Strategic Business Reporting (International) · Financial instruments

Effective Interest Rate Method and Amortised Cost in SBR

Updated 11 October 2026 · Fact-checked

Under IFRS 9, you measure a financial instrument at initial recognition at fair value, adjusted for transaction costs unless it is at fair value through profit or loss. For amortised cost items, you then roll the balance forward each year: opening balance plus interest at the effective interest rate, minus cash paid or received.

Understand Initial and Subsequent Measurement and the Effective Interest Rate

Every financial asset or liability starts life in your books at a number. IFRS 9 says that number is fair value at initial recognition. For most items fair value is the transaction price. If the item is not at fair value through profit or loss (FVTPL), you also adjust for transaction costs. Add them to a financial asset. Deduct them from the proceeds of a financial liability. For FVTPL items, you expense the costs straight away.

After that, the measurement depends on classification. Some items go to fair value each year. Items held at amortised cost do not. Instead, you spread the interest, and any difference between the initial amount and the final repayment, over the life of the instrument. You do this using the effective interest rate (EIR).

The EIR is the single rate that discounts all estimated future cash flows to the initial carrying amount. Those cash flows include coupons, the final repayment, premiums and the transaction costs you capitalised. It is not the coupon rate. Coupon is cash. EIR is the true cost or yield. This is why a bond issued with costs or a redemption premium has a finance cost above its coupon.

The yearly mechanics are simple. Finance cost (or finance income) = opening balance × EIR. The closing balance = opening balance + finance cost − cash paid. The balance moves towards the amount repayable at maturity. Over the whole life, the total P&L charge equals total cash paid minus the net amount first received.

Examiners use this in SBR in several ways. You may build an amortised cost table for a loan or bond. You may have to fix the initial figure after costs. Or you may have to explain why the finance cost differs from the interest paid. Always show the working in a short table. It earns method marks even if one number slips.

Key rules to remember

Initial measurement (not FVTPL): Asset = fair value + transaction costs; Liability = fair value − transaction costs; For FVTPL items, transaction costs go to profit or loss immediately. Fair value is normally the transaction price.
Finance cost / income for the year: Opening amortised cost × EIR; Use the EIR, not the coupon rate. Time-apportion if the period is not a full year.
Amortised cost roll-forward: Closing = Opening + (Opening × EIR) − cash paid (liability) or cash received (asset); Cash means coupon or instalment actually paid or received in the period. A final repayment is also cash.
Effective interest rate: EIR is the rate r where Σ [cash flow ÷ (1 + r)^t] = initial carrying amount; The cash flows include the capitalised transaction costs and any premium or discount. In most exam questions the EIR is given.
Change in estimated cash flows: New carrying amount = PV of revised cash flows at the original EIR; difference to profit or loss; This applies to items at amortised cost when the estimates change. For floating-rate items, re-estimating cash flows normally changes the EIR instead.
Trade receivables: Initial amount = transaction price (IFRS 15) if no significant financing component; Otherwise use fair value.

How to solve Initial and Subsequent Measurement and the Effective Interest Rate questions

Use this order for any question that asks for initial measurement or an amortised cost balance.

1Identify the instrument: asset or liability, and the classification (amortised cost or FVTPL). The classification decides how you treat transaction costs.
2Work out the initial carrying amount. Start with fair value or proceeds. Add costs for an asset. Deduct costs for a liability. Expense them if FVTPL.
3Find the EIR. If it is given, use it. If not, check whether the question expects you to solve it by trial and error between two rates.
4Set up a table with columns: opening balance, finance cost at EIR, cash paid or received, closing balance.
5Fill in each year. Multiply the opening balance by the EIR. Add that, and subtract the cash. Round as the question requires.
6Check the final year. The closing balance should equal the final repayment due just before it is paid. If it does not, find your error.
7Post the entries. Debit or credit finance cost or income in profit or loss. Show the closing balance in the statement of financial position, split current and non-current if asked.
8Add a short sentence of explanation. Say why the charge differs from the coupon. Link it to the scenario.

Quickest way: Four-column table shortcut

When to use it: Use this when the EIR is given and you need balances for one to three years under time pressure.

Write the initial amount in the first opening cell. Do the cost adjustment in one line beside it.
Compute opening × EIR once per year. Do not recompute from the start.
Closing = opening + interest − cash. Carry the closing figure to the next opening.
Test the last year. The closing amount before the final payment must match the repayment. This takes ten seconds and catches most errors.
Copy the interest column into the P&L note and the closing column into the SOFP note.

Common mistakes in Initial and Subsequent Measurement and the Effective Interest Rate

Charging the coupon rate to profit or loss instead of the EIR.
The coupon is the number stated in the question, so it feels like the interest cost.
Fix: Finance cost = opening balance × EIR. The coupon only appears in the cash column.
Adding transaction costs to a financial liability instead of deducting them.
Students remember that costs are added for assets and apply the same rule to both.
Fix: For a liability, the costs reduce the net proceeds. The opening liability is proceeds less costs.
Capitalising transaction costs on an FVTPL instrument.
Students apply the amortised cost rule without checking the classification.
Fix: Check the classification first. For FVTPL items, expense the costs immediately.
Calculating interest on the nominal value rather than the carrying amount.
The nominal value is the round number in the question.
Fix: Always apply the EIR to the opening amortised cost. The nominal value only sets the cash flows.
Forgetting to deduct the cash paid before rolling the balance forward.
Students focus on the interest line and skip the cash column.
Fix: Use all four columns every time. Opening, plus interest, minus cash, equals closing.
Failing to apply the revised-cash-flow rule when the estimates change.
Students keep using the old schedule because it is already built.
Fix: When the question changes the expected cash flows, recompute the carrying amount at the original EIR and take the difference to profit or loss.

Worked examples

Example 1

On 1 January 20X1, Kiro issues $100,000 of 5% bonds at par. The bonds are redeemable at par on 31 December 20X3. Interest is paid annually in arrears. Issue costs are $2,673. The bonds are held at amortised cost and the effective interest rate is 6%. Show the finance cost and the carrying amount at the end of each year.

Show the solution

The bonds are a financial liability, so deduct the issue costs from the proceeds. Initial carrying amount = $100,000 − $2,673 = $97,327.
Annual cash coupon = 5% × $100,000 = $5,000.
Year 20X1: finance cost = $97,327 × 6% = $5,840 (rounded). Closing = $97,327 + $5,840 − $5,000 = $98,167.
Year 20X2: finance cost = $98,167 × 6% = $5,890 (rounded). Closing = $98,167 + $5,890 − $5,000 = $99,057.
Year 20X3: finance cost = $99,057 × 6% = $5,943 (rounded). Closing before redemption = $99,057 + $5,943 − $5,000 = $100,000.
Check: $100,000 is the amount repayable, so the table is correct. The $100,000 is then paid on redemption.
Explain: the finance cost is higher than the $5,000 coupon because the issue costs raise the effective cost of borrowing. The extra is added to the liability each year.

Answer: Opening liability $97,327. Finance costs: 20X1 $5,840; 20X2 $5,890; 20X3 $5,943. Carrying amounts: end 20X1 $98,167; end 20X2 $99,057; end 20X3 $100,000 before redemption.

Example 2

On 1 January 20X1, Tavi buys $100,000 nominal of 4% bonds for $97,000 and pays transaction costs of $1,141. The bonds pay interest annually in arrears and are redeemable at par on 31 December 20X2. Tavi holds them to collect contractual cash flows, and the cash flows are solely payments of principal and interest. The effective interest rate is 5%. (a) Show the amortised cost at 31 December 20X1 and 20X2 and the finance income. (b) State how the $1,141 would be treated if the bonds were classified as FVTPL.

Show the solution

(a) Initial carrying amount of the asset = $97,000 + $1,141 = $98,141. Costs are added because it is an asset not at FVTPL.
Annual cash coupon received = 4% × $100,000 = $4,000.
Year 20X1: finance income = $98,141 × 5% = $4,907 (rounded). Closing = $98,141 + $4,907 − $4,000 = $99,048.
Year 20X2: finance income = $99,048 × 5% = $4,952 (rounded). Closing before redemption = $99,048 + $4,952 − $4,000 = $100,000.
Check: $100,000 equals the par redemption amount, so the schedule is correct.
(b) If the bonds were at FVTPL, the $1,141 would be charged to profit or loss immediately. The initial carrying amount would be $97,000, the fair value.

Answer: (a) Initial amount $98,141. Finance income: 20X1 $4,907; 20X2 $4,952. Carrying amount: 31 December 20X1 $99,048; 20X2 $100,000 before redemption. (b) Under FVTPL, the $1,141 is expensed in profit or loss and the asset starts at $97,000.

Exam tips

Read the classification first. A single word like 'held to collect' or 'FVTPL' changes how you treat the transaction costs.
If the EIR is given, do not try to recalculate it. Use the time on the table and the explanation.
Show a four-column table every time. If one figure is wrong, the method marks still follow.
Link the answer to the scenario. Say why the finance cost exceeds the coupon, or what a higher EIR tells the board about the cost of borrowing. This earns professional skills marks.
Watch for twists: costs on a loan, a premium on redemption, a change in expected cash flows, or a part-year period. Each needs one extra line, not a new method.

Practice questions from Financial instruments

Initial and Subsequent Measurement and the Effective Interest Rate in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Initial and Subsequent Measurement and the Effective Interest Rate: frequently asked questions

What is the difference between the coupon rate and the effective interest rate?

The coupon rate sets the cash interest on the nominal value. The effective interest rate is the rate that discounts all the cash flows to the initial carrying amount, so it also reflects costs, discounts and premiums. You use the EIR for the P&L charge and the coupon for the cash.

Do transaction costs go into profit or loss under IFRS 9?

Only for items at fair value through profit or loss. For other financial assets you add the costs to the initial amount. For other financial liabilities you deduct them from the proceeds. Either way, they then reach profit or loss through the EIR over the life of the instrument.

How do I calculate the amortised cost of a loan in the exam?

Start with the initial amount after costs. Each year, add opening balance × EIR and subtract the cash paid. Check that the final balance equals the repayment. Most questions give you the EIR.

What happens if the expected cash flows change?

For an item at amortised cost, you recalculate the carrying amount as the present value of the revised cash flows, discounted at the original EIR. The difference goes to profit or loss. Floating-rate instruments are different, because re-estimating the cash flows normally changes the EIR instead.