Chapter 5: Bonds Payable

Bond
 A formal unconditional promise, made under seal, to pay a specified sum of money at a
determinable future date, and to make periodic interest payment at a stated rate until the
principal sum is paid.
 A contract of debt
 Is evidenced by a certificate and the contractual agreement between the issuer and the
investor is contained in a document known as “bond indenture”.
Term and serial bonds
Term bonds – has a single date of maturity.
 May require the issuing entity to establish a sinking fund to provide adequate money to
retire the bond issue at one time.
Serial bonds – has a series of maturity dates instead of a single one/ installments.
Secured and unsecured bonds
Mortgage bonds – secured by a mortgage on real properties.
Collateral trust bonds – secured by shares and bonds of other corporation.
Debenture bonds – unsecured/ without collateral security.
Registered and bearer bonds
Registered bonds – require the registration of the name of the bondholders on the books of the
corporation.
Coupon or bearer bonds – unregistered bonds/ the name of the bondholder is not recorded on
the entity books.
 Interest on coupon bonds is paid to the person submitting a detachable interest coupon.
Other types of bonds
Convertible bonds – can be exchanged for shares of the issuing entity.
Callable bonds – may be called in for redemption prior to the maturity date.
Guaranteed bonds – another party promises to make payment if the borrower fails to do so.
Junk bonds – high-risk, high-yield bonds issued by entities that are heavily indebted or
otherwise in weak financial condition.
Zero-coupon bonds – pay no interest but the bonds offer a return in the form of a ‘deep
discount’ or huge discount from the face amount.
Features of bond issue
a) A bond indenture or deed of trust
 Detailed document that shows the terms of the loan and the rights and duties of
the borrower and other parties to the contract.
b) Bond Certificates
c) Trustee – pledging of properties as security for the loan.
 Act as the representative of the bondholders
 Usually a bank or trust entity
d) Registrar/ Disbursing agent
 Borrower deposits interest and principal payments to them and they distribute the
funds to the bondholders.
 Usually a bank or trust entity
Sale of bonds
 May be undertaken by the entity itself.
 Normally however, the entire bond issue is sold to an underwriter or investment
bank that assumes responsibility for reselling the bonds to investors.
 Sometimes, ask for a commission to be deducted from the proceeds of
sale.
 The entity undertakes to pay the face amount of the bond issue on maturity date and the
periodic interest.
 Interest is usually semiannually (but there are certain bonds that pay interest annually or
quarterly)
1. January 1 and July 1
2. February 1 and August 1
3. March 1 and September 1
4. April 1 and October 1
5. May 1 and November 1
6. June 1 and December 1
Initial Measurement of Bonds Payable
 PFRS 9, paragraph 5.1.1
 FAIR VALUE MINUS TRANSACTION COSTS ( NOT DESIGNATED AT
FVTPL)
 Fair value of bonds payable = present value of the future cash payments to
settle the bond liability; the issue price or net proceeds from the issue of
the bonds, excluding accrued interest.
 Bond issue costs – deducted from the fair value or issue price
 Bonds at FVTPL – treated as expense immediately
Subsequent measurement of bonds payable
 PFRS 9, paragraph 5.3.1
  At amortized cost, using the effective interest method
 The amount at which the bond liability is measured initially minus
principal repayment, plus or minus the cumulative amortization using the
effective interest method of any difference between the face amount and
present value of the bonds payable.
 Difference between face amount and present value – Discount/
Premium
 At FVTPL
Accounting for issuance of bonds
 Memorandum approach
 Authorization of the bonds – memorandum entry
 The sale of the bonds at face amount
Cash
Bonds payable
 Journal entry approach
 Authorization of the bonds
Unissued bonds payable
Authorized bonds payable
 The sale of the bonds at face amount
Cash
Unissued bonds payable
Issuance of bonds at a premium
 If the sale price is more than the face amount of the bonds.
 Not treated as an outright gain
 The effective rate is less than the nominal rate of interest.
 Nominal rate of interest – the rate appearing on the face of the bond certificate.
It is the interest which the issuing entity periodically pays to the buyer or
bondholder.
 Because of the relationship of the premium to the interest, the bond premium is amortized
over the life of the bonds and credited to interest expense.
Premium on Bonds payable
Interest expense
Issuance of bonds at a discount
 If the sale price is less than the face amount of the bonds.
 Not treated as an outright loss
 The effective rate is higher than the nominal rate.
 The bond discount is amortized as loss over the life of the bonds and charged to interest
expense.
Interest expense
 Discount on bonds payable

Presentation of discount and premium

 The discount on bond payable is a deduction from the bond payable and the premium on
bond payable is an addition to the bond payable.
 Discount represents an amount that the issuer cannot borrow because of interest
differences
 Premium represents an amount in excess of face amount that the issuer is able to
borrow.
 Shall not be considered separate from the bonds payable account. Both accounts
shall be treated consistently as valuation accounts of the bond liability
Bond issue costs
 Transaction costs directly attributable to the issue of bonds payable.
1. Printing and engraving cost
2. Legal and accounting fee
3. Registration fee with regulatory authorities
4. Commission paid to agents and underwriters
 Under the effective interest method of amortization, the bond issue cost must be ‘lumped’
with the discount on bonds payable and ‘netted’ against the premium on bonds payable.
Recording interest on bonds
a. Payment of interest during the year
b. Accrual of interest at the end of the year
Issuance of bonds between interest dates
 1st Approach
To record the issue of the bonds: To record the 1st payment of semiannual interest
Cash Interest expense
Bonds payable Cash
Premium on bonds payable
Interest expense
 2nd Approach
To record the issue of the bonds: To record the 1st payment of semiannual interest
Cash Accrued interest payable
Bonds payable Interest expense
 Premium on bonds payable Cash
Accrued interest payable
*The approach of crediting interest expense instead of accrued interest payable is preferable.
Bond retirement on maturity date
 Establishing a sinking fund
 The periodic cash deposits plus the interest earned on sinking fund securities
should cause the fund to approximately equal the amount of bond issue on
maturity date.
 Any excess cash is returned to the issuing entity.
 To retire the bonds together with the payment of the last semiannual interest out of a
sinking fund.

Bonds payable
Interest expense
Sinking fund
 If not, the payment of the bonds will come from the general cash of the issuing entity.

Bonds payable
Interest expense
Cash
Bond retirement prior to maturity date
1. The bond premium or bond discount should be amortized up to the date of retirement.
2. The balance of the bond premium or bond discount should be determined.
3. The accrued interest to date of retirement should be determined.
4. Total cash payment should be computed.
 Retirement price ( a certain percent of the face amount of the bonds) plus accrued
interest
5. Carrying amount of the bonds retired is determined.
 Face amount of the bond plus the unamortized premium or minus the
unamortized discount
6. Gain or loss on the retirement
 The difference between the retirement price and the carrying amount of the bond
 If retirement price is more than carrying amount – LOSS
 If retirement price is less than carrying amount - GAIN
7. Retirement of the bond is recorded by canceling the bond liability together with the
unamortized premium/ discount.
 Any accrued interest – debited to interest expense
Bonds payable
Interest expense
Cash
 Discount on bonds payable
Gain on early retirement of bonds (component of finance cost or other income)

*Another approach
Suppose only bonds with a certain face amount is retired – the same procedures discussed
previously are followed
March 1, 2020, 5M, 5 years, issued for March 1, 2020, 1M of 5M, 5 years, issued
4730k are retired on July 2023, Mar. 1 & for 4730k are retired on July 2023, Mar. 1
Sept. 1 (interest payment) & Sept. 1 (interest payment)
(1) Interest exp. 27k Interest exp. 27k
Discount on BP 27k Discount on BP 27k
(7) Bonds payable 5M Bonds payable 1M
Interest expense 200k Interest expense 40k
Cash 5050k Cash 1010k
Discount on BP 90k Discount on BP 18k

Gain on early retirement of bonds 60k Gain 12k

Treasury bonds
 Entity’s own bonds originally issued and reacquired but not cancelled.
 Acquisition = formal retirement of bonds prior to maturity date
Acquisition
Treasury bonds
Premium on BP
Interest expense
Cash
Gain on acquisition of treasury bond (acquisition cost and the carrying amount)
 When subsequently sold – same manner as bonds originally issued
Reissuance at a premium Reissuance at discount
Cash Cash
Treasury bonds Discount on BP
Premium on BP Treasury bonds
*Premium/ discount – amortized over the remaining life of the bonds
 When not subsequently sold – canceled against the bonds payable account on the date of
maturity
Bonds payable
Treasury bonds
Statement presentation

Bonds payable xx
Treasury bonds (xx)
Bonds payable outstanding xx
Premium on BP/ Discount ±xx
Carrying amount xx

Bond Refunding
 Floating of new bonds the proceeds from which are used in paying the original bonds.
 Premature retirement of old bonds by means of issuing new bonds – Bond refinancing
 May be made on or before the date of maturity of the old bonds
 When refunding is made prior to the maturity date of the old bonds
 Refunding charges
 Includes the unamortized bond discount/ premium and redemption
premium on the old bonds being refunded.
 Charged to loss on extinguishment
 Shall be accounted for as an extinguishment of a financial liability
 Difference between the carrying amount of the financial liability extinguished and the
consideration paid = PROFIT/LOSS
Amortization of bond discount/ premium
a. Straight- line
 Equal amortization
 Divide the amount of bond premium/discount by the life of the bonds
 Life of the bonds – period commencing on the date of sale of the bonds up
to the maturity date.
b. Bond outstanding method
 Applicable to serial bonds whether issued at discount/premium
 Annual premium amortization – computed by multiplying the fractions by the
amount of the premium
 Interest expense shall decrease every year by reason of the decreasing principal
bond liability
Premature retirement of serial bonds
  It calls for the cancelation of any unamortized discount/premium related to the serial
bonds retired.
Accounting procedures
1. Get the ratio of the total premium/discount to the common denominator of the fractions
developed, total of bond outstanding – represents the amortization rate per year.
2. Multiply the rate computed in (1) by the face amount of the bonds retired – unamortized
premium/discount per year related to the bonds retired.
3. Multiply the unamortized premium/discount per year computed in (2) by the period from
date of retirement to the scheduled maturity date of the retired bonds – unamortized
premium/discount applicable to bonds retired which should be canceled.
Fair value option of measuring bonds payable
 PFRS 9, paragraph 4.2.2
 Initial recognition – may be irrevocably designated as at FVTPL
 No more amortization of bond discount/premium.
 Interest expense is recognized using the nominal or stated rate.
Change in fair value recognized in OCI
 PFRS 9, paragraph 5.7.7
a. The change in fair value attributable to the credit risk of the liability is recognized in
OCI
 Credit risk – the risk that the issuer of the liability would cause a financial
loss to the other party by failing to discharge the obligation.
 Doesn’t include market risk such as interest, currency, and price risk
b. The remaining amount of the change in fair value is recognized in P/L.
 Paragraph 5.7.8 – if presenting the change in fair value attributable to credit
risk would create an accounting mismatch, all gains and losses including the
effects of changes in credit risk– P/L
 Application Guidance B5.7.9
 The amounts recognized in OCI resulting from changes in fair value of credit
risk of a financial liability designated at FVTPL shall not be subsequently
transferred to P/L
 Cumulative gain or loss – transferred within equity or retained earnings.