LESSON 4: BONDS PAYABLE

📜 Definition of Bonds

🌵 Bonds
• 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.

Simply stated: A bond is a contract of debt whereby one party called the issuer borrows funds
from another party called the investor.

Note: A bond is evidenced by a certificate and the contractual agreement between the issuer
and investor is contained in another document known as “bond indenture”.

📜 Features of Bond Issue

1. 🌵 Bond Indenture or Deed of Trust

• The document which shows in detail the terms of the loan and the rights and
duties of the borrower and other parties to the contract.
2. 🌵 Bond Certificates
• Each bond certificate represents a portion of the total loan. The usual
minimum denomination in business practice is Php 1,000 although smaller
denominations may be issued occasionally.

3. If the property is pledged as a security loan, a trustee is named to hold title to the
property serving as security. The trustee acts as the representative of the bondholders
and is usually a bank or trust entity.
4. A bank or trust entity is usually appointed as registrar or disbursing agent. The borrower
deposits interest and principal payments with the disbursing agent, who then distributes
the funds to the bondholders.

📜 Contents of Bond Indentures

*Bond Indenture – the contract between the bondholders and the borrower or issuing entity. It
normally contains the following:
i. Characteristics of the bonds
ii. Maturity date and provision for repayment
iii. Period of grace allowed to issuing entity
 iv. Establishment of a sinking fund and the periodic deposit therein
v. Deposit to cover interest payments
vi. Provisions affecting mortgaged property, such as taxes, insurance coverage, collection
of interest or dividends on collaterals
vii. Access to corporate books and records of trustee
viii.Certification of bonds by trustee
ix. Required debt to equity ratio
x. Minimum working capital to be maintained, if any

📜 Types of Bonds

1. 📌 Term and serial bonds

🌵 Term bonds
• Bonds with single date of maturity. It may require the issuing entity to establish a
sinking fund to provide adequate money to retire the bond issue at one time.
🌵 Serial Bonds
• Bonds with a series of maturity dates instead of a single one. It allows the issuing
entity to retire the bonds by installments.

2. 📌 Secured and unsecured bonds

🌵 Mortgage bonds
• Bonds secured by a mortgage on real properties. These bonds may first
mortgage bonds with senior claims on entity assets, or second mortgage bonds
or bonds with subordinated claims on entity assets.
🌵 Collateral trust
• Bonds secured by stocks and bonds of other corporation.
🌵 Debenture bonds
• Bonds without collateral security. These bonds are unsecured and therefore rank
as general creditors in the preference of credits.

3. 📌 Registered and bearer bonds

🌵 Registered bonds
• Require the registration of the name of the bondholders on the books of the
corporation.
Note: If the bondholder sells a bond, the old bond certificate is surrendered to the entity and a
new bond certificate is issued to the buyer. Interest is periodically paid by the issuing entity to
the bondholders of record.
🌵 Coupon or Bearer Bonds
• Unregistered bonds in the sense that the name of the bondholder is not recorded
on the entity books. The issuing entity does not maintain a record of who owns
the bonds at any point in time. Thus, interest on coupon bonds is paid to the
person submitting a detachable interest coupon.

4. 📌 Other types of Bonds

🌵 Convertible Bonds
• Bonds that can be exchanged for shares of the issuing entity.
🌵 Callable Bonds
• Bonds which may be called in for redemption prior to the maturity date,
🌵 Guaranteed Bonds
• Bonds issued whereby 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.

🌵 Sale of Bonds
The bonds needed for the issuance of bonds are usually too large for one buyer to pay. Thus,
very often, the bonds are divided into various denominations of say Php 100, 1,000, 10,000,
thus enabling more than one buyer or investor to purchase the bonds. Quite often, however,
instead of selling bonds of various denominations, the bonds are sold in equal denominations
of say Php 1,000 only.

The Php 1,000 denomination is called the face value of the bonds. Each bond is evidenced by
a certificate called a bond certificate.

Thus, if Php 50,000 face value bonds are sold, divided into Php 1,000 denominations, there
shall be Php 50,000

The sale of bonds may be undertaken by the entity itself. Normally however, the issuing entity
does not attempt to sell the bonds directly to the public. Instead, the entire bond issue is sold
to an underwriter or investment bank that assumes responsibility for reselling the bonds to
investors.
Sometimes, the underwriter merely undertakes to sell the bonds on the basis of a commission
to be deducted from the proceeds of sale.

When an entity sells a bond issue, it undertakes to pay the face value of bond issue maturity
date and the periodic interest.

Interest is usually payable semiannually or every six months as follows:

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

Of course, there are certain bonds that pay interest annually or at the end of every bond year.

📌 Initial Measurement of Bonds Payable

Par. 5.1.1 of PFRS 9

Bonds payable not designated at fair value through profit or loss shall be measured initially at
fair value minus transaction costs that are directly attributable to the issue of bonds payable.

✔ The fair value of the bonds payable is equal to the present value of the future cash
payments to settle the bond liability.
✔ Bond issue costs shall be deducted from the fair value or issue price of the bonds
payable in measuring initially the bonds payable.

Bonds designated and accounted for at fair value through profit or loss
✔ The bond issue costs are treated as expense immediately.

Note: The fair value of the bonds payable is the same as the issue price or net proceeds from
the issue of the bonds, excluding accrued interest.

📌 Subsequent measurement of bonds payable

Par. 5.3.1 of PFRS 9 – after initial recognition, bonds payable shall be measured either:
a) At amortized cost, using effective interest method
b) At fair value through profit or loss
📌 Amortized cost of bonds payable
✔ 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 initial amount and the maturity amount.
✔ The difference between the face amount and present value of bonds payable is
amortized using the effective interest method.
✔ The difference between the face amount and the present value is either discount or
premium.
➢ Accounting for issuance for bonds
▪ 🌵 Memorandum approach – no entry is made upon the authorization of the
entity to issue bonds. Authorized bonds payable account is not maintained.
▪ 🌵 Journal entry approach – made to record the authorized bonds payable.
Illustration:

An entity is authorized on January 1, 2020 to issue Php 7,500,000, 10-year, 12% face value
bonds, interest payable, January 1 and July 1, consisting of 7,500 units of Php 1,000 face
value. The bonds are sold at face value to an underwriter.

Memorandum Approach
• The authorization of bonds is recorded as follows:
“The entity is authorized on January 1, 2020 to issue Php 5,000,000 face value, 10-year 12%
bonds, dated January 1, 2020, interest payable January 1 and July 1, consisting of 7,500 units
of Php 1,000 face value”.
• The subsequent sale of bonds at face value is recorded as follows:

Note: The memorandum approach of accounting for bonds will be employed, as this is the one
generally followed. Journal Entry Approach
• The authorization of bonds is recorded as follows:
GENERAL JOURNAL
Date
2020
Descriptions

PR
Page Number 01

Debit
Credit
Jan 1
Unissued bonds payable

7,500,000

Authorized bonds payable

7,500,000
• The subsequent sale of bonds at face value is recorded as follows:
GENERAL JOURNAL
Date
2020
Descriptions

PR
Page Number 01

Debit
Credit

Cash

7,500,000

Unissued Bonds Payable

7,500,000

• Issuance of Bonds at a Premium

▪ The sales price is more than the face value of the bonds
▪ The investor or the buyer is amenable to receive interest that is somewhat less than
the nominal or stated rate of interest.
▪ The effective rate is less than the nominal rate.
▪ Nominal rate – the rate appearing on the face of the bond certificate. It is that interest
which the issuing entity periodically pays to the buyer or bondholder.
▪ WHEN BONDS ARE SOLD AT FACE VALUE, THE NOMINAL INTEREST RATE AND
THE EFFECTIVE INTEREST RATE ARE THE SAME.
▪ Example: An entity sells Php 7,500,000 face value of bonds at 105. The quoted price
of 105 means “105% of the face value of the bonds”. Thus, the sales price is Php 7,875,000,
computed by multiplying 105% by Php 7,500,000.
 ▪ Entry to record sale of the bonds:
GENERAL JOURNAL
Date
2020
Descriptions

PR
Page Number 01

Debit
Credit

Cash

7,875,000

Bonds Payable

7,500,000

Premium on bonds payable

375,000
Note:
1. The bond premium is in effect a gain on the part of the issuing entity because it received
more than what it is obligated to pay under the terms of the bond issue.
2. The obligation of the issuing entity is limited only to the face value of bonds.
3. The bond premium is not reported as an outright gain.
4. 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.
▪ In the previous example, if the bonds have a 10-year life and the straight-line method
is used for simplicity, the entry to record the amortization of the bond premium is:
GENERAL JOURNAL
Date
2020
Descriptions

PR
Page Number 01
Debit
Credit

Premium on bonds payable

37,500

Interest expense (375,000/10)

37,500

• Issuance of Bonds at a Discount

▪ The sales price of the bonds is less than the face value
▪ The effective rate is higher than the nominal rate.
▪ The buyer wants to accept a rate of interest that is somewhat higher than the nominal
rate.
▪ Example: An entity sells Php 7,500,000 face value of bonds at 95.
▪ Entry to record the sale of bonds:
GENERAL JOURNAL
Date
2020
Descriptions

PR
Page Number 01

Debit
Credit

Cash

7,125,000

Discount on bonds payable

375,000

Bonds Payable
7,500,000
Note:
1. The bond discount is in effect a loss to the issuing entity. However, it is not treated as an
outright loss.
2. The bond discount is amortized as a loss over the life of the bonds and charged to
interest expense.
▪ Thus, in the preceding example, if the bonds have life of 10 years and the straight-line
method is used, the entry to record the amortization of bond discount is:
GENERAL JOURNAL
Date
2020
Descriptions

PR
Page Number 01

Debit
Credit

Interest expense (375,000/10)

37,500

Discount on bonds payable

37,500

• Presentation of Discount and Premium

▪ Discounts and premium on bonds are reported as adjustments to the bond liability
account
▪ The discount on bonds payable is a deduction from the bond payable and the
premium on bond payable is an addition to the bond payable
▪ Observe the following presentation in the statement of financial position:
Non-current liabilities: Bonds payable
Discount on bonds payable

Non-current liabilities: Bonds payable

Premium on bonds payable

Php 7,500,000
(375,000) Php 7,125,000
Php 7,500,000
375,000
Php 7,875,000

▪ The amortization of bond discount or premium may be on every interest date or at the
end of the year (theoretically, it must be specified in the problem)

Bond Issue Costs

• Transaction costs directly attributable to the issue of bonds payable, i.e. printing and
engraving cost, legal and accounting fee, registration fee with regulatory authorities,
commission paid to agents and underwriters and other similar charges.
• (PFRS 9) – BICs shall be deducted from the fair value of issue price of bonds payable in
measuring initially the bonds payable, but shall be expensed outright if the bonds are
measured at fair value through profit or loss.
• Under the effective interest method of amortization, the bond issue costs must be “lumped”
with the discount on bonds payable and “netted” against the premium on bonds payable.

Recording interest on bonds

• Requires recognition of two items, namely:
a. Payment of interest during the year
b. Accrual interest at the end of the year

GENERAL JOURNAL
Date
2020
Descriptions

PR
Page Number 01

Debit
Credit
Sept 1
Interest expense

450,000
Cash
*Semi-annual interest payment
(Php 7,500,000 x 12% x ½ = 450,000)

450,000
Dec 31
Interest expense

300,000

Accrued interest payable

*Interest accrued for 4 months from September to December 31, 2020
(Php 7,500,000 x 12% x 4/12 = 300,000)

300,000

GENERAL JOURNAL

Date
2021
Descriptions

PR
Page Number 01

Debit
Credit

Jan 1
Accrued interest payable

300,000
Interest expense
*Reversing entry

300,000

Mar 1
Interest expense

450,000

Cash
*Semi-annual payment

450,000

GENERAL JOURNAL

Date
2021
Descriptions

PR
Page Number 01

Debit
Credit

Sept 1
Interest expense

450,000
Cash
*Semi-annual payment

450,000

Dec 31
Interest expense

300,000

Accrued interest payable

*Interest accrued for 4 months from September to December 31, 2020
(Php 7,500,000 x 12% x 4/12 = 300,000)

300,000

Issuance of Bonds
Note: Issuance of bonds may be made:
a. On interest date
b. Between interest dates
◦ If the bonds are issued between interest dates, an accrued interest is involved.
Normally, when bonds are issued between interest dates, the accrued interest is paid by the
buyer or investor.
◦ Accrued interest may be recorded using expense method or accrual method but the
expense method is preferred.

Expense Method
• Issuance at a premium
GENERAL JOURNAL
Date
2021
Descriptions

PR
Page Number 01
Debit
Credit

Cash

xxx

Bonds Payable

xxx

Premium on bonds payable

xxx

Interest Expense

xxx

• Issuance at a discount
GENERAL JOURNAL
Date
2021
Descriptions

PR
Page Number 01

Debit
Credit

Cash

xxx

Discount on Bonds Payable

xxx

Bonds Payable

xxx

Interest Expense

xxx

• First interest payment after issuance

GENERAL JOURNAL
Date
2021
Descriptions

PR
Page Number 01

Debit
Credit

Interest expense (including the accrued interest)

xxx

Cash

xxx
Accrual Method
• Issuance at a premium
GENERAL JOURNAL
Date
2021
Descriptions

PR
Page Number 01
Debit
Credit

Cash

xxx

Bonds Payable

xxx

Premium on bonds payable

xxx

Accrued Interest Payable

xxx

• Issuance at a discount
GENERAL JOURNAL
Date
2021
Descriptions

PR
Page Number 01

Debit
Credit

Cash

xxx

Discount on Bonds Payable

xxx

Bonds Payable

xxx

Accrued Interest Payable

xxx

• First interest payment after issuance

GENERAL JOURNAL
Date
2021
Descriptions

PR
Page Number 01

Debit
Credit

Interest expense

xxx

Accrued Interest Payable

xxx

Cash

xxx

Retirement of Bonds
Bonds may be retired:
• On maturity date
 • Before maturity date
◦ When bonds are reacquired prior to maturity date, they may be:
▪ Cancelled and permanently retired
(Procedures)
1. Premium or discount should be amortized up to the date of retirement
2. The balance of the bond or premium should be determined. This balance is important
because the amount related to the bonds retired is cancelled.
3. The accrued interest to the date of retirement should be determined.
4. The total cash payment should be computed. This is equal to the retirement price plus
accrued interest. The retirement price is a certain percent of the face amount of the bonds.
5. The carrying amount of the bonds retired is determined. The face amount of the bonds
plus the unamortized premiums or minus the unamortized discount gives the carrying amount
of the bonds.
6. The gain or loss on the retirement of the bonds is computed.
◦ This is the difference between the retirement price and the carrying amount of the
bonds.
◦ If the retirement price is more than the carrying amount of the bonds, there is a loss.
◦ If the retirement price is less than the carrying amount of the bonds, there is a gain.
7. The retirement of the bonds is then recorded by cancelling the bond liability together with
the unamortized premium or discount. Any accrued interest is debited to interest expense.
▪ Held in the treasury for future reissue when the need for fund arises.