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The ratable accrual method is a simplified calculation approach that spreads a fixed amount of bond discount or premium evenly over a period based on the number of days the instrument is held, rather than compounding it based on the bond's yield. The Internal Revenue Service treats it as the default method for amortizing acquisition premium on original issue discount bonds and for accreting market discount when a bondholder elects to include that discount in income annually. It produces a straight-line allocation: the same dollar amount per day regardless of what interest rates or bond prices do.
Think of it as dividing a known total into equal daily slices rather than recalculating each period based on a compound interest curve.
The method appears in two specific tax contexts for bondholders.
The first is market discount accrual. When you purchase a bond on the secondary market at a price below its adjusted issue price, that difference is market discount. If you elect to include market discount in income each year as it accrues rather than deferring it until sale or maturity, the ratable accrual method is the default. You divide the total market discount by the number of days between your purchase date and the bond's maturity date. Then you multiply that daily amount by the number of days you held the bond during the tax year.
The second is acquisition premium amortization. When you buy an original issue discount bond at a price above its adjusted issue price but below face value, the difference is an acquisition premium. That premium can be amortized to reduce the original issue discount income you must report annually. Under the ratable accrual method, you divide the total acquisition premium by the number of days from purchase to maturity, and apply that daily fraction to reduce your original issue discount inclusion for each day held.
The constant yield method, also called the constant interest rate method, ties accrual to the bond's actual economic yield. It compounds periodically and produces accrual amounts that grow over time as the adjusted issue price approaches face value. The ratable method produces flat, equal daily amounts regardless of the compounding effects of interest.
For original issue discount bonds issued after July 1, 1982, the Internal Revenue Service requires the constant yield method to measure the original issue discount itself. The ratable method applies only to the adjustments layered on top, specifically the market discount accrual and the acquisition premium amortization. To switch from ratable to constant yield for market discount, you must attach a statement to a timely filed tax return making the election for that specific bond, and the election is irrevocable for that bond.
Under the ratable accrual method, your broker typically calculates and reports the accrued market discount for you. As of 2014, brokers are required to track and report market discount on covered securities. The ratable amount reduces the capital gain you report when you eventually sell or redeem the bond, because the discount already included in ordinary income adjusts your basis upward. Not tracking this creates a risk of double taxation: reporting both the accrued discount as ordinary income and the full discount again as capital gain at sale.
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