(Intermediate Accounting 2)

LECTURE AID

ZEUS VERNON B. MILLAN

Chapter 3 Bonds Payable & Other Concepts
Learning Competencies

• State the initial and subsequent

measurement of bonds payable.
• Account for compound financial
instruments.
• Explain the accounting for derecognition of
liabilities.
• State the requirements for the offsetting of
financial assets and financial liabilities.
Bonds payable

• Bonds are long-term debt instruments similar to term

loans and notes except that they are usually offered to
the public and sold to many investors.

• Bond indenture is the contractual arrangement between

the issuer and the bondholders. It contains restrictive
covenants intended to prevent the issuer from taking
actions contrary to the interests of the bondholders.
 Types of bonds

• As to maturity
1. Term bonds – bonds that mature on a single date.
2. Serial bonds – bonds that have series of maturity dates. These bonds
are payable in installments.

3. Extendible and Retractable bonds – bonds that have more than one
maturity date permitting investors to choose the maturity dates that meet
their needs.
a. Extendible bonds – bonds that give holders the right to extend
the initial maturity to a longer maturity date.
b. Retractable bonds – bonds that give holders the right to advance
the return of principal to an earlier date than the original maturity.
Types of bonds (continuation)

• As to recording point of view and payment of interests

4. Registered bonds – bonds issued in the name of the holder
(owner). Interests are paid directly to the holder. When the holder sells
registered bonds, the bond certificate must be surrendered and a new
certificate is issued.

5. Coupon (bearer) bonds – bonds that can be freely transferred

and have a detachable coupon for each interest payment.

6. Zero-coupon bonds (strip bonds or deep-discount bonds) –

bonds that do not pay periodic interests. Principal and compounded
interests are due only at maturity date.
Types of bonds (continuation)

7. Income bonds – bonds that pay interest only if the issuer earns
profits.

8. Participating bonds – bonds that participate in excess earnings of

the issuer as defined in the indenture.

9. Indexed bonds (purchasing power bonds) – bonds that pay

interest that is indexed to a measure of general purchasing power.

10. Inflation-linked bonds (Treasury Inflation Protected Securities

‘TIPS’) – bonds that provide protection against inflation in that the
principal is increased by the change in inflation over a period.
Types of bonds (continuation)
• As to security and risk
11. Mortgage bonds – bonds secured by real property.
12. Collateral trust bonds – bonds secured by the issuer’s financial
assets or the issuer’s own equity instruments which are deposited and
held by a trustee for the bondholders.
13. Asset-backed securities – bonds based on underlying pools of
assets.
14. Subordinated bonds (subordinated debentures) – bonds that
normally have a higher yield than secured bonds. They are
subordinated (inferior) to the claims of other general creditors, secured
parties, and parties with priorities in bankruptcy.
Types of bonds (continuation)
15. Debenture bonds – long-term bonds not secured by specific
property.
16. Junk bonds – bonds that are very high-risk, high-yield securities
issued to finance leveraged buyouts and mergers. They are issued by
troubled companies.

• As to right of redemption
17. Callable bonds – bonds that contain call provisions giving the
issuer thereof the right to redeem the bonds prior to their maturity
date.
18. Convertible bonds – bonds that give the holder thereof the
option of exchanging the bonds for shares of stocks of the issuer.
Types of bonds (continuation)
• As to issuer
19. Corporate bonds – bonds issued by private companies.

20. Government Bonds – bonds issued by a government and backed

by its full faith and credit.

• As to currency
21. International bonds –
(a) Foreign bonds – bonds denominated in the currency of the
nation in which they are sold.
(b) Euro bonds – bonds denominated in a currency other than
that of the nation where they are sold.
 Types of bonds (continuation)
22. Foreign currency bonds - – bonds issued by a foreign entity in a
domestic market. Foreign bonds are denominated in the domestic market’s
currency and are regulated by the domestic market authorities.

• Examples of foreign bonds:

• Samurai bonds – yen-denominated bonds issued in Japan by a foreign entity.
• Kangaroo bonds or Matilda bonds – Australian dollar-denominated bonds issued in
Australia by a foreign entity.
• Maple bonds – Canadian dollar-denominated bonds issued in Canada by a foreign
entity.
• Matador bonds – Euro-denominated bonds (Spain’s currency is Euro) issued in Spain
by a foreign entity.
• Bulldog bonds – British pound-denominated bonds issued in the British market by a
foreign entity.
• Yankee bonds – US dollar-denominated bonds issued in the US market by a foreign
entity.
Accounting for bonds

• Bonds are accounted for in much the same way as

notes and loans payable. However, bonds normally are
long-term, bear interest, issued at a premium or
discount, and entail transaction (issue) costs.
Bond premium and discount

INTERMEDIATE ACCTG 2 (by:

MILLAN)
Accounting for transaction costs

• Transaction costs on the issuance of bonds (bond issue costs) are

included in the carrying amount of the bonds and amortized using
the effective interest method.

• Transaction costs are deducted when determining the carrying

amount of the bonds payable.
Issuance of bonds in between interest dates

• When bonds are issued in between interest dates, any accrued

interest prior to the issuance date is sold to the investor
together with the bonds.
• Any accrued interest charged to an investor should not be
included in the carrying amount of the bond but rather
credited to interest expense or interest payable.
• Moreover, the net interest expense recognized during the
period should represent only the post-issuance interest
expense.
Issue price of bonds

• The issuer may want to estimate the issue price of a bond

under a specified current market rate. The estimated
issue price is simply computed as the present value of
the future cash flows of the bonds discounted at a
specified effective interest rate.
Treasury bonds

• Treasury bonds are an entity’s own bonds which were

originally issued but subsequently reacquired but not
cancelled. Treasury bonds are presented in the financial
statements as a deduction from bonds payable issued to
arrive at the carrying amount of bonds payable
outstanding.
Bond refunding

• Bond refunding refers to the issuance of new bonds

(normally with lower interest rate), the proceeds from
which is used to retire existing outstanding bonds.

• Bond refunding is treated as an extinguishment of the

outstanding bonds.
Retirement of bonds prior to maturity

• Retirement of bonds, whether prior to maturity or at maturity and

whether through refunding or nonrefunding, is treated as
extinguishment of liability.

• The carrying amount of the bonds is updated for any discount

or premium amortization up to the date of extinguishment and any
difference between the updated carrying amount and the
reacquisition price is recognized in profit or loss as gain or
loss from extinguishment.
Compound financial instruments

• A compound financial instrument is a financial

instrument that, from the issuer’s perspective, contains
both a liability and an equity element. These
elements are classified and accounted for separately.
Accounting for compound financial instruments
Reclassification

• An entity shall not reclassify any financial liability.

Derecognition of a financial liability

• An entity shall remove a financial liability (or a part of a

financial liability) from its statement of financial position
when it is extinguished such as when the obligation
specified in the contract is discharged or cancelled or
expires.
Transfer of noncash assets (Asset swap)

• When an obligation is settled by transferring noncash

assets to the creditor, the difference between the
carrying amount of the liability extinguished and the
carrying amount of the noncash asset transferred is
recognized in profit or loss.
Transfer of equity securities (Equity swap)

• The difference between the carrying amount of the

financial liability extinguished and the consideration
paid (i.e., fair value of equity instrument or fair value
of financial liability extinguished, whichever is more
clearly determinable) is recognized in profit or loss.
Modification of terms
• A substantial modification of the terms of an existing financial
liability (whether or not attributable to the financial difficulty of the
debtor) shall be accounted for as an extinguishment of the original
financial liability and the recognition of a new financial liability.

• The terms are substantially different if the present value of the

cash flows under the new terms, discounted using the original
effective interest rate, is at least 10% different from the carrying
amount of the original financial liability.
Offsetting a financial asset and a financial
liability
• An entity shall offset a financial asset and a financial liability and the
net amount presented in the statement of financial position only
when the entity
1. currently has a legally enforceable right to set off the recognized
amounts; AND
2. intends either to settle on a net basis, or to realize the asset and settle
the liability simultaneously.
INTERMEDIATE ACCTG 2 (by: MILLAN)