What is the main purpose of an effective interest method?

The main purpose of the effective interest method is to allocate interest income or expense over time in a systematic manner that reflects the true economic substance of financial transactions. This method is particularly used in accounting for financial instruments, such as bonds or loans, where the interest paid may not always equal the interest earned based on the carrying amount.

By using the effective interest method, a company can better match interest revenue or expenses with the financial periods in which they are incurred, leading to more accurate financial reporting. The interest is calculated based on the carrying amount of the financial instrument and its effective interest rate, allowing for a consistent and precise allocation of interest costs or revenues as the instrument matures. This approach ensures that the reported financial results reflect the underlying economic reality of the financial resources involved.