Intermediate Accounting 2 Chapter 5

CHAPTER 5

A C TG 2 5 – I N T E R M E D I AT E A C C O U N T I N G 2

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INTRODUCTION
SCRIPOPHILY is the study and collection
of stock and bond certificates.

• Condition
• Age
• Signatures
• Rarity
• Aesthetics
• Type of Company
• Original Face Value
• Cancellation Markings
• Type of Engraving Process

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DEFINITION OF BOND
BOND is an instrument of indebtedness of the bond issuer to the holders.

ISSUER HOLDER

"Why would a corporation issue bonds instead of just borrowing from a bank?"

"Why not issue stocks or shares instead of bonds that need to be repaid?”

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TYPES OF BONDS
Term Bonds and Serial Bonds
Secured Bonds (Mortgage or Collateral) and Unsecured Bonds (Debenture)
Registered Bonds and Coupon Bonds (Bearer)
Convertible Bonds, Callable Bonds, Guaranteed Bonds, Junk Bonds, and Zero-
Coupon Bonds

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FEATURES OF BOND ISSUE

Bond Indenture or Deed of Trust
Bond Certificates
Trustee
Registrar or Disbursing Agent

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MEASUREMENT OF BONDS PAYABLE

DESIGNATION INITIAL SUBSEQUENT BOND ISSUE COSTS

BONDS PAYABLE Present Value Amortized Cost Deduction to the bonds

NOT DESIGNATED AT FVPL

BONDS PAYABLE Fair Value Fair Value Outright expense

AT FVPL

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BOND ISSUANCE ACCOUNTING

MEMORANDUM APPROACH JOURNAL ENTRY APPROACH
Unissued bonds payable 5,000,000

MEMO ENTRY Authorized bonds payable 5,000,000

Cash 5,000,000 Cash 5,000,000

Bonds payable 5,000,000 Unissued bonds payable 5,000,000

✓ X
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WHAT IS AMORTIZED COST?

INITIAL MEASUREMENT

LESS OR ADD
DIFFERENCE
between the FACE
DISCOUNT OR PREMIUM AMOUNT and the
PRESENT VALUE

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BOND PREMIUM VS BOND DISCOUNT

PREMIUM DISCOUNT

Stated Rate > Effective Rate Stated Rate < Effective Rate

Face Amount < Sales Price Face Amount > Sales Price

The obligation of the issuing entity is limited only to the FACE AMOUNT OF THE BONDS.

GAIN INTEREST EXPENSE LOSS

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ILLUSTRATIVE PROBLEM
An entity issued bonds with face amount of P5,000,000 at 105.

BOND ISSUED AT A PREMIUM

Cash (P5M x 105%) 5,250,000
Bonds payable 5,000,000
Premium on bonds payable 250,000

Premium on bonds payable 25,000

Interest expense 25,000

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ILLUSTRATIVE PROBLEM
An entity issued bonds with face amount of P5,000,000 at 95.

BOND ISSUED AT A DISCOUNT

Cash (P5M x 95%) 4,750,000
Discount on bonds payable 250,000
Bonds payable 5,000,000

Interest expense 25,000

Discount on bonds payable 25,000

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PRESENTATION OF PREMIUM AND DISCOUNT

Noncurrent liabilities:
Bonds payable 5,000,000
Discount on bonds payable (250,000) 4,750,000

Noncurrent liabilities:
Bonds payable 5,000,000
Premium on bonds payable 250,000 5,250,000

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INTEREST ON BONDS
Payment of interest during the year
Accrual of interest at the end of the year

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ILLUSTRATIVE PROBLEM (ISSUANCE OF BONDS AT INTEREST DATES)

On June 1, 2020, an entity issued bonds with face amount of P5,000,000 at 97. The bonds mature in 5
years and pay 12% interest semiannually on June 1 and December 1. The straight line method is used for
simplicity in amortizing discount on bonds payable.

2020
June 1 Cash (5M x 97%) 4,850,000
Discount on bonds payable 150,000
Bonds payable 5,000,000
Dec. 1 Interest expense (5M x 12% x 6/12) 300,000
Cash 300,000
Dec. 31 Interest expense (5M x 12% x 1/12) 50,000
Accrued interest payable 50,000
Dec. 31 Interest expense (150,000/5 years = 30,000 per year x 7/12) 17,500
Discount on bonds payable 17,500

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At December 31, 2021, the bonds payable will be reported as follows:

Noncurrent liabilities:
Bonds payable 5,000,000
Discount on bonds payable (102,500) 4,897,500

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ILLUSTRATIVE PROBLEM (ISSUANCE OF BONDS BETWEEN INTEREST DATES)

On April 1, 2020, an entity issued bonds with face amount of P5,000,000 at P5,228,000 plus accrued
interest. The bonds are dated January 01, 2020, mature in 5 years, and pay 12% interest semiannually on
January 1 and July 1.

2020
April 1 Cash (5,228,000 + 150,000) 5,378,000
Bonds payable 5,000,000
Premium on bonds payable 228,000
Interest expense (5,000,000 x 12% x 3/12) 150,000
July 1 Interest expense (5M x 12% x 6/12) 300,000
Cash 300,000

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BOND RETIREMENT
The RETIREMENT OF BONDS refers to the repurchase of bonds from investors that had
been previously issued.

BEFORE
AT MATURITY
MATURITY
DATE
DATE

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BOND RETIREMENT BEFORE MATURITY DATE

STEP 1 Amortize the bond premium or bond discount up to the date of retirement.

STEP 2 Compute for the remaining balance of the bond premium or bond discount for cancellation.

STEP 3 Determine the interest to be accrued up to the date of retirement.

STEP 4 Compute for the total cash payment = RETIREMENT PRICE PLUS ACCRUED INTEREST

STEP 5 Get the carrying amount of the bonds retired.

STEP 6 Determine gain or loss on retirement of the bonds = CARRYING AMOUNT LESS RETIREMENT PRICE

STEP 7 Retire the bonds by cancelling the bond liability and its related premium or discount.

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ILLUSTRATIVE PROBLEM
On March 1, 2020, bonds with face amount of P5,000,000 are issued for P4,730,000. The bonds are
dated March 1, 2020 and mature in 5 years, and pay 12% interest semiannually on March 1 and
September 1. The straight line method is used for simplicity in amortizing discount on bonds payable.
All of the bonds are retired on July 1, 2023 at 97.

STEP 1 Amortize the bond premium or bond discount up to the date of retirement.

July 1 Interest expense 27,000

Discount on bonds payable 27,000

(270,000/60 months = 4,500 per month x 6 = 27,000)

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STEP 2 Compute for the remaining balance of the bond premium or bond discount for cancellation.

Discount on bonds payable – March 1, 2020 (5M – 4.730M) 270,000

Less: Amortization from March 1, 2020 to July 1, 2023 (180,000)
(4,500 x 40 months)
Balance, July 1, 2023 90,000

STEP 3 Determine the interest to be accrued up to the date of retirement.

Accrued interest (5,000,000 x 12% x 4/12) 200,000

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STEP 4 Compute for the total cash payment = RETIREMENT PRICE PLUS ACCRUED INTEREST

Retirement price (5,000,000 x 97) 4,850,000

Accrued interest 200,000
Total cash payment 5,050,000

STEP 5 Get the carrying amount of the bonds retired.

Face amount 5,000,000

Unamortized discount (90,000)
Carrying amount, July 1, 2023 4,910,000

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STEP 6 Determine gain or loss on retirement of the bonds = CARRYING AMOUNT LESS RETIREMENT PRICE

Carrying amount, July 1, 2023 4,910,000

Retirement price (4,850,000)
Gain on early retirement 60,000

STEP 7 Retire the bonds by cancelling the bond liability and its related premium or discount.

Bonds payable 5,000,000

Interest expense 200,000
Cash 5,050,000
Discount on bonds payable 90,000
Gain on early retirement of bonds 60,000

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WHAT IF NOT ALL THE BONDS ARE RETIRED ON JULY 1, 2023?

The same procedures are followed.

It is a matter of pro-rata allocation.

Say P1,000,000 bonds were retired.

Bonds payable 1,000,000
Interest expense (P1M x 12% x 4/12) 40,000
Cash (P1M x 97% = 970,000 + 40,000) 1,010,000
Discount on bonds payable (90,000 unamortized x 1M / 5M) 18,000
Gain on early retirement of bonds (982,000 CA – 970,000 RP) 12,000

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BOND REFUNDING
BOND REFUNDING is the floating of new bonds, the proceeds from which are used in
paying the original bonds.

P1M P2M

• Refunding is made ON MATURITY DATE

• Refunding is made BEFORE THE MATURITY DATE
-issue on REFUNDING CHARGES (unamortized premium or discount and redemption
premium)

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ILLUSTRATIVE PROBLEM
1. Issuance of NEW 10-year 10% bonds, with face amount of P1,500,000 for P1,600,000.
2. Refunding of OLD 12% bonds, with remaining life of 4 years, at 102.
Bonds payable – old P1,000,000
Discount on bonds payable 30,000
Retirement price (1M x 102%) 1,020,000
Cash 1,600,000
Bonds payable (new) 1,500,000
Premium on bonds payable 100,000

Bonds payable (old) 1,000,000

Loss on extinguishment of bonds 50,000
(970,000 CA – 1,020,000 RP)
Cash 1,020,000
Discount on bonds payable 30,000

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AMORTIZATION OF BOND PREMIUM OR DISCOUNT

STRAIGHT LINE BOND OUTSTANDING EFFECTIVE INTEREST
METHOD METHOD METHOD

Equal amortization Amortization decreases as the

amount of bonds decreases
Discussed in Chapter 6

= Amount of premium or = (Bonds outstanding ÷ Total

discount ÷ Life of the bonds bonds outstanding)
X Amount of premium or
discount

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ILLUSTRATIVE PROBLEM (BOND OUTSTANDING METHOD)

Face amount of bonds 5,000,000

Issue price 5,300,000
Date of bonds January 1, 2020
Date of issue January 1, 2020
Interest rate 12%
Semiannual interest dates June 30 and December 31

The bonds mature on December 31 of each year at the rate of P1,000,000 for 5 years.

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AMORTIZATION TABLE

Year Bond outstanding Fraction Premium amortization

2020 5,000,000 5/15 100,000
2021 4,000,000 4/15 80,000
2022 3,000,000 3/15 X P300,000 60,000
2023 2,000,000 2/15 40,000
2024 1,000,000 1/15 20,000
15,000,000 300,000

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SERIAL BOND RETIREMENT BEFORE MATURITY DATE

If for example, P1,000,000 face amount of bonds, scheduled to be retired on December 31, 2022, are
prematurely retired on December 31, 2020 at 103.

STEP 1 Get the ratio of total premium or discount to the common denominator developed.

300,000 ÷ 15,000,000 = 0.02 amortization rate per year

STEP 2 Multiply the rate computed in Step 1 by the amount of bonds retired.

P1,000,000 x 0.02 = P20,000 unamortized premium per year

Multiply the unamortized premium or discount per year computed in Step 2 by the period from
STEP 3 the retirement date to the maturity date.

P20,000 x 2 years = P40,000 unamortized premium related to P1M

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ILLUSTRATIVE PROBLEM (BOND OUTSTANDING METHOD)

Face amount of bonds 5,000,000

Issue price 4,700,000
Date of bonds April 1, 2020
Date of issue April 1, 2020
Interest rate 12%
Semiannual interest dates April 1 and October 1

The bonds mature on April 1 of each year at the rate of P1,000,000.

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AMORTIZATION TABLE
Year Bond outstanding Fraction Premium amortization

Apr 1, 2020 – March 31, 2021 5,000,000 5/15 100,000

Apr 1, 2021 – March 31, 2022 4,000,000 4/15 80,000

X P300,000
Apr 1, 2022 – March 31, 2023 3,000,000 3/15 60,000

Apr 1, 2023 – March 31, 2024 2,000,000 2/15 40,000

Apr 1, 2024 – March 31, 2025 1,000,000 1/15 20,000

15,000,000 300,000

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2020 Apr 1 – Dec 31 100,000 x 9/12 75,000

2021 Jan 1 – Mar 31 100,000 x 3/12 25,000

Apr 1 – Dec 31 80,000 x 9/12 60,000 85,000

2022 Jan 1 – Mar 31 80,000 x 3/12 20,000

Apr 1 – Dec 31 60,000 x 9/12 45,000 65,000

2023 Jan 1 – Mar 31 60,000 x 3/12 15,000

Apr 1 – Dec 31 40,000 x 9/12 30,000 45,000

2024 Jan 1 – Mar 31 40,000 x 3/12 10,000

Apr 1 – Dec 31 20,000 x 9/12 15,000 25,000

2025 Jan 1 – Mar 31 20,000 x 3/12 5,000

300,000

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FAIR VALUE OPTION

INITIAL MEASUREMENT SUBSEQUENT MEASUREMENT

NO AMORTIZATION

FAIR VALUE FAIR VALUE

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ILLUSTRATIVE PROBLEM
On January 1, 2020, an entity issued bonds with face amount of P5,000,000 and 12% stated
interest rate for P5,379,100. The bonds are sold to yield 10%. Interest is payable annually on
December 31. The entity paid bond issue cost of P100,000. On December 31, 2020, the fair
value of the bonds is determined to be P5,300,000.

Cash 5,379,100
Bonds payable 5,379,100
Transaction cost 100,000
Cash 100,000

Interest expense (5M x 12%) 600,000

Cash 600,000
Bonds payable (5,379,100 – 5,300,000) 79,100
Gain from change in fair value 79,100

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CHANGE IN FAIR VALUE

TOTAL CHANGE IN FAIR VALUE

DUE TO CREDIT RISK REMAINING

OCI P/L

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EXERCISES
A C TG 2 5 – I N T E R M E D I AT E A C C O U N T I N G 2

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PROBLEM 5-9
Blue Company reported the following financial liabilities on December 31, 2020:

9% debentures, callable in 2021, due in 2022 3,500,000

11% collateral trust bonds, convertible into share
capital beginning in 2021, due in 2022 3,000,000
10% debentures, P300,000 maturing annually 1,500,000

What is the total amount of term bonds?

a. 3,000,000
b. 3,500,000
c. 5,000,000
d. 6,500,000

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SOLUTION 5-9

9% debentures 3,500,000

11% collateral bonds 3,000,000

TOTAL TERM BONDS 6,500,000

ANSWER: D
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PROBLEM 5-10
Hancock Company reported the following noncurrent liabilities on December 31, 2020:

Unsecured
9% registered bond, P250,000 maturing annually beginning in 2021 2,750,000
11% convertible bonds, callable beginning in 2021, due 2022 1,250,000
Secured
12% guaranty security bonds, due 2022 2,500,000
10% commodity backed bonds, P500,000 maturing annually beginning in 2021 2,000,000

1. What total amount of serial bonds should be reported?

a. 4,750,000
b. 3,750,000
c. 4,500,000
d. 2,000,000

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SOLUTION 5-10

9% registered bonds 2,750,000

10% commodity backed bonds 2,000,000

TOTAL SERIAL BONDS 4,750,000

ANSWER: A
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2. What is the total amount of debenture bonds?

a. 4,000,000
b. 1,250,000
c. 6,500,000
d. 6,000,000

9% registered bonds 2,750,000

11% convertible bonds 1,250,000

TOTAL DEBENTURE BONDS 4,000,000

ANSWER: A
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PROBLEM 5-12
Zola Company had the following long-term debt:

Bonds maturing in installments, secured by machinery 1,000,000

Bonds maturing on a single date, secured by realty 1,800,000
Collateral trust bonds 2,000,000

1. What is the total amount of debenture bonds?

a. 2,000,000
b.
c.
1,000,000
1,800,000 ANSWER: D
d. 0
2. What is total amount of secured bonds?
a. 4,800,000

ANSWER: A
b. 2,800,000
c. 3,800,000
d. 3,000,000

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PROBLEM 5-16
During the current year, Cain Company incurred the following costs in connection with the issuance of
bonds:

Promotion cost 200,000

Printing and engraving 150,000
Legal fees 800,000
Fees paid to independent accountants for registration information 100,000
Commissions paid to underwriter 900,000

What total amount should be recorded as bond issue cost?

a. 1,950,000
b. 2,150,000
c. 1,800,000
d. 2,000,000

ANSWER: B
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PROBLEM 5-17
Aye Company is authorized to issue P5,000,000 of 6%, 10-year bonds dated July 1, 2020 with interest
payments on June 30 and December 31. When the bonds are issued on November 1, 2020, the entity
received cash of P5,150,000 including accrued interest.

What is the discount or premium from the issuance of the bonds?

a. 150,000 bond premium
b. 50,000 bond premium
c. 150,000 bond discount
d. No bond premium and discount

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SOLUTION 5-17

Cash received 5,150,000

Accrued interest from June 30 to November 1, 2020 (5M x 6% x 4/12) (100,000)
Issue price of bonds payable 5,050,000
Face value 5,000,000
Premium on bonds payable 50,000

ANSWER: B
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PROBLEM 5-19
On January 31, 2020, Beau Company issued P3,000,000 maturity value, 12% bonds for P3,000,000
cash. The bonds are dated December 31, 2019, and mature on December 31, 2029. Interest will be paid
semiannually on June 30 and December 31.

What amount of accrued interest payable should be reported on September 30, 2020?
a. 270,000
b. 240,000
c. 180,000
d. 90,000

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SOLUTION 5-19

Accrued interest payable from July 1 to September 30, 2020 (3M x 12% x 3/12) 90,000

ANSWER: D
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PROBLEM 5-21
On January 1, 2020, Nilo Company reported bonds payable of P8,000,000 and related unamortized
discount of P430,000.

On January 1, 2020, the entity retired P4,000,000 of the outstanding bonds at face amount plus a call
premium of P100,000.

What amount should be reported in the 2020 income statement as loss on early extinguishment of
debt?
a. 0
b. 100,000
c. 215,000
d. 315,000

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SOLUTION 5-21

Bonds payable 8,000,000

Less: Discount on bonds payable (430,000)
Carrying amount 7,570,000
Carrying amount retired (4M/8M x 7,570,000) 3,785,000
Less: Retirement price (4M + 100) 4,100,000
Loss on early extinguishment (315,000)

ANSWER: D
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PROBLEM 5-23
On January 1, 2020, Carmina Company received P5,385,000 for a P5,000,000 face amount 12% bond, a
price that yields 10%. The bond pays interest semiannually on June 30 and December 31.

The entity elected the fair value option. On December 31, 2020, the fair value of the bond is
determined to be P5,125,000 based on market and interest factors.

1. What amount should be reported as interest expense for 2020?

a. 600,000
b. 500,000
c. 646,200
d. 538,500

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SOLUTION 5-23

Stated interest (12% x P5,000,000) 600,000

ANSWER: A
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2. What is the gain or loss that should be recognized in 2019 to report the bond at fair value?
a. 260,000 gain
b. 260,000 loss
c. 600,000 loss
d. 340,000 loss

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SOLUTION 5-23

Carrying amount – Jan. 1, 2020 5,385,000

Carrying amount – Dec. 31, 2020 5,125,000
Decrease in liability - gain 260,000

ANSWER: A
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3. What is the carrying amount of the bonds payable on December 31, 2020?

a. 5,385,000
b. 5,125,000
c. 5,000,000
d. 5,250,000

ANSWER: B
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4. Prepare journal entries for 2020.

Jan. 1 Cash 5,385,000

Bonds payable 5,385,000
June 30 Interest expense 300,000
Cash 300,000
Dec. 31 Interest expense 300,000
Cash 300,000
Dec. 31 Bonds payable 260,000
Gain from change in FV 260,000

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NEXT SESSIONS
ACTG25 – INTERMEDIATE ACCOUNTING 2

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CHAPTER 6
MULTIPLE CHOICE PROBLEMS

DISCUSSION ITEMS: 13, 14, 16, 17, 21, 22, 24, 27

ON THESE
MULTIPLE CHOICE THEORIES

ALL ITEMS UNDER

PROBLEMS 28 TO 30

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CHAPTER 7
MULTIPLE CHOICE PROBLEMS

DISCUSSION ITEMS: 9, 10, 11, 13, 16, 17, 18

ON THESE
MULTIPLE CHOICE THEORIES

ALL ITEMS UNDER

PROBLEMS 19 AND 20

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