Accounting 24- Intermediate Accounting 2

Accounting for Bonds Payable

Two Methods of Long-Term Financing

1. Debt Financing
2. Equity Financing
Why issue bonds rather than stock
Bonds (debt)—Interest payments to bondholders are an expense that reduces taxable income
Stock (equity)—Dividend payments are made from after tax net income and retained earnings
Earnings per share on common stock can often be increased by issuing bonds rather than
additional stock.

Bond – is a debt instrument (a loan) issued for a period of more than one year. The investor acquiring a
bond earns interest by lending money, while the borrower (the issues) gets needed capital (cash).
-It is evidenced by a certificate and the contractual agreement between the issuer and investor is
contained in another document known as “bond indenture”.
Types of Bonds
• Secured and unsecured bonds: bonds secured by collateral (real estate, stocks)
Mortgage bonds – secured by mortgage on real properties
Collateral trust bonds - bonds secured by shares and bonds of other corporation
Debenture bonds -are unsecured or bonds without collateral
• Serial bonds: mature in instalments
• Callable bonds: give issuer right to call and retire debt prior to maturity
• Convertible bonds: can be converted into other corporate securities for a specified time after issue
• Bearer bonds or Coupon bonds: are freely transferable by current owner
• Guaranteed bonds – are bonds issued whereby another party promises to make payment if the
borrower fails to do so
• Junk bonds – are high-risk, high-yield bonds issued by entities that are heavily indebted or
otherwise in weak financial condition.
 • Zero-coupon bonds- are bonds that pay no interest but the bonds offer a return in the form of a
“deep discount” or huge discount from the face amount

Bond agreements -the written legal agreement among all parties involved in a bond issue is called an
indenture (or deed of trust).
Covenants
Protective covenants set limits or restrictions on certain actions the company might be taking during the
term of the agreement. They are particularly important feature in a bond indenture.
Types of covenants
1. Negative covenants – limit or prohibit the borrower from certain actions. Paying too
much in dividends, pledging assets to other lenders, selling major assets, merging with
another firm, and acquiring more long-term debts.
2. Positive (affirmative) covenants – specify actions that the borrower promises to
perform. Examples include maintaining certain ratios, preserving collateral in good
condition, and making timely interest and principal payments. A failure to abide by
positive covenants could place the bond issuer at default.

Bond Principal
Principal (also known as par value, par, or face value) represents the peso amount of the bond and is the
amount the lender is repaid when the bond matures. Most bonds are denominated in increments of P1,000.
Bond Interest
The interest rate stated in a bond is referred to as the coupon rate or nominal rate.
Bond Maturity
Bonds typically have a stated maturity. This is the date on which the bond debt becomes due for payment
and the obligation is settled. Face or par value is the value of a bond at maturity and the amount that is paid
to the bondholders. A bond often is bought and sold during its lifetime. At maturity, the bondholder receives
the par value of the bond. A P1,000 bond is worth P1,000 at maturity.
Bond Issue Cost
Bond issue cost are transaction costs directly attributable to the issue of bonds payable. It includes printing
and engraving cost, legal and accounting fee, registration fee with regulatory authorities, commission paid
to agents and underwriters and other similar charges.
Under effective interest method, bond issue cost shall be lumped with discount and netted against premium
on bond payable
If bonds are measured at FVTPL, the bond issue costs are expensed immediately.
Initial Measurement of Bonds payable
If designated at FVTPL - @ FV or the issue price or net proceeds excluding accrued interest
- Bond issue cost expensed immediately
If not designated at FVTPL - @FV minus transaction cost
Subsequent measurement
Bonds payable shall be measured either :
1. Amortized cost using effective interest method
2. At fair value through profit or loss

Issuance of Bonds
1. At Face value
2. At a Premium – when the issue price of the bonds exceeds the face value.
market rate  stated rate  bond sells at premium
SR – 10% MR -9%
3. At a Discount – when the issue price of the bonds is less than the face value
market rate  stated rate  bond sells at discount

MR – 10%
SR – 9%
Face value – 5M
SP – 4.5M
Pro-forma Journal Entries for the Issuance of Bonds
Sold at Par
Cash xx
Bonds Payable xx
Sold at a Premium
Cash xx
Premium on Bonds payable xx
Bonds Payable xx
Sold at a Discount
Cash xx
Discount on Bonds payable xx
Bonds Payable xx

Recording of interest on bonds payable

Accounting for interest expense on bonds payable requires recognition of two items, namely:
a. Payment of interest during the year
Interest expense/accrued interest xx
Cash xx
b. Accrual of interest
Interest expense xx
Accrued interest payable xx

Amortizing the Bond Premium/Discount

• A premium effectively decreases the annual interest expense for the corporation
• The discount effectively increases the annual interest expense for the issuing corporation
Methods in Amortization
1. Straight line - allocates the same amount of discount (or premium) to each interest period
2. Bond outstanding method (Applicable to serial bonds)
3. Effective interest - allocates the discount or premium in increasing amounts over the bond term

Pro-forma journal entries on amortization of premium/discount

Issued @ Premium

Premium on bonds payable xx

Interest expense xx

Issued @ discount

Interest expense xx

Discount on bonds payable xx

CA of Bonds payable:
Face value of the bonds xx
Unamortized Premium xx
Unamortized discount (xx)

Issuance of Bonds between interest dates

When bonds are issued between interest dates, the accrued interest is paid by the buyer or investor.
Pro-forma journal entry
Sold at Par
Cash xx
Bonds Payable xx
Interest expense/accrued interest payable xx
Sold at a Premium
Cash xx
Premium on Bonds payable xx
Bonds Payable xx
Interest expense/accrued interest payable xx

Sold at a Discount
Cash xx
Discount on Bonds payable xx
Bonds Payable xx
Interest expense/accrued interest payable xx
To compute for remaining life of the bonds(if issued between interest dates):
Original life of the bonds xx
Less: expired life on the date of sale xx
Remaining life of the bonds xx
Illustration:
On April 1,2021, an entity issued bonds payable with face amount of P5,000,000 at P5,228,000
plus accrued interest. The bonds are dated January 1,2021, mature in 5 years and pay 12%
interest semiannually on January 1 and July 1.

April 1,2021
To record the issuance of the bonds
Cash 5,378,000
Bonds payable 5,000,000
Premium on bonds payable 228,000
Accrued int.payable 150,000*

*Interest from Jan-April 1 - (5M x 12% x 3/12= 150,000)

July 1,2021
To record the payment of interest
Interest expense 300,000
Cash 300,000
(5M x 12% x 6/12)

Accrued int.payable 150,000

Interest expense 150,000
Cash 300,000

December 31,2021
To record accrual of interest expense
Interest expense 300,000
Accrued interest payable 300,000

To record amortization of premium on bonds payable

Premium on bonds payable 36,000
Interest expense 36,000
(228,000/57 months)*9

Original life of the bonds 60 months

Less: expired life on the date of sales 3 months
Remaining life of the bonds 57months

Bond retirement on maturity date

To make a bond issue more attractive, an entity may agree in the bond indenture to establish a sinking fund
exclusively for use in retiring the bonds at maturity.

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.
When the bonds approach maturity date, the trustee sells the securities and uses the sinking fund cash to pay the
bondholders. An excess cash is returned to the issuing entity.

Illustration
An entity issued bonds payable with face amount of P5,000,000 on March 1,2021 with 12% interest payable March 1
and September 1 and the bonds mature on March 1,2026.

To record the retirement of bonds together with interest -if sinking fund is used
Bonds payable 5,000,000
Interest expense 300,000
Sinking fund 5,300,000

To record the retirement of bonds together with interest -if general cash is used
Bonds payable 5,000,000
Interest expense 300,000
Cash 5,300,000

Bond retirement prior to maturity date

1. Determine the carrying amount of the bond
2. Determine the Retirement price
3. Compute for the gain/loss on early retirement
Retirement price xx
Carrying amount of the bonds (xx)_
Gain/loss on retirement xx
=====
4. Compute for the total cash payment
Retirement price xx
Accrued interest xx
Total Cash payment xx
Illustration:
On January 1, 2013, Harlet Company redeemed its 15-year bonds of P5,000,000 par value for 102. The bonds were
originally issued on January 1, 2001 at 98 with a maturity date of January 1, 2016. Interest is payable semiannually
every January 1 and July 1 at 10%. The bond issue cost relating to this transaction was P200,000. The entity
amortizes discounts, premiums and bond issue cost using the straight line method.

January 1,2001
Cash 4,700,000
Bond issue cost 200,000
Discount on bonds payable 100,000
Bonds payable 5,000,000

Interest expense
Discount on bonds payable
 Carrying amount of bonds payable
Face value of bonds 5,000,000
Unamortized discount (100,000x3/15) ( 20,000)
Unamortized BIC(200,000 x3/15) (40,000)
4,940,000

Retirement price (P5,000,000x1.02) 5,100,000

Gain/loss on retirement
Retirement price 5,100,000
Carrying amount of bonds (4,940,000)
Loss on retirement 160,000

Total cash payment

Retirement price 5,100,000
Accrued interest (5Mx10%x6/12) 250,000
5,350,000

Journal entry:
Bonds payable 5,000,000
Loss on retirement of bonds 160,000
Interest payable 250,000
Cash 5,350,000
Discount on bonds payable 20,000
Bond issue cost 40,000

Bond Outstanding Method of Amortization – applicable to serial bonds

Illustration
The entity issued P5,000,000 face value bonds at 5,300,000 on January 1, 2013. The bonds will mature at the rate of
P1,000,000 every year for years and pays interest semiannually every June 30 and December 31 at a stated rate of
12%.
Year Bond outstanding Fraction Prem. Amort.
2013 5,000,000 5/15 100,000
2014 4,000,000 4/15 80,000
2015 3,000,000 3/15 60,000
2016 2,000,000 2/15 40,000
2017 1,000,000 1/15 20,000
15,000,000 300,000

January 1 2013
Cash 5,300,000
Bonds payable 5,000,000
Premium on bonds payable 300,000
June 30,2013
Interest expense 300,000
Cash 300,000
(5M x 12% x 6/12)
December 31,2013

Interest expense 300,000

Cash 300,000

Premium on bonds payable 100,000

Interest expense 100,000

To record maturity of bonds

Bonds payable 1,000,000
Cash 1,000,000

Premature retirement of serial bonds

1. Get the ratio of the total premium or discount to the common denominator of the fractions developed, total of
bond outstanding column. This ratio represents the amortization rate per year.
2. Multiple the rate computed in (1) by the face amount of the bonds retired. The answer gives the unamortized
premium or discount per year related to the bonds retired.
3. Multiple the unamortized premium or discount per year computed in (2) by the period from the date of
retirement to the scheduled maturity date of the retired bonds.

Illustration
Assume serial bonds (in example above) face amount of P1,000,000 scheduled to be retired on December 31,2015
are retired at 103 on December 31,2013, two years prior to their redemption date.
1. Ratio of the total premium
300,000/15,000,000 = .02 per year
2. Unamortized premium on bonds per year
1,000,000 x .02=20,000
3. Unamortized premium applicable to the retired bonds
20,000x2=40,000

Journal entry
Bonds payable 1,000,000
Premium on bonds payable 40,000
Cash 1,030,000
Gain on early retirement of bonds 10,000
Seatwork (Show your complete solution)
Problem 1
Punctual Co.’s December 31, 2014 statement of financial position contained the following items in the long-
term liabilities section:

Unsecured
9.375% registered bonds (P 25,000 maturing annually beginning in 2018) P275,000

11.5% convertible bonds, callable beginning in 2022, due 2034 P125,000

Secured
9.875% guaranty security bonds, due 2025 P275,000

10.0% commodity backed bonds (P 50,000 maturing annually beginning in 2019) P200,000

What are the total amounts of serial bonds and debenture bonds?

Problem 2
On March 1, 2014, Honest Co. issued 5,000 of its P 1,000 face value bonds at 110 plus accrued interest.
Honest Co. paid bond issue costs of P 300,000. The 10-year bonds were dated November 1, 2013 and
carry a 12% interest payable semiannually on May 1 and November 1. Net amount received from issuance
was?

Problem 3
On January 1, 2014, Good Co. redeemed its 15-year bonds of P 1,500,000 par value for 102. They were
originally issued on January 1, 2002 at 98 with a maturity date of January 1, 2017. The bond issue costs to
this transaction were P 90,000. Good amortizes discounts, premiums, and bond issue costs using the
straight-line method. What amount of loss should Good recognize on the redemption of these bonds
(ignore taxes)?

Problem 4
On January 1, 2014, TEL Inc. issued a 3-year P2,000,000 bonds payable with annual interest of P10%
payable annually every December 31. The principal will be payable at the end of the term. The bonds payable
are issued at 110 and TEL incurred P96,917 bond issue cost. The effective interest rate of the bonds payable
is 8%.

What is the initial measurement of the bonds payable on January 1, 2014? _________________

what is the carrying value of bonds payable on December 31, 2015?__________________

Problem 5

On January 31, 2017, Beau Corporation issued P300,000 maturity value, 12% bonds for P300,000 cash.
The bonds are dated December 31, 2016, and mature on December 31, 2026. Interest will be paid
semiannually on June 30 and December 31. What amount of accrued interest payable should Beau report
in its September 30, 2017 balance sheet?____________

Problem 6

Boni Corporation issued P5,000,000 face value, 12%, 10-year bonds on October 1, 2007 at 95. The bonds
are dated October 1, 2007 and pay semiannual interest on April 1 and October 1. What is the interest
expense to be reported for the year 2017?____________

Problem 7

Easy Company showed the following balances in connection with its noncurrent liabilities on December 31,
2016.
Bonds payable, 12%, maturing Dec. 31, 2026 P5,000,000
Premium on bonds payable 600,000
Bonds payable, 14%, maturing Dec. 31, 2021 4,000,000
Discount on bonds payable 200,000
Bond issue cost 60,000
The premium is related to the 12% bonds payable and the discount and bond issue costs are applicable
to the 14% bonds payable. No bonds were retired during 2017. Straight-line method was used for the
amortization. How much interest expense on the bonds payable should Easy report in its 2017 income
statement?__________
Problem 7
On January 1, 2017, Kent Inc. redeemed its 15-year bonds of P5,000,000 par value for 102. The bonds were
originally issued on January 1, 2005 at 98 with a maturity date of January 1, 2020. The bond issue cost
relating to this transaction was P200,000. Kent amortizes discounts, premiums and bond issue cost using
the straight line method. What amount of loss should Kent recognize on the redemption of these bonds?
____________