Financial assets classified at amortized cost are measured using the effective interest method. The effective interest rate is the exact rate that discounts estimated future cash receipts through the expected life of the financial asset to its gross carrying amount.

Gross Carrying Amount_0 = Σ(t=1 to n) Cash Flows_t / (1 + EIR)^t

This rate accounts for any initial premiums, discounts, or capitalized transaction costs, spreading them smoothly over the life of the instrument.

Each period, the interest income recognized in the income statement is calculated by applying the EIR to the asset’s opening carrying value. The difference between the cash interest received and the interest income recognized is adjusted against the carrying value of the investment:

Interest Income = Carrying Value at Start of Period × EIR
Amortization Adjustment = Interest Income − (Nominal Principal Balance × Stated Coupon Rate)