DEFINITION OF BONDS

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”.

Types of bonds
1. Term bonds are bonds with a single date of maturity.
2. Serial bonds are bonds with a series of maturity dates instead of a single one.
3. Mortgage bonds are bonds secured by a mortgage on real properties.
These bonds may be first mortgage bonds or bonds with senior claims on entity assets, or second mortgage bonds or bonds
with subordinated claims on entity assets.
4. Collateral trust bonds are bonds secured by stocks and bonds of other corporation.
5. Debenture bonds are bonds without collateral security. These bonds are unsecured and therefore rank as general creditors in
the preference of credits.
6. Registered bonds require the registration of the name of the bondholders on the books of the corporation.
7. Coupon or bearer bonds are unregistered bonds in the sense that the name of the bondholder is not recorded on the entity
books.

Other types of bonds

Convertible bonds are bonds that can be exchanged for shares of the issuing entity.

Callable 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 condition.

Features of bond issue

1. 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.
2. Bond certificates are used. Each bond certificate represents a portion of the total loan.
3. If property is pledged as security for the loan, a trustee is name to hold the title to the property serving as security.
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 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. Provision 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. Certificate of bonds by trustee
i. Required debt to equity ratio
j. Minimum working capital to be maintained, if any.

Initial measurement of bonds payable

Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 1
In accordance with 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 bonds payable.

The fair market value of the bonds payable is equal to the present value of the future cash payments to settle the bonds liability. It is
same as the issue price or net proceeds from the issue of the bonds, excluding accrued interest.

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.

Subsequent measurement of bonds payable

In accordance with PFRS 9, paragraph 5.3.1, 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

The “amortized cost” of bonds payable is the amount at which the bond liability is measure initially minus principal repayment, plus
or minus the cumulative amortization using the effective interest method of any difference between the face amount and the present
value of the bonds payable. Simply stated, the difference between the face amount and present value is either discount or premium and
is amortized using effective interest method.

Accounting for issuance of bonds

a. Memorandum approach – In this approach, no entry is made upon the authorization of the entity to issue bonds. Authorized
binds payable account is not maintained.

b. Journal entry approach – In this approach, a journal entry is made to record the authorized bonds payable.

Illustration

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

Memorandum Approach

“The entity is authorized on January 1, 2020, to issue P5,000,000 face value, 10-year 12% bonds, dated January 1, 2020, interest
payable January 1 and July, consisting of 5,000 units of P1,000 face value”.

The subsequent sale of the bonds at face value is recorded as follows:

Cash 5,000,000
Bonds Payable 5,000,000

In the succeeding discussions, the memorandum approach of accounting for bonds will be employed, as this is the one generally
followed.

Journal entry approach

The authorization of the bonds is recorded as follows:

Unissued bonds payable 5,000,000

Authorized bonds payable 5,000,000

The subsequent sale of the bonds at face value is recorded as follows:

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

Issuance of bonds at a premium

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If the sales price is more than the face value of the bonds, the bonds are said to be sold at a premium.

For example, an entity sells P5,000,000 face value bonds at 105. The quoted price of 105 means “105% of the face value 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 value 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 case, the effective rate is less that 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.

Needless to say, when bonds are sold at face value, the nominal interest rate and the effective interest rate are the same.

Accordingly, in the foregoing example, if the bonds have a 10-year life and the straight line method is issued for simplicity, the entry
to record the amortization 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 value, the bonds are said to be sold at a discount.

For example, an entity sells P5,000,000 face value bonds at 95. The sale of the bonds is recorded as follows:

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.

When bonds are sold at a discount, the effective rate is higher than the nominal rate.

Thus, in the preceding example, 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

Discount and bond payable and premium on bond payable are reported as adjustments to the bond liability account.

The discount on bond payable is a deduction from the bond payable and the premium on bond payable is a deduction to the bond
payable.

Bond issue costs

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Bond issue costs or “transaction costs” are incremental costs that are 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.

Bond issue costs are not treated as outright expense amortized over the life of the bond issue in a manner similar to that used for
discount on bonds payable. Bond issue costs are conceived as cost of borrowing and therefore will increase interest expense. The
amortization of bond issue costs is recorded by debiting interest expense and crediting bond issue cost.

Accordingly, bond issue costs shall be presented as a deduction from bonds payable.

Under the effective interest method of amortization, the bond issue cost must be “lumped” with the discount on binds 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

Of course, the items are in addition to the proper amortization of premium on bonds payable and discount on bonds payable.

Illustration

On March 1, 2020, entity sells P5,000,000 face value bonds with 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 ½ = 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 sells P5.000,000 face value bonds 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.
Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 4
Journal entries for 2020 and 2021
2020
June 1 Cash (5,000,000 x 97%) 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

Dec 31 Interest expense 50,000

Accrued interest payable 50,000

Interest accrued for one month from December 1 to December 31, 2020
(5,000,000 x 12% x 1/12 = 50,000)

Dec 31 Interest expense 17,500

Discount on bonds payable 17,500

Amortization of bond discount from June 1 to December 31, 2020

(P150,000 / 5 years = P30,000 annual amortization, x 7/12 = P17,500)

The amortization of the bond discount or premium may be on every interest date or at the end of every year. In the given example, the
amortization is made at the end of the year.

If amortization is made on every interest date, the entries are:

2020
Dec. 1 Interest expense 15,000
Discount on bonds payable 15,000
Amortization for 6 months from June 1 to December 1, 2020
(30,000 x 6/12 = 15,000)

Dec 31 Interest expense 2,500

Discount on bonds payable 2,500
Amortization for one month from December 1 to December 31, 2020
(30,000 x 1/12 = 2,500)

It is preferable to amortize only once at the end of the year.

2021
Jan. 1 Accrued interest payable 50,000
Interest expense 50,000
Reversing entry

June 1 Interest expense 300,000

Cash 300,000
Semiannual interest payment

Dec. 1 Interest expense 300,000

Cash 300,000
Semiannual interest payment

Dec. 31 Interest expense 50,000

Accrued interest payable 50,000
Interest accrued for one month

Dec. 31 Interest expense 30,000

Discount on bonds payable 30,000
Amortization of bond discount for one year, 2021

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If a statement of financial position is prepared on December 31, 2021, the accrued interest payable of P50,000 is classified as current
liability. The bonds payable should be classified as noncurrent liability as follows:

Bonds payable 5,000,000

Discount on bonds payable ( 102,500)
Carrying Amount 4,897,500

Issuance of bonds between interest dates

In the preceding example, the bonds are issued at the beginning of an interest period. This is not always true because securities can be
sold anytime after they are dated.

Since interest payments of fixed amounts must be paid on specified dates, some adjustments must be made at the time of sale for
interest that has accrued from the last payment date.

Illustration

On April 1, 2020, an entity sells P5,000,000 face value bonds at P5,228,000 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. The sake of the bonds on April 1, 2020 is
recorded as follows:

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% x 3/12) 150,000
Total cash received 5,378,000

Note that if the binds are sold between interest dates, an accrued interest is involved. Normally, when bonds are sold between interest
dates, the accrued interest is paid by the buyer or investor.

Thus, in the illustration, 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 months after the sale, the investor is going to receive interest for 6 months from January 1 to July 1,
2020. In the foregoing entry, the accrued interest “sold” is credited to interest expense.

On July 1, 2020, the journal entry to record the payment of semiannual interest is:

Interest expense (5,000,000 x 12% x 1/2) 300,000

Cash 300,000

Note that if at this point the interest expense account is posted, it has a debit balance of P150,000 which represents the correct amount
of interest expense from April 1 to July 1, 2020.

Another approach is to credit the accrued interest on the date of sale to accrual interest payable account, following this approach, the
sale of the binds is recorded as follows:

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

If the accrued interest payable account is credited for the accrued interest sold at the time of the sale of the bonds then the payment of
the first semiannual interest is recorded as follows:

Accrued interest payable 150,000

Interest expense 150,000
Cash 300,000

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The approach of crediting interest expense instead of accrued interest payable is preferable. This will be followed in succeeding
illustrations.

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 December 31, 2020 (4,000 x 9) 36,000

The straight line method is used in amortizing the premium on bonds payable for simplicity.

If the statement of financial position is prepared on December 31, 2020, the accrued interest payable of P300,000 is classified as
current liability. The bonds payable should be classified as noncurrent liability as follows:

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 bods at maturity.

Sinking fund or redemption fund is a fund set aside for the liquidation of long-term debt, more particularly bonds payable. As a rule,
sinking fund is classified as a noncurrent investment.

However, if the related bond payable is due to be settled within twelve months after the end of the reporting period, the sinking fund
shall be reclassified as current asset because the bond payable is also reclassified as current liability.

The classification of a cash fund shall parallel the classification applied to the related liability.

Illustration

An entity sells P5,000,000 face value bonds 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

However, not all bond issue require the creation of a dinking fund or redemption fund. If a sinking fund is not used, then payment of
the bonds will come from the general cash of the issuing entity.

In this case, the retirement of the bonds and the payment of the interest shall be recorded as follows:

Bonds payable 5,000,000

Interest expense 300,000
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 Cash 5,300,000

Bond retirement prior to maturity date

When bonds are reacquired prior to maturity date, they may be cancelled and permanently retired, or held in the treasury for future
reissue when the need for fund arises.

If the reacquired bonds are cancelled and permanently retired, the following procedures are followed.

1. The bond premium or bond discount and issue cost should be amortized up to the date of retirement.
2. The balance of the bond premium or bond discount and issue cost should be determined.
3. The accrued interest to date of retirement should be determined.
4. The total cash payment should be computed. The equal to the retirement price plus the accrued interest. The retirement price is a
certain present value of the face value of the bonds.
5. The carrying amount of the bonds retired is determined. The face value of the bonds plus the unamortized premium or minus the
unamortized discount and issue cost gives the carrying amount of 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 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 the recorded by canceling the bond liability together with the unamortized premium or discount and
issue cost. Any accrued interest is debited to interest expense.

Illustration

On March 1, 2020, P5,000,000 face value bonds are sold for P4,730,00. 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. The procedures for the retirement of the bonds on July 1, 2023 are:

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 discount for 6 months from January 1 to July 1, 2023 should
be recorded as follows:

Interest expense 27,000

Discount on bonds payable 27,000
(270,000/5 years = 54,000 annual amortization)
(54,000 x ½ = 27,000)

2. The balance of the discount on bonds payable is computed as follows:

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 follows: P5,000,000 x 12% x 4/12 = P200,000. 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. The total cash payment is computed as follows:

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

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

5. The carrying amount of the bonds is computed as follows:

Bonds payable 5,000,000

Discount on bonds payable ( 90,000)
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 Carrying amount on July 1, 2023 4,910,000

6. Gain or loss on the early retirement or extinguishment is computed as follows:

Carrying amount of bonds payable 4,910,000

Less: retirement price 4,850,000
Gain on early retirement 60,000

7. The journal entry to record the retirement of the bonds on July 1, 2023 is as follows:

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
The gain on early retirement or extinguishment of bonds may be presented as component of finance cost or other income.

Query
Suppose in the preceding illustration, not all the bonds are retired on July 1, 2023? Suppose only P1,000,000 face value bonds are
retired at 97?

The same procedures discussed previously are followed. Thus the amortization of the discount is updated as follows:

Interest expense 27,000

Discount on bonds payable 27,000

On July 1, 2023, after recording the discount amortization, the discount on the bonds payable will have an adjusted debit balance of
P90,000. The following computations are pertinent:

a. Total cash payment

Retirement price (P1,000,000 x 97) 970,000
Add: Accrued interest on P1,000,000
From March 1 to July 1, 2023
(P1,000,000 x 12% x 4/12) 40,000
Total cash payment 1,010,000

b. Carrying amount of bonds retired and gain on retirement

Bonds payable retired 1,000,000
Discount on bonds payable applicable to the bonds retired
(1,000,000/5,000,000 x 90,0000) ( 18,000)
Carrying amount – July 1, 2023 982,000
Less: Retirement price 970,000
Gain on early retirement 12,000
Note that the discount balance of P90,000 pertains to the P5,000,000 face value bonds, inasmuch as only P1,000,000 face value is
retired, necessarily the discount applicable to the P1,000,000 bonds or 1/5 of P90,000 or P18,000 should be cancelled.

Thus, the journal entry to record the retirement of the P1,000,000 face value bond is:

Bond payable 1,000,000

Interest expense 40,000
Cash 1,010,000
Discount on bonds payable 18,000
Gain on early 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 P4,000,000 face value bonds.

Remaining journal entries for 2023

Sep. 1 Interest expense 240,000

Cash 240,000
(P4,000,000 x 12% x ½ = 240,000)
Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 9
Dec. 31 Interest expense 160,000
Accrued interest payable 160,000
(P4,000,000 x 12% x4/12)

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 P54,000, P27,000 / 5 years. This amount pertains to the P5,000,000 face value bonds. Only
P4,000,000 face value bonds remain. Thus, the annual amortization should be revised to apply only to the P4,000,000 remaining face
value bonds.

Hence, P4,000,000/P5,000,000 x P54,000 equals P43,200 revised annual amortization. Thus, for six months from July 1 to December
31, 2023, the amortization is P21,600.

Treasury bonds

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

The difference between the acquisition costs and the carrying amount of the treasury bonds is treated as gain or loss on the acquisition
of treasury bonds.

Illustration

An entity originally issued P5,000,000 face value bonds at 105 or a premium of P250,000.

Subsequently, the entity reacquired P1,000,000 face value bonds to be placed in the treasury at 103.

At the time of the reacquisition, the unamortized premium balance is P200,000, the accrued interest on the treasury bonds is P30,000
which is paid in cash.

The journal entry to record the acquisition of the treasury bonds is:
Treasury bonds 1,000,000
Premium on bonds payable 40,000
Interest expense 30,000
Cash 1,060,000
Gain on acquisition of treasury bonds 10,000

Face value of treasury bonds 1,000,000

Applicable premium (1,000,000/5,000,000 x 200,000) 40,000
Carrying amount 1,040,000
Less: Reacquisition price (1,000,000 x 103%) 1,030,000
Gain on acquisition of treasury bonds 10,000

Reacquisition price 1,030,000

Accrued interest on the bonds 30,000
Total cash payment 1,060,000

If the treasury bonds are subsequently sold, they are recorded in the same manner as bonds originally issued.

Reissuance at a premium

For example if the P1,000,000 treasury bonds are sold for P1,200,000, the journal entry is:

Cash 1,200,000
Treasury bonds 1,000,000
Premium on bonds payable 200,000
Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 10
Reissuance at a discount

If the bonds are sold for P900,000, the journal entry is:

Cash 900,000
Discount on bonds payable 100,000
Treasury bonds 1,000,000

The premium or discount on the reissue of the treasury bonds should be amortized over the remaining life of the treasury bonds.

When the treasury bonds are not subsequently sold, on the date of maturity, they are simply canceled against the bonds payable
account as follows:

Bonds payable 1,000,000

Treasury bonds 1,000,000

Statement Presentation

Using the preceding illustration, the P1,000,000 face value treasury bonds would be reported as follows:

Bonds payable 5,000,000

Treasury bonds (1,000,000)
Bond issued and outstanding 4,000,000
Premium on bond payable 160,000
Carrying amount 4,160,000

Bond refunding
Bond refunding is the floating of new bonds the proceeds from which are issued 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 cancellation of the bind liability. There is no unamortized
premium or discount involved.

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, unamortized bond issue and
redemption premium on the old bonds being refunded. The refunding charges are charged to loss on extinguishment.

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.

Illustration

1. Issuance of new 10-year 10% bonds, with face value of P1,500,000, for P1,600,00.

2. Refunding of old 12% bonds, with remaining life of 4 years, at 102.

Bonds payable – old 1,000,000

Discount on bonds payable 30,000
Retirement price (1,000,000 x 102 ) 1,020,000

Journal entries
1. To record the issuance of the new bond payable:
Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 11
 Cash 1,600,000
Bonds payable 1,500,000
Premium on bonds payable 100,000

2. To record the retirement of the old bonds payable:

Bonds payable 1,000,000

Loss on extinguishment of bonds 50,000
Cash 1,020,000
Discount on bonds payable 30,000

The loss on extinguishment of bonds is represented by the refunding charges of P50,000, compute as follows:

Unamortized discount 30,000

Redemption premium (1,000,000 x 2%) 20,000
Total refunding charges 50,000

Or

Bonds payable 1,000,000

Discount on bonds payable ( 30,000)
Carrying amount 970,000
Less: Retirement price 1,020,000
Loss on extinguishment ( 50,000)

Amortization of bond discount and premium

There are three approaches in amortizing bond premium or bond discount, namely
a. Straight line
b. Bond outstanding method
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.

Straight line method

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.

Bond outstanding method

The bond outstanding method is applicable to serial bonds whether issued at discount or premium.

Illustration – Accounting year and bond year coincide

Face value 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 every December 31 of each year at the rate of P1,000,000 for 5 years.

The table of amortization following the bond outstanding method may appear as follows:

Year Bond outstanding Fraction Premium amortization

2020 5,000,000 5/15 100,000
Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 12
 2021 4,000,000 4/15 80,000
2022 3,000,000 3/15 60,000
2023 2,000,000 2/15 40,000
2024 1,000,000 1/15 30,000
15,000,000 300,000

The annual premium amortization is computed by multiplying the fractions by the amount of the premium. Thus, for 2020, 5/15 times
P300,000 equals P100,000.

Journal entries for 2020 and 2021

2020
Jan.1 Cash 5,300,000
Bonds payable 5,000,000
Premium on bonds payable 300,000

June 30 Interest expense 300,000

Cash (5,000,000 x 12% x 6/12) 300,000
Semiannual interest payment

Dec. 31 Interest expense 300,000

Cash 300,000
Semiannual interest payment

Dec. 31 Premium on bond payable 100,000

Interest expense 100,000
Amortization of premium for 2013

Dec. 31 Bonds payable 1,000,000

Cash 1,000,000
Payment of the first series of bonds.

2021
June 30 Interest expense 240,000
Cash (4,000,000 x 12% x 6/12) 240,000
Semiannual interest payment

Dec. 31 Interest expense 240,000

Cash 240,000
Semiannual interest payment

Dec. 31 Premium on bonds payable 80,000

Interest expense 80,000
Amortization of the premium for 2014.

Dec. 31 Bonds payable 1,000,000

Cash 1,000,000
Payment of the second series of bonds.

Premature retirement of serial bonds

When serial bonds are paid on the regular maturity dates, no accounting problem arises. However, the problem occurs when the serial
bonds are retired prior to their scheduled maturity date because in this case, the retirement call for the cancellation of any unamortized
discount or premium related to the serial bonds retired.

Illustration
Using the preceding illustration, assume serial bonds with face value of P1,000,000 scheduled to be retired on December 31, 2022, are
retired at 103 on December 31, 2020, two years prior to their redemption date.

The following procedures may be followed in determining the unamortized premium or discount related to the prematurely retire
serial bonds:

Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 13

1. Get the ratio of the total premium or discount to the common denominator of the fractions developed, total of bond outstanding
column. The ratio represents the amortization rate per year.
300,000/15,000,000 = .02 rate per year

2. Multiply the rate computed in (1) by the face of the bonds retired. The answer gives the unamortized premium or discount per
year related to the bonds retired.

P1,000,000 x .02 = P20,000 unamortized premium per year.

3. Multiply the unamortized premium or discount per year computed in (2) by the period from date of retirement to the scheduled
maturity date of the retired bonds. The answer is the unamortized premium or discount applicable to the bonds retired which
should be cancelled.

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

P1,000,000 face value of bonds retired

The entry to record the retirement of the P1,000,000 face value serial bonds on December 31, 2020 is:

Bonds payable 1,000,000

Premium on bonds payable 40,000
Cash (1,000,000 x 103) 1,030,000
Gain on early retirement of bonds 10,000

A revised schedule of premium amortization may then be prepared as follows:

Original premium Premium Revised premium
Year amortization cancelled amortization
2020 100,000 100,000
2021 80,000 20,000* 60,000
2022 60,000 20,000** 40,000
2023 40,000 40,000
2024 20,000 20,000
300,000 40,000 260,000

* For 2021 **For 2022

Illustration – Accounting year and bond year do not coincide

Face value of the bonds 5,000,000

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

The bonds mature on April 1 of each year at the rate of P1,000,000. The amortization table may appear as follows:

Bond Year Bond Discount

Form To Outstanding Fraction Amortization
April 1, 2020 March 31, 2021 5,000,000 5/15 100,000
April 1, 2021 March 31, 2022 4,000,000 4/15 80,000
April 1, 2022 March 31, 2023 3,000,000 3/15 60,000
April 1, 2023 March 31, 2024 2,000,000 2/15 40,000
April 1, 2024 March 31, 2025 1,000,000 1/15 20,000
15,000,000 300,000

The amortization schedule every accounting year may be prepared as follows:

2020 April 1 to Dec.31 100,000 x 9/12 = 75,000

2021 Jan. 1 to Mar. 31 100,000 x 3/12 = 25,000
April 1 to Dec. 31 80,000 x 9/12 = 60,000 85,000
2022 Jan. 1 to Mar. 31 80,000 x 3/12 = 20,000
April 1 to Dec. 31 60,000 x 9/12 = 45,000 65,000
Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 14
2023 Jan. 1 to Mar. 31 60,000 x 3/12 = 15,000
April 1 to Dec. 31 40,000 x 9/12 = 30,000 45,000
2024 Jan. 1 to Mar. 31 40,000 x 3/12 = 10,000
April 1 to Dec. 31 20,000 x 9/12 = 15,000 25,000
2025 Jan. 1 to Mar. 31 20,000 x 3/12 = 5,000
300,000

Journal entries for 2020 and 2021

2020
April 1 Cash 4,700,000
Discount on bonds payable 300,000
Bonds payable 5,000,000

Oct. 1 Interest expense 300,000

Cash 300,000
Semiannual interest payment.
(P5,000,000 x 12% x ½ = P300,000)

Dec. 31 Interest expense 150,000

Accrued interest payable 150,000
Interest accrued for 3 months
(P5,000,000 x 12% x 3/12 = P150,000)

Dec 31 Interest expense 75,000

Discount on bonds payable 75,000
Amortization of discount for 2020.

2021
Jan. 1 Accrued interest payable 150,000
Interest expense 150,000
Reversing entry

April 1 Interest expense 300,000

Bond payable 1,000,000
Cash 1,300,000
Semiannual interest payment and payment of the first series of bonds.

Oct. 1 Interest expense 240,000

Cash 240,000
Semiannual interest
(P4,000,000 x 12% x 1/2 = P240,000)

Dec. 31 Interest expense 120,000

Accrued interest payable 120,000
Interest accrued for 3 months
(P4,000,000 x 12% x 3/12 = P120,000)

Dec. 31 Interest expense 85,000

Discount on bonds payable 85,000
Fair value option of measuring bonds payable

In accordance with PFRS 9, paragraph 4.2.2, 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 re-measured at every year-
end with any changes in fair value recognized in profit or loss.

There is no more amortization of bond discount and bond premium. Any transaction cot or bond issue cost should be expensed
immediately.
Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 15
Illustration

On January 1, 2020, an entity issued bonds with face amount of P5,000,000 and 12% stated 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.

The journal entries for 2020 assuming the entity elects the fair value option of measuring the bonds payable are as follows:

Jan. 1 Cash 5,379,100

Bonds payable 5,379,100

1 Transaction cost 100,000

Cash 100,000

Dec. 31 Interest expense 600,000

Cash (12% x 5,000,000) 600,000

31 Bonds payable 79,100

Gain from change in fair value 79,100

Bonds payable – January 1, 2020 5,379,100

Fair value - December 31, 2021 5,300,000
Decrease in fair value of bonds payable - gain 79,100

Change in fair value recognized in OCI

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 comprehensive income.
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, current risk and price risk.

b. The remaining amount of the change in fair value is recognized in profit or loss.

However, paragraph 5.7.8 provides that if representing 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 crated or enlarge 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 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.

Illustration

On January 1, 2020, an entity issued bonds payable with face amount of P5,000,000 and 10% stated interest rate for P4,800,00.

The bonds have a 5-year term and interest is payable annually every December 31. The entity elected the fair value option in
measuring the bonds payable.

On December 31, 2020, the fair value of the bonds is P5,500,000.

It is reliably determined that the fair value increase of P700,000 comprised P200,000 attributable to credit risk and P500,000
attributable to change in the market interest rate.

Journal entries for 2020

Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 16
Jan. 1 Cash 4,800,000
Bonds payable 4,800,000

Dec. 31 Interest expense 500,000

Cash (10% x 5,000,000) 500,000

Dec. 31 Loss on credit risk – OCI 200,000

Loss from change in fair value 500,000
Bonds payable 700,000

The loss on credit risk is presented as component of other comprehensive income.

The loss from change in fair value is recognized in profit or loss.

PFRS 9 requires that discount on bonds payable, premium on bonds payable and bond issue cost shall be amortized using the effective
interest method.

This method distinguishes two kinds of interest rate, namely the nominal rate and effective rate.

The nominal rate is the coupon or stated rate. The effective rate is the yield or market rate.

The effective rate is the rate that exactly discounts estimated cash future payments through the expected life of the bonds payable or
when appropriate, a shorter period to the net carrying amount of the bonds payable. When bonds payable sold at face value, the
effective rate and the nominal rate are the same.

When bonds are sold at a premium, the effective rate is lower than the nominal rate. When the bonds are sold at a discount, the
effective rate is higher than the nominal rate.

Effective interest method

The effective interest expense is determined by multiplying the effective rate by the carrying amount of the bonds. The effective
interest is then compared with the nominal interest. The difference is the premium or discount amortization.

Thus, the premium amortization is computed as follows:

Nominal interest (nominal rate x face value) xx

Less: Effective interest (effective rate x carrying amount) xx
Premium amortization xx

The discount amortization is computed as follows:

Effective interest xx
Less: Nominal interest xx
Discount amortization xx

Effective amortization of discount

On January 1, 2020, an entity issued two-year 8% P1,000,000 face value bonds for P964,540, a price which will yield a 10% effective
interest cost per year. Interest is payable semiannually on June 30 and December 31.
The schedule of amortization may appear as follows:

Interest Interest Discount Carrying

Date paid expense amortization amount
Jan. 1, 2020 964,540
Jun. 30, 2020 40,000 48,227 8,227 972,767
Dec. 31, 2020 40,000 48,638 8,638 981,405
Jun. 30, 2021 40,000 49,070 9,070 990,475
Dec. 31, 2021 40,000 49,525 9,525 1,000,000

Interest paid – Face value times semiannual nominal rate of 4% or P40,000.

Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 17

Interest expense – Carrying amount times semiannual effective rate. Thus, for the period January 1 to June 30, 2020, the interest
expense is P964,540 times 5% or P48,227.

Discount amortization – Interest expense minus interest paid. Thus, for the period January 1 to June 30, 2020, the discount
amortization is P48,227 minus P40,000 or P8,227.

Carrying amount – Preceding carrying amount plus the discount amortization. Thus, in June 30, 2020, the carrying amount is
P964,540 plus P8,227 or P972,767.

The carrying amount is actually the amortized cost contemplated in the standard.

Journal entries for 2020

Jan. 1 Cash 964,540
Discount on bonds payable 35,460
Bonds payable 1,000,000

June 30 Interest expense 48,227

Cash 40,000
Discount on bonds payable 8,227

Note that the payment of the semiannual interest and the periodic
amortization of the discount are compounded in one entry. The
two items can be separately recorded.

Dec. 31 Interest expense 48,638

Cash 40,000
Discount on bonds payable 8,638

Effective amortization of premium

On January 1, 2020, an entity issued three-year 12% P1,000,000 face value bonds for P1,049,740, a price which will yield a 10%
effective interest cost per year. The interest is payable annually every December 31.

Schedule of amortization
Interest Interest Discount Carrying
Date paid expense amortization amount
Jan. 1, 2020 1,049,740
Dec. 31, 2020 120,000 104,974 15,026 1,034,714
Dec. 31, 2021 120,000 103,471 16,529 1,018,185
Dec. 31, 2022 120,000 101,815 18,185 1,000,000

Interest paid – Face value of P1,000,000 times the annual nominal rate of 12% or P120,000.

Interest expense – Carrying amount times annual effective rate. Thus, for 2020, the interest expense is P1,049,740 times 10% or
P104,974.

Premium amortization – Interest paid minus interest expense. Thus, for 2020, the premium amortization is P120,000 minus P104,974
or P15,026.

Carrying amount – Preceding carrying amount minus the premium amortization. Thus, on December 31, 2020, the carrying amount is
P1,049,740 minus P15,026 or P1,034,714.

Journal entries for 2020

Jan. 1 Cash 1,049,740
Bonds payable 1,000,000
Premium on bonds payable 49,740

Dec. 31 Interest expense 104,974

Premium on bonds payable 15,026
Cash 120,000

Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 18

Market price or issue price of bond payable

The market price or issue price of bond payable is equal to the present value of the principal bond liability plus the present value of
future interest payments using the effective or market rate of interest.

The present value of the principal bond liability is equal to the face value of the bond multiplied by the present value of 1 factor at
the effective rate for a number of interest periods.

The present value of the future interest payments is equal to the periodic nominal interest multiplied by the present value of an
ordinary annuity of 1 factor at the effective rate for a number of interest periods.

Of course, the present value factor can be compute through the use of an ordinary calculator.

Illustration 1

Face value of bonds 4,000,000

Nominal rate 6%
Effective rate 8%

The bonds are issued on January 1, 2020 and mature in four years on January 1, 2024. The interest is payable annually every
December 31.

Since the interest is payable annually, there are 4 interest periods. The relevant present value factors are:

PV of 1 at 8% for 4 periods .7350

PV of an ordinary annuity of 1 at 8% for 4 periods 3.3121

The present value of the bonds is compute as follows:

Present value of principal (4,000,000 x .7350) 2,940,000

Present value of annual interest payments (240,000 x 3.3121) 794,904
Total present value 3,734,904

The annual interest payment of P240,000 is determined by multiply the face value of P4,000,000 by the nominal rate of 6%.

Face value 4,000,000

Market price or issue price 3,734,904
Discount on bonds payable 265,096

Table of amortization

Interest Interest Discount Carrying

Date paid expense amortization amount
Jan. 1, 2020 3,734,904
Dec. 31, 2020 240,000 298,792 58,792 3,793,696
Dec. 31, 2021 240,000 303,496 63,496 3,857,192
Dec. 31, 2022 240,000 308,575 68,575 3,925,767
Dec. 31, 2023 240,000 314,233 74,233 4,000,000

Illustration 2

Face value of bonds 5,000,000

Nominal rate 12%
Effective rate 10%

The bonds are issued on January 1, 2020 and mature in three years on January 1, 2023. The interest is payable semiannually every
June 30 and December 31.

Since the interest is payable semiannually, there are 6 interest periods. The relevant present value factors are:

PV of 1 at 5% for 6 periods .7462

PV of an ordinary annuity of 1 at 5% for 6 periods 5.0757
Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 19
The present value of the bonds is determined as follows:

Present value of principal (5,000,000 x .7462) 3,731,000

Present value of interest payments (300,000 x 5.0757) 1,522,710
Total present value 5,253,710

The semiannual interest payment of P300,000 is computed by multiply the face value of P5,000,000 by semiannual nominal rate of
6%.

Market price or issue price of bonds 5,253,710

Face value 5,000,000
Premium on bonds payable 253,710

Table of amortization
Interest Interest Discount Carrying
Date paid expense amortization amount
Jan. 1, 2020 5,253,710
June 30, 2020 300,000 262,686 37,314 5,216,396
Dec. 31, 2020 300,000 260,820 39,180 5,177,216
June 30, 2021 300,000 258,861 41,139 5,136,077
Dec. 31, 2021 300,000 256,804 43,196 5,092,881
June 30, 2022 300,000 254,644 45,356 5,047,525
Dec. 31, 2022 300,000 252,475 47,525 5,000,000

Illustration 3 – serial bonds

Face value of bonds 3,000,000

Nominal rate 12%
Effective rate 10%
Date of issue January 1, 2020

The bonds mature on every December 31 of each year at the rate of P1,000,000 for 3 years. The interest is payable annually on
December 31.

The present value of 1 at 10% is as follows:

One period 0.9091

Two periods 0.8264
Three periods 0.7513

Again, the market price or issue price of the bonds payable is equal to the present value of the principal bond liability plus the present
value of future interest payments.

The present value of the bonds payable is computed as follows:

(a ) (b ) (a x b)
Principal Interest Total PV Present
Date payment payment payment factor value
12/31/2020 1,000,000 360,000 1,360,000 .9091 1,236,376
12/31/2021 1,000,000 240,000 1,240,000 .8264 1,024,736
12/31/2022 1,000,000 120,000 1,120,000 .7513 841,456
Total present value 3,102,568
Face value 3,000,000
Premium on bonds payable 102,568

Interest payment
December 31, 2020 (3,000,000 x 12%) 360,000
December 31, 2021 (2,000,000 x 12%) 240,000
December 31, 2022 (1,000,000 x 12%) 120,000

Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 20

Table of amortization

Interest Interest Premium Principal Carrying

Date paid expense amortization payment amount
1/1/2020 3,102,568
12/31/2020 360,000 310,257 49,743 1,000,000 2,052,825
12/31/2021 240,000 205,282 34,718 1,000,000 1,018,107
12/31/2022 120,000 101,893 18,107 1,000,000 -

December 31, 2020

Interest paid (3,000,000 x 12%) 360,000
Interest expense (3,102,568 x 10%) 310,257
Premium amortization for 2020 49,743

Carrying amount – January 1, 2020 3,102,568

Premium amortization for 2020 ( 49,743)
Principal payment on December 31, 2020 (1,000,000)
Carrying amount – December 31, 2020 2,052,825

December 31, 2021

Interest paid (2,000,000 x 12%) 240,000
Interest expense (3,102,568 x 10%) 205,282
Premium amortization for 2021 34,718

Carrying amount – December 31, 2020 2,052.825

Premium amortization for 2021 ( 34,718)
Principal payment on December 31, 2021 (1,000,000)
Carrying amount – December 31, 2021 1,018,107

December 31, 2022

Interest paid (1,000,000 x 12%) 120,000
Interest expense 101,893*
Premium amortization for 2022 18,107

* 10% x P1,018,107 equals P101,811. There is a difference of P82 due to rounding of present value factors.

Journal entries for 2020

1. Issuance of bonds

Cash 3,102,568
Bonds payable 3,000,000
Premium on bonds payable 102,568

2. Payment of interest

Interest Expense 360,000

Cash 360,000

3. Amortization of premium

Premium on bonds payable 49,743

Interest expense 49,743

4. Payment of principal

Bonds payable 1,000,000

Cash 1,000,000

Effective interest method – bond issue cost

PFRS 9 provides that “transaction costs” that are directly attributable to the issue of a financial liability shall be included in the initial
measurement of the financial liability.
Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 21
Transaction costs are defined as fees and commissions paid to agents, advisers, brokers and dealers, levies by regulatory agencies and
securities exchanges, and transfer taxes and duties. Clearly, transaction costs include bond issue costs. The calculation of effective
interest rate shall include all transaction costs, premiums and discounts.

Thus, bond issue costs will increase discount on bonds payable and will decrease premium on bonds payable. Under the effective
interest method, bond issue cost must be “lumped” with the discount on bonds payable and “netted” against the premium on bonds
payable.

Illustration 1 – Discount and bond issue cost

On January 1, 2020, an entity issued three – year bonds with face value of P10,000,000 and 9% stated rate. The bonds mature on
January 1, 2023 and interest is payable annually on December 31.

The bonds are issued at P9,751,210 with an effective yield of 10% before considering the bond issue cost. The entity paid bond issue
cost of P239,880.

Face value 10,000,000

Discount on bonds payable ( 248,790)
Issue price 9,751,210
Bond issue cost ( 239,880)
Net proceeds 9,511,330

The effective rate is 10% but because of the bond issue cost, the effective rate must be higher than 10%.

Thus, the problem is to find an effective rate that will equate the present value of the cash outflows for the bonds payable to the net
proceeds of P9,511,330.

The cash outflows for the bonds payable include the principal of P10,000,000 and the annual interest payment of P900,000 for 3 years.

The effective rate cannot be computed algebraically but by means of trial and error or the “interpolation process”.

The calculation of the effective rate requires the use of mathematical table of present value of a single payment and present value of an
ordinary annuity.

Again, the original effective rate is 10% but because of the bond issue cost the new effective rate must be higher than 10%.

By interpolation and using an effective rate of 11%, the present value of 1 for three periods is .7312 and the present value of an
ordinary annuity of 1 for three periods is 2.4437.

The present value of the bonds payable using an interest rate of 11% is determined as follows:

PV of principal (10,000,000 x .7312 ) 7,312,000

PV of interest payments (900,000 x 2.4437) 2,199,330
Total present value 9,511,330

Coincidentally, the present value of the bonds payable of P9,511,330 is the same as the net proceeds of P9,511,330.

In conclusion, the new effective rate is 11%.

Journal entries

1. To record the issuance of the bonds:

Cash 9,511,330
Bond discount and issue cost 488,670
Bonds payable 10,000,000

Under the effective interest method, the bond issue cost is added to the discount on bonds payable.

2. To record the annual interest payment:

Interest expense (10,000,000 x 9%) 900,000

Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 22
 Cash 900,000

3. To record the amortization of the bond discount and issue cost using the effective interest method:

Interest expense 146,246

Bond discount and issue cost 146,246

Interest expense (9,511,330 x 11%) 1,046,246

Interest paid (10,000,000 x 9%) 900,000
Amortization of bond discount and issue cost 146,246

Illustration 2 – Discount and bond issue cost

On January 1, 2020, an entity issued 5-year bonds with face value of P10,000,000 at 95. The nominal rate is 10% and the interest is
payable annually on December 31.

The bond mature on January 1, 2025. The entity paid bond issue cost of P200,000.

Face value 10,000,000

Discount on bonds payable ( 500,000)
Issue price (10,000,000 x 95% ) 9,500,000
Bond issue cost ( 200,000)
Net proceeds 9,300,000

Again, the problem is to find an effective rate applicable to the net proceeds of P9,300,00. Since the bonds are issued at a discount the
effective rate must be higher than the nominal rate of 10%.

By interpolation, using a rate of 11%, the present value of 1 for 5 periods is .5935 and the present value of an ordinary annuity of 1 for
5 periods is 3.6959.

PV of principal (10,000,000 x .5935) 5,935,000

PV of interest payments (1,000,000 x 3.6959) 3,695,900
Total present value 9,630,900

The net proceeds of P9,300,000 are lower than the present value of the bods payable of P9,630,900 using 11% interest rate. This
means that the effective rate must be higher than 11%.

So another interpolation is made using another rate of 12%. The present value of 1 for 5 periods is .5674 and the present value of an
ordinary annuity of 1 is 3.6048.

PV of principal (10,000,000 x .5674) 5,674,000

PV of interest payments (1,000,000 x 3.6048) 3,604,800
Total present value 9,278,800

The net proceeds of P9,300,000 are higher than the present value of the bonds payable of P9,278,800 using 12% interest rate. This
means that the effective rate must be lower than 12%.

In conclusion, the effective rate must be between 11% and 12%.

With this scenario, the differential between 11% and 12% is interpolated as follows (Let X as the unknown effective rate):

X-11%
12%-11%

The present value applicable to the rates are then substituted as follows:

9,300,000 – 9,630,900
9,278,800 – 9,630,900

330,900
352,100

Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 23

=.94

This differential of .94 between 11% and 12% is added to 11% to get an effective rate of 11.94%.

Illustration 3 – Premium and bond issue cost

On January 1, 2020, an entity issued 5-yeaar bonds with face value of P10,000,000 at 105. The nominal rate is 10% and the interest is
payable annually on December 31.

The bonds matures on January 1, 2025. The entity paid bond issue cost of 200,000

Face value 10,000,000

Premium on bonds payable 500,000
Issue price (10,000,000 x 105%) 9,500,000
Bond issue cost ( 200,000)
Net proceeds 10,300,000

Cash 10,300,000
Bonds payable 10,000,000
Premium on bonds payable 300,000

Under the effective interest method, the bond issue cost is “netted” against the premium on bonds payable. Since the bonds are issued
at a premium, the effective rate must be lower than 10%.

By interpolation, using a rate of 9%, the present value of 1 for 5 periods is .6499 and the present value of an ordinary annuity of 1 for
5 periods is 3.8897.

PV of principal (10,000,000 x .6499) 6,499,000

PV of interest payments (1,000,000 x 3.8897) 3,889,700
Total present value 10,388,700

The net proceeds of P10,300,000 are lower than the present value of the bonds payable of P10,388,700 using a 9% interest rate.

This means that the effective rate must be higher than 9%. In conclusion, the effective rate must be between 9% and 10%.

The differential between 9% and 10% is interpolated as follows (Let X as the unknown effective rate):

X-9%
10%-9%

The present value applicable to the rates are then substituted as follows:

10,300,000 – 10,388,700
10,000,000 – 10,388,700

88,700
388,700

=.23

Thus, the effective rate is 9.23% (9% plus .23)

Module for Intermediate Accounting 2, Jonard S. Baloyo, CPA Page 24