CHAPTER 5

BONDS
PAYABLE
 What is Bond
● it is used primarily by corporations and government units
● 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 investor.
● evidenced by a certificate and the contractual agreement between the issuer and
investor is contained in a document known as “bond indenture”.
Term and
Serial
 Term Bonds Serial Bonds
● bonds with a single date of ● bonds with series of maturity
maturity dates instead of a single one.

● may require the issuing entity ● allow the issuing entity to

to establish a sinking fund to retire the bonds by installments.
provide adequate money to
retire the bond issue at one
time.
Secured and
Unsecured
 Secured Bonds Unsecured Bonds
● Mortgage bonds are bonds ● Debenture bonds are
secured by a mortgage on real unsecured or bonds without
properties collateral security.
● Collateral trust bonds are
bonds secured by shares and
bonds of other corporation.
Registered
and Bearer
 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.
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 or bearer bonds is paid to
the person submitting a detachable
interest coupon.
Other Types of Bonds
● Convertible bonds - are bonds that can be exchanged for shares of the
issuing entity.
● Collable bonds - are bonds which may be called in for redemption prior to
the maturity date.
● 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 conditon.
● 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.
Features of bond issue
a. A bond indenture or deed of trust is the document which shows in details
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 i business practice is ₱ 1, 000
although smaller denomination 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,
who then distributes the funds to the bondholders.
Contents of 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 payment
c. Period of grace allowed to issuing entity
d. Establishment of a sinking fund and the periodic deposit therein.
e. Deposit to cover interest in 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.

Sale of Bonds
● bonds are divided into various denominations of say ₱100, ₱1,000,
₱10,000, thus enabling more that one buyer or investor to purchase the
bonds.
● bonds are sold in equal denomination of say ₱1,000 only. The ₱1,000
denomination is called the face amount of the bonds. Each bond is evidenced
by a certificate called a bond certificate.
● if bonds with face amount of 50,000,000 are sold, divided into ₱1,000
denomination, there shall be 50,000 bond certificates containing a face
amount of ₱1,000.
● 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 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 d. April 1 and October 1
b. February 1 and August 1 e. May 1 and November 1
c. March 1 and September 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.
Initial measurement of bonds 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 attributes 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.
● If the bonds are designated and accounted for “at fair value through
profit or loss”, the bond issue costs are treated as expense immediately.
Subsequent 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

Amortized cost of bonds payable

- is the amount at which the bond liability is measured initially minus principal
repayment, plus minus the cumulative amortization using the effective interest
method of any difference between the face amount and present value of the bonds
payable.
Accounting for issuance of bonds
2 approaches in accounting for the authorization and issuance of bonds
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 ₱5,000,000, interest payable January 1 and July 1, consisting of 5,000 units
of ₱1,000 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 ₱5,000,000 face amount, 10-year
12％ bonds, interest payable January 1 and July 1, consisting of 5,000 units of ₱1,000
face amount.

The 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
On January 1, 2020, the entity is authorized to issue ₱5,000,000 face amount, 10-year
12％ bonds, interest payable January 1 and July 1, consisting of 5,000 units of ₱1,000
face amount.

The 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
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 premium.
For example, an entity issued bonds with face amount of ₱5,000,000 at 105. The
quoted price of 105 means”105% of the face amount of the bonds.” Thus, the sales
price is ₱5, 250,000, computed by multiplying 105% by ₱5,000,000.
Journal entry
Cash 5,250,000
Bonds payable 5,000,000
Premium on bonds payable 250,000
● 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 is howeveris 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.
● in such case, the effective rate is less than the nominal rate of interest.
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.
● if the bonds have a 10-year life and the straight line method is used for simplicity,
the entry to record the amorization of the bond premium is:

Premium on bonds payable 25,000

Interest expense (250,000/10years) 25,000
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 ₱5,000,000 at 95.
Journal entry
Cash (5,000,000 x 95%) 4,750,000
Discount on bonds payable 250,000
Bonds payable 5,000,000

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.
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 (250,000/10years) 25,000
Discount on bonds payable 25,000

Presentation of discount and premium

● the discount on bond payable is a deduction from the bond payable and the
premium on bond payable is an addition to the bond payable.
● the discount on bonds payable and the premium on bonds payable shall not be
considered separate from the bonds payable account. Both accounts shall be treated
consistently as valuation accounts of the bond liability.
Observe the following presentation in the statement of financial position.

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

Bond issue costs

-are transaction costs directly attributable to the issue of bonds payable.
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.

Recording interest on bonds

Accounting for interest expense on bonds requires recognition of two items, namely:
a. Payment of interest during the year
b. Accrual of interest at the end of the year
Illustration
On Mach 1, 2020, an entity sold bonds with face amount of ₱5,000,000 and 12%
interest payable semiannually on March 1 and September 1.

Inasmuch as the bonds are sold on March 1, 2020, the first payment of interest will be
on September 1, 2020.

Journal entries
2020
Sept. 1 Interest expense 300,000
Cash 300,000
Semiannual interest payment
(5,000,000 x 12% x 1/2 = 300,000)
Dec. 31 Interest expense 200,000
Accrued interest payable 200,000
Interest accrued for 4 months from
september 1 to December 31, 2020
(5,000,000 x 12% x 4/12=200,000
2021
Jan. 1 Accrued interest payable 200,000
Interest expense 200,000
Reversing entry
March 1 Interest expense 300,000
Cash 300,000
Semiannual interest payment
Sept. 1 Interest expense 300,000
Cash 300,000
Semiannual interest payment
Dec. 31 Interest expense 200,000
Accrued interest payable 200,000
Interest accrued for 4 months from
September 1 to December 31, 2021

Issuance of bonds on interest date

On June 1, 2020, an entity issued bonds with face amount of ₱5,000,000 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.

Journal entries
2020
June 1 Cash (5,000,000 x97%) 4,850,000
Discount on bonds payable 150,000
Bonds payable 5,000,000
Dec. 1 Interest expense 300,000
Cash 300,000
Semiannual interest payment
31 Interest expense 50,000
Accrued interest payable 50,000
Interest accrued for 1 month from
December 1 to December 31, 2020
(5,000,000 x 12% x 1/12 = 50,000)
31 Interest expense 17,500
Discount on bonds payable 17,500

Amortization of bond discount

from June 1 to December 31, 2020
(₱150,000 / 5years = ₱ 30,000
annual amortization, x 7/12 = ₱17, 500)
The amortization of the bond discount or premium may be on every interest date or at
the end of every year.
2021
Jan. 1 Accrued interest payable 50,000
Interest expense 50,000
Reversing entry

June 1 Interest expense 300,000

Cash 300,000

Dec. 1 Interest expense 300,000

Cash 300,000
Semiannual interest payment
31 Interest expense 50,000
Accrued interest payable 50,000
Interest accrued for one month
31 Interest expense 30,000
Discount on bonds payable 30,000
Amortization of bond discount
for one year, 2021
If a statement of financial position is prepared on December 31, 2021, the accrued
interest payable of ₱50,000 is classified as current liability.
The bonds payable should be classified as noncurrent liability:
Bonds payable 5,000,000
Discount on bonds payable ( 102,500)
Carrying amount 4,897,500
Issuance of bonds between interest dates
On April 1, 2020, an entity issued bonds with face amount of ₱5,000,000 at ₱5,228,000
plus accrued interest.
The bonds are dated January 1, 2020, mature in 5 years and pay 12% interest
semiannually on January 1 and July 1.
To record the issue of the bonds on April 1, 2020.
Cash 5,378,000
Bonds payable 5,000,000
Premium on bonds payable 228,000
Interest expense 150,000
Issue price 5,228,000
Add: Accrued interest from January 1 to April 1, 2020
(5,000,000 x 12% 3/12) 150,000
Total cash received 5,378,000
Note that 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.

The accrued interest on the date of sale for 3 months from January 1 to April 1, 2020 is
paid by the investor because on July 1, 2020, three moths after the sale, the investor is
going to receive interest for 6 months from January 1 to July 1, 2020.

The accrued interest “sold” is credited to interest expense.

On July 1, 2020, the journal entry to record the paymentof semiannual interest is:
Interest expense (5,000,000 x 12% x 1/2) 300,000
Cash 300,000
Another approach for the interest accrued
Another approach is to credit the accrued interest on the date of sale to accrued
interest payable account.

Cash 5,378,000
Bond payable 5,000,000
Premium on bonds payable 228,000
Accrued interest payable 150,000

The payment of first semiannual interest is recorded as:

Accrued interest payable 150,000
Interest expense 150,000
Cash 300,000
In either approach, the debit balance of the interest expense account must be
₱150,000, the correct interest expense.

The approach of crediting interest expense instead of accrued interest payable is

preferable.

Continuing the illustration, on December 31, 2020, the adjusting entries are:
a. Interest expense 300,000
Accrued interest payable 300,000
Interest accrued for 6 months from
July 1 to December 31, 2020
b. Premium on bonds payable 36,000
Interest expense 36,000
Original life of bonds (5 years x 12) 60 months
Less: Expired Life on the date of sale
(January 1 to April 1) 3 months
Remaining life of bonds 57 months
Monthly amortization (228,000/57 months) 4,000

Amortization for 9 months from

April 1 to cember 31, 2020 (4,000 x 9) 36,000

The straight line method is used in amortizing the premium on bonds payable for
simplicity.
Financial statement presentation
If a statement of financial position is prepared on December 31, 2020, the accrued
interest payable of ₱300,000 is classified as noncurrent liability.

Bonds payable, due January 1, 2025 5,000,000

Premium on bonds payable 192,000
Carrying amount 5,192,000

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 thfund to approximately equal the amount of bond issue on maturity date.
Illustration
An entity sold bods with face amount of ₱5,000,000 on March 1, 2020 with 12%
interest payable March 1 and September 1 and the bonds mature on march 1, 2025.

On March 1, 2025, the journal entry to retire the bonds together with the payment of
the last semiannual interest out of a sinking fund is:

Bonds payable 5,000,000

Interest expense 300,000
Sinking fund 5,300,000
If a sinking fund is not used, the payment of the bonds will come from the general
cash of the issuing entity.
Bonds payable 5,000,000
Interest expense 300,000
Cash 5,300,000

Bond retirement prior to maturity date

When bonds are reacquired prior to maturity date, they may be canceled and
permanently retired, or held in the treasury for future reissue when the need for fund
arises.
The retirement of bonds prior to maturity date may present some complex accounting
problems.
If the reacquired bonds are canceled and permanently retired, the following
procedures are followed.
1. The bond premium or bond discount should be amortized up to the date of
retirement.
2. The balance of the bond premium or bond discount should be determined. This
balance is important because the amount related to the bonds retired is canceled.
3. The accrued interest to date of retirement should be determined.
4. The total cash payment should be computed. This is equal to the retirement price
plus the 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 premium or minus the unamortized discount gives the
carrying amount of the bounds.
6. The gain or loss on the retirement of the bonds is computed.
This is the diffrence 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 loss.
If the retirement price is less than the carrying amount of the bonds, there is gain.
7. The retirement of the bonds is then recorded by canceling the bond liability
together with the unamortized premium or discount. Any accrued interest is debited
to interest expense.

Illustration
On March 1, 2020, bonds with face amount of ₱5,000,000 are issued for ₱4,730,000.
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 of amortization is used for simplicity.

All of the bonds are retired on July 1, 2023 at 97.

1. The amortization of the bond discount is recorded up to July 1, 2023. If the entity
uses the calendar period, presumably, the last amortization was on December 31,
2022.
Thus, an amortization of the dicount for 6 months from January 1 to July 1, 2023
should be recorded.

Interest expense 27,000

Discount on bonds payable 27,000
(270,000 /5 years = 54,000 annual amortization)
(54,000 x 1/2 = 27,000)
2. Balance of the discount on bonds payable
Discount on bonds payable - March 1, 2020 270,000
Less: Amortization from March 1, 2020
to July 1, 2023 or 40 months (40/60 x 270,000) 180,000
Balance, July 1, 2023 90,000
3. The accrued interest on the date of retirement, July 1, 2023 is computed as
₱5,000,000 x 12% x 4/12 = ₱200,000
The last payment of interest was March 1, 2023. Thus, the accrued interest is for 4
months, from March 1 to July 1, 2023.
4. Total cash payment
Retirement price (₱5,000,000 x 97) 4,850,000
Add: Accrued interest 200,000
Total cash payment 5,050,000
5. Carrying amount of the bonds payable
Bonds payable 5,000,000
Discount on bonds payable ( 90,000)
Carrying amount on July 1, 2023 4,910,000
6. Gain on yhe early retirement or extinguishment
Carrying amount of bonds payable 4,910,000
Less: Retirement price 4,850,000
Gain on early retirement 60,000
7. To record the retirement of the bonds on July 1, 2023
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
Query
-Suppose in the preceding illustration, not all the bonds are retired on July 1, 2023?
-Suppose only bonds with face amount of ₱1,000,000 are retired at 97?
-The same procedures discussed previously are followed.
Thus the amortization of the discount is updated on July 1, 2023.
Interest expense 27,000
Discount on bonds payable 27,000
On July 1, 2023, after recording the discount amortization the discount on bonds payable will
have an adjusted debit balance of ₱90,000.
a. Total cash payment
Retirement price (₱1,000,000 x 97) 970,000
Add: Accrued interest on ₱1,000,000
from March 1 to July 1, 2023
(₱1,000,000 x 12% x 4/12) 40,000
Total cash payment 1,010,000
Thus, the journal entry to record the retirement of the bonds with face amount of
₱1,000,000 is:
Bonds payable ₱1,000,000
Interest expense 40,000
Cash 1,010,000
Discount on bonds payable 18,000
Gain on retirement of bonds 12,000
In the immediately preceding illustration, the additional accounting problems would
be the entries subsequent to July 1,2023 pertaining to the remaining ₱4,000,000 face
amount.
Remaining journal entries for 2023
Sept. 1 Interest expense 240,000
Cash 240,000
(₱4,000,000 x 12% x 1/2 = 240,000)
Dec. 31 Interest expense 160,000
Accrued interest payable 160,000
(₱4,000,000 x 12% x 4/12)
Dec. 31 Interest expense 21,600
Discount on bonds payable 21,600
Amortization of bond discount
for 6 months
Note that the amortization of the bond discount was updated on July 1, 2023. Thus,
the amortization for 2023 shall only be for 6 months from July 1 to December 31,
2023.

● The original annual amortization is ₱54,000, ₱27,000 / 5 years. This amount pertains
to ₱5,000,000 face amount.
● Only ₱4,000,000 face amount remains. Thus, the annual amortization should be
revised to apply only to the ₱4,000,000 remaining face amount.
● Hence, ₱4,000,000/₱5,000,000 x ₱54,000 equals ₱43,200, revised annual
amortization. Thus, for six months from July 1 to December 31, 2023, the amortization
is ₱21,600.