In the issuance of a term bond, the stated cash interest rate is often different from the effective interest rate negotiated by the creditor and the debtor. To compute the amount to be exchanged for this bond, the cash flows must be determined based on the specifics of the contract and their present value calculated. The resulting total is the amount paid so that the agreed upon rate of interest is earned over the life of the bond. The bond is initially recorded at present value to reflect its principal at that time. Cash interest payments are recorded thereafter and then adjusted based on the effective interest rate. The interest rate stated in the contract times the face value provides the amount of the cash payments. The principal times the effective rate gives the interest to be recognized for the period. The difference in the effective interest and the cash payment is compounded (added to the principal of the debt).
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