The effective interest method books interest at the true yield on the carrying amount.
So reported interest differs from the coupon when a bond is bought at a discount or premium.
Amortised-cost assets ignore market price moves, unlike fair-value ones.
For banks and NBFCs that can hide unrealised rate losses — check the classification.

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Common questions

Short, direct answers to what people ask about this topic.

what is amortised cost: Amortised cost is a way of carrying a financial asset or liability — typically a bond or loan — on the balance sheet, where the value gradually moves from what you paid toward what it will eventually settle at. A bond bought below its face value is recorded at that lower price and written up over its life toward face value, while one bought above face is written down. The adjustment each period is driven by the effective interest method, so the carrying amount reflects the price paid plus the interest earned but not yet received in cash.
what is the effective interest method: The effective interest method recognises interest income or expense at a constant rate — the effective interest rate — applied to the carrying amount of the instrument, rather than simply booking the stated coupon. The effective rate is the yield that makes the present value of all future cash flows equal to the price paid, so it captures both the coupon and any discount or premium on purchase. As a result the interest reported in the accounts is the true economic yield, which can differ noticeably from the headline coupon.
amortised cost vs fair value: Amortised cost carries an instrument at its purchase price adjusted for interest, ignoring day-to-day market price moves, whereas fair value marks it to its current market price each reporting date. The choice matters most for banks and NBFCs: bonds held at amortised cost do not show gains or losses as interest rates move, so a rate spike can leave large unrealised losses invisible on the balance sheet, while the same bonds held at fair value would reveal them immediately. How a lender classifies its investments therefore shapes how rate risk appears — or does not — in its accounts.
why is a bond’s book value not its face value: Because a bond is rarely bought exactly at face value: if you pay less than face, you are compensated for a coupon lower than the market yield, and that discount is earned back gradually as the carrying value rises toward face by maturity. The book value at any point is the price paid plus the interest accrued under the effective interest method, so it sits between the purchase price and the face value and converges on face only at maturity. Face value is what it repays; amortised cost is what it is worth on the books along the way.