NOTRE DAME OF MIDSAYAP COLLEGE

Midsayap, Cotabato

COLLEGE OF BUSINESS AND ACCOUNTANCY

LEONISA GUERRERO TORINO

BSA 2
INTERMEDIATE ACCOUNTING 2
CHAPTER 5

1. Define a bond.
Whenever funds being borrowed can be obtained from a small number of sources, mortgages or notes
are usually used. However, when large amounts are needed, an entity may have to borrow from the general
investing public through the use of a bond issue.
Bonds are used primarily by corporations and government units. A bond is 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.
In simple language, a bond is a contract of debt whereby one party called the issuer borrows funds from
another party called the investor. A bond is evidenced by a certificate and the contractual agreement between
the issuer and investor is contained in a document known as "bond indenture".

2. Explain some features of a bond.

a. A bond indenture or deed of trust is 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.
b. Bond certificates are used. Each bond certificate represents a portion of the total loan. The usual
minimum denomination in business practice is P1,000, although smaller denominations may be
issued occasionally.
c. If property is pledged as security for the 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.
d. 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.

3. What are some contents of a bond indenture?

The bond indenture is the contract between the bondholders and the borrower or issuing entity.
Normally, the bond indenture contains the following items:
a. Characteristics of the bonds
b. Maturity date and provision for repayment
c. Period of grace allowed to issuing entity
d. Establishment of a sinking fund and the periodic deposit therein.
e. Deposit to cover interest payments
f. Provisions affecting mortgaged property, such as taxes, insurance coverage, collection of interest or
dividends on collaterals
g. Access to corporate books and records of trustee
h. Certification of bonds by trustee
i. Required debt to equity ratio
j. Minimum working capital to be maintained, if any.

4. Define the following bonds:

a. Term bonds - are bonds with a single date of maturity. Term bonds may require the issuing entity to
establish a sinking fund to provide adequate money to retire the bond issue at
one time.
b. Serial bonds - are bonds with a series of maturity dates instead of a single one. In other words, serial bonds
allow the issuing entity to retire the bonds by installments.
c. Mortgage bonds - are bonds secured by a mortgage on real properties.
d. Collateral trust bonds - are bonds secured by shares and bonds of other corporation.
e. Debenture bonds - are unsecured or bonds without collateral security
 f. Registered bonds - require the registration of the name of the bondholders on the books of the corporation.
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 bondholders of record

g. Coupon or bearer bonds - are 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.
h. Convertible bonds - are bonds that can be exchanged for shares of the issuing entity.
i. Callable bonds - are bonds which may be called in for redemption prior to the maturity date.
j. Guaranteed bonds - are bonds issued whereby another party promises to make payment if the borrower
fails to do so.
k. Junk bonds - are high-risk, high-yield bonds issued by entities that are heavily indebted or otherwise in weak
financial condition.

5. Describe the process in the 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 P100, P1, 000, P10, 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 P1,000 only. The P1,000 denomination is called the face amount of the bonds. Each bond
is evidenced by a certificate called a bond certificate. Thus, if bonds with face amount of P50,000,000 are sold,
divided into P1,000 denomination, there shall be 50,000 bond certificates containing a face amount of P1,000.
The sale of the 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 amount of the bond issue on maturity
date and the periodic interest.
Interest is usually payable semiannually or every six months as follows:
a. January 1 and July 1
b. February 1 and August 1
c. March 1 and September 1
d. April 1 and October 1
e. May 1 and November 1
f. June 1 and December 1

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

6. When is interest on bonds usually payable?

PFRS 9, paragraph 5.1.1, provides that 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 the
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. However, if the bonds are designated and accounted for "at fair value through profit
or loss", the bond issue costs are treated as expense immediately. Actually, 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.

7. Explain the two approaches of recording the issuance of bonds.

There are two approaches in accounting for the authorization and issuance of bonds, namely:
a. Memorandum approach
b. Journal entry approach

Illustration On January 1, 2020, an entity is authorized to issue 10-year, 12% bonds with face amount of
P5,000,000, interest payable January 1 and July 1, consisting of 5,000 units of P1,000 face amount. The bonds
are sold at face amount to an underwriter.

Memorandum approach
The following memorandum entry is made in the general journal and a notation of the amount
authorized:
On January 1, 2020, the entity is authorized to issue P5,000,000 face amount, 10-year 12% bonds,
interest payable January 1 and July, consisting of 5,000 units of P1,000 face amount.
 To record the sale of the bonds at face amount:
Cash 5, 000, 000
Bonds payable 5,000,000

Journal entry approach

To record the authorization of the bonds:
Unissued bonds payable 5,000,000
Authorized bonds payable 5,000,000

To record the sale of the bonds at face amount:

Cash 5,000,000
Unissued bonds payable 5,000,000

8. Explain the issuance of bonds at a premium.

If the sales price is more than the face amount of the bonds, the bonds are said to be sold at a premium.
For example, an entity issued bonds with face amount of P5,000,000 at 105. The quoted price of 105 means
"105% of the face amount of the bonds." Thus, the sales price is P5,250,000, computed by multiplying 105% by
P5,000,000.
Journal entry
Cash 5,250,000
Bonds payable 5,000,000
Premium on bonds payable 250,000

The bond premium is in effect a gain on the part of the issuing entity because it receives more than what
it is obligated to pay under the terms of the bond issue. The obligation of the issuing entity is limited only to the
face amount of the bonds. The bond premium however is not reported as an outright gain. When the bonds are
sold at a premium, it means that the investor or the buyer is amenable to receive interest that is somewhat less
than the nominal or stated rate of interest.
Thus, in such a case, the effective rate is less than the nominal rate of interest. The nominal rate of
interest is 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.
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.
Accordingly, 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:
Premium on bonds payable 25,000
Interest expense (250,000/10 years) 25,000

9. Explain the issuance of bonds at a discount.

If the sales price of the bonds is less than the face amount the bonds are said to be sold at a discount.
For example, an entity issued bonds with face amount of P5,000,000 at 95.
Journal entry
Cash (5,000,000 x 95% )
Discount on bonds payable
Bonds payable

The bond discount is in effect a loss to the issuing entity. However, it is not treated as an
outright loss. When bonds are sold at a discount, it means that the buyer or investor is not willing to
accept simply the nominal rate of interest.
The buyer wants to accept a rate of interest that is somewhat higher than the nominal rate.
Thus, when bonds are issued at a discount, the effective rate is higher than the nominal rate.
Accountingwise, the bond discount is amortized as loss over the life of the bonds and charged to
interest expense. Thus, if the bonds have a life of 10 years and the straight line method is used, the
journal entry to record the amortization of the bond discount is:
Interest expense (250,000/10 years) 25,000
Discount on bonds payable 25,000

10. Explain the measurement of bonds payable.

PFRS 9, paragraph 5.3.1, provides that after initial recognition, bonds payable shall be measured either:
a. At amortized cost, using the effective interest method
b. At fair value through profit or loss
11. What is a bond issue cost?
Bond issue costs are transaction costs directly attributable to the issue of bonds payable. Such costs
include printing and engraving cost, legal and accounting fee, registration fee with regulatory authorities,
commission paid to agents and underwriters and other similar charges.

12. Explain the treatment of a bond issue cost.

Under PFRS 9, bond issue costs shall be deducted from the fair value or issue price of bonds payable in
measuring initially the bonds payable. 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."
However, if the bonds are measured at fair value through profit or loss, the bond issue costs are expensed
immediately.

13. What are treasury bonds?

Treasury bonds are an entity's own bonds originally issued and reacquired but not cancelled. The
acquisition of treasury bonds calls for the same accounting procedures accorded to a formal retirement of bonds
prior to the maturity date.

14. Explain the treatment of treasury bonds.

In other words, the treasury bonds should be debited at face amount and any related unamortized
premium or discount should be cancelled. Any accrued interest paid is charged to interest expense.. The
difference between the acquisition cost and the carrying amount of the treasury bonds is treated as gain or loss
on the acquisition of treasury bonds.

15. What is bond refunding?

Bond refunding is the floating of new bonds the proceeds from which are used in paying the original
bonds. Simply stated, bond refunding is a premature retirement of the old bonds by means of issuing new
bonds. Bond refunding is also known as bond refinancing.
Refunding may be made on or before the date of maturity of the old bonds. Where refunding is made
on the date of maturity of the old bonds, no accounting problem arises as this would simply call for the
cancelation of the bond liability. There is no unamortized premium or discount involved.
The retirement is handled in the usual manner and the new bond issue is recorded in the normal way.
However, where refunding is made prior to the maturity date of the old bonds, consideration must be given to
the refunding charges pertaining to the old bonds. The refunding charges include the unamortized bond
discount or premium and redemption premium on the old bonds being refunded.

16. Explain the treatment of bond refunding charges.

The accounting problem is the treatment of these refunding charges. Bond refunding shall be accounted
for as an extinguishment of a financial liability. The difference between the carrying amount of the financial
liability extinguished and the consideration paid shall be included in profit or loss. Accordingly, the refunding
charges are charged to loss on extinguishment.

17. What are the methods of amortizing discount or premium on bonds payable?
There are three approaches in amortizing bond premium or bond discount, namely:
a. Straight line - The straight line method provides for an equal amortization of bond premium or bond
discount. The procedure is simply to divide the amount of bond premium or bond discount by the
life of the bonds to arrive at the periodic amortization. The life of the bonds is that period
commencing on the date of sale of the bonds up to the maturity date.
b. Bond outstanding method - The bond outstanding method is applicable to serial bonds whether
issued at discount or premium. Serial bonds are those with a series of maturity dates.
c. Effective interest method or simply "interest method" or scientific method PFRS 9 requires the use
of the effective interest method in amortizing discount, premium and bond issue cost.

18. Explain the fair value option of measuring bonds payable.

PFRS 9. paragraph 4.2.2, provides that at initial recognition, bonds payable may be irrevocably
designated as at fair value through profit or loss.
In other words, under the fair value option, the bonds payable shall be measured initially at fair value
and remeasured at every year-end with any changes in fair value generally recognized in profit or loss. There is
no more amortization of bond discount and bond premium.
Any transaction cost or bond issue cost should be expensed immediately. As a matter of fact, interest
expense is recognized using the nominal or stated rate.
 19. What is the treatment in the change in fair value of a financial liability designated at fair value through profit
or loss?
PFRS 9, paragraph 5.7.7, provides that the gain or loss on financial liability designated at fair value
through profit or loss shall be accounted for as follows:
a. The change in fair value attributable to the credit risk of the liability is recognized in other income.
b. The remaining amount of the change in fair value is recognized in profit or loss.

However, Paragraph 5.7.8 provides that if presenting the change in fair value attributable to credit
risk would create or enlarge an accounting mismatch, all gains and losses including the effects of
changes in credit risk are recognized in profit or loss.

An accounting mismatch would be created or enlarged if presenting the effects of changes in the
credit risk in other comprehensive income would result in a material or greater difference in profit or
loss than if those amounts were presented in profit or loss.

Application Guidance B5.7.9 provides that amounts recognized in other comprehensive income
resulting from changes in fair value of credit risk of a financial liability designated at fair value through
profit or loss shall not be subsequently transferred to profit or loss. However, the cumulative gain or loss
recognized may be transferred within equity or retained earnings.

20. What is a credit risk?

Credit risk is the risk that the issuer of the liability would cause a financial loss to the other party by
failing to discharge the obligation. Credit risk does not include market risk such as interest risk, currency risk and
price risk.

REFERENCES:

BOOK - Valix, C.T., Peralta, J.F., & Valix, C.A.M. (2020). Intermediate Accounting Volume 2: Chapter 5:
BONDS PAYABLE: GIC ENTERPRISES & CO., INC