(Effective Interest Method) Mathilda B. Reichenbacher, an intermediate accounting student, is having difficulty amortizing bond premiums and discounts using the effective interest method. Furthermore, she cannot understand why GAAP requires that this method be used instead of the straight-line method. She has come to you with the following problem, looking for help.

On June 30, 2006, Joan Elbert Company issued $3,000,000 face value of 13%, 20-year bonds at $3,225,690, a yield of 12%. Elbert Company uses the effective interest method to amortize bond premiums or discounts.

The bonds pay semiannual interest on June 30 and December 31. Compute the amortization schedule for four periods.

Instructions Using the data above for illustrative purposes, write a short memo (1–1.5 pages double-spaced) to Mathilda, explaining what the effective interest method is, why it is preferable, and how it is computed.

(Do not forget to include an amortization schedule, referring to it whenever necessary.)