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The objective of determining an effective interest rate is to identify the economic rate of return of a financial asset based on the concepts of accrual accounting. The difference between the purchase price of an investment and the amount due at maturity (or principal payments received over the instrument's term) coupled with any coupon interest paid over the investment's life determine the investor’s rate of return on its investment. US GAAP requires the amortization of premiums and discounts (including certain deferred origination costs and fees) to be recognized through interest income. This results in the recognition of interest income based on the effective rate of return on the financial instrument.
The ASC Master Glossary provides a definition of the effective interest rate.

Definition from the ASC Master Glossary

Effective interest rate: The rate of return implicit in the financial asset, that is, the contractual interest rate adjusted for any net deferred fees or costs, premium, or discount existing at the origination or acquisition of the financial asset. For purchased financial assets with credit deterioration, however, to decouple interest income from credit loss recognition, the premium or discount at acquisition excludes the discount embedded in the purchase price that is attributable to the acquirer's assessment of credit losses at the date of acquisition.

The following sections describe some of the items that cause an adjustment to the contractual interest rate to arrive at the effective interest rate.

6.4.1 Impact of discounts and premiums on effective interest rate

As discussed in LI 6.3, the market interest rate of a financial instrument depends on a number of factors, including the risk-free interest rate, credit risk, and liquidity. When an asset does not provide a coupon equal to the rate demanded by market participants, a loan or security may be issued at a discount or premium. Normally, the market price of a debt instrument is equal to the present value of its future cash flows discounted at the rate of return demanded by market participants.
Discounts and premiums are the difference between the amount paid upon acquisition of a financial asset and the amount repayable at its maturity (or in scheduled principal payments made over its life). Discounts occur when a financial asset is purchased for an amount less than the par amount of an instrument and are typically seen when the coupon on the investment is less than the market yield for that instrument. Premiums arise when a financial asset is purchased for an amount greater than the par amount of an instrument and are typically seen when the coupon on the instrument is higher than the market yield for that instrument.
The difference between the purchase price of an investment and the amount to be repaid at maturity (the premium or discount) coupled with any coupon interest received over the instrument's life determine the investor's yield on its investment. If a debt instrument is originated or purchased at a discount, the effective interest rate on the instrument will be higher than the stated rate. Conversely, if a debt instrument is originated or purchased at a premium, the effective rate is lower than the stated rate.

6.4.1.1 Accounting for discounts on loans held for sale

Nonmortgage and mortgage loans held for sale are carried at the lower of cost or fair value. In accordance with ASC 948-310-35-2, purchase discounts on mortgage loans should not be amortized as interest income during the period the loan or security is classified as held for sale.
Refer to LI 4.3.3 for guidance on how to transfer a loan into or out of the held for sale classification.

6.4.2 Effective interest rate: loan origination fees and costs

As discussed in LI 4.4, certain loan origination fees and costs are deferred and amortized over the life of the related loan; these deferred loan fees and costs should be considered when determining the effective interest rate of a loan. Deferred loan fees or costs create a discount or premium to the stated loan amount. For example, if a bank lends $1,000,000 to a borrower and incurs $50,000 of net deferred costs associated with originating that loan, the initial amortized cost basis of the loan is $1,050,000.
In accordance with ASC 310-20-15-3(c), reporting entities that account for receivables and debt instruments at fair value with changes in fair value recorded in net income should not defer fee recognition. See LI 6.9 for information on interest income recognition for those reporting entities.
See LI 6.6 for information on prepayment fees and LI 4.6.1 for information on loan syndication fees. ASC 310-10-25-13 provides guidance on the accounting for delinquency fees.
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