Page | 1

Chapter 3
Bonds Payable & Other Concepts
PROBLEM 1: TRUE OR FALSE
1. TRUE
2. FALSE - A debenture is an unsecured bond.
3. FALSE - Monitoring for compliance with the indenture is the
responsibility of the trustee of the bond issue.
4. FALSE – the conversion option belongs to the bondholder, not
the issuer
5. TRUE – The increased rate is intended to entice investors to
buy bonds during periods when the demand is low.
6. FALSE - lower (*par value of bonds is another term for face
amount of bonds)
7. FALSE
8. FALSE
9. FALSE
10. TRUE

PROBLEM 2: MULTIPLE CHOICE – THEORY

1. C
2. C
3. A
4. D
5. C
6. D
7. C
8. C
Sample assumptions:
☞ Face amount: 1M
☞ Nominal int. rate: 10%
☞ n=3
☞ Effective int. rate: 12%
 Page | 2

Initial carrying amount: (1M x PV of 1 @12%, n=3) + (100K x PV

ord. annuity @12%, n=3) = 951,963

Using effective interest method:

Interest Present
Date expense Payments Amortization Value
1/1/x1 951,963
12/31/x1 100,000 114,236 14,236 966,199

Using straight-line method:

Discount on bonds (1M – 951,963) 48,037
Divide by: Term 3
Annual amortization of discount 16,012

Carrying amount - 1/1/x1 951,963

Discount amortization - 20x1 16,012
Carrying amount - 12/31/x1 967,975

I. Effect on Bond carrying amount

967,975 SLM vs. 966,199 EIM = Overstated

II. Effect on Retained earnings

☞ 100K interest + 16,012 amort. = 116,012 int. expense under SLM

☞ 116,012 SLM vs. 114,236 EIM: overstated
☞ Effect on Retained earnings: Understated

9. B
Solution:
EFFECT ON DECEMBER 31, 20X1:
Using straight line method:
Discount on bonds - 1/2/x1 150,000
Divide by: Term 6
Annual amortization of discount 25,000
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Discount on bonds - 1/2/x1 150,000

Amortization - 20x1 (25,000)
Discount on bonds - 12/31/x1 125,000

Face amount 1,000,000

Discount on bonds - 12/31/x1 (125,000)
Carrying amount - 12/31/x1 875,000

Using effective interest method:

Interest Present
Date expense Payments Amortization Value
1/2/x1 850,000
12/31/x1 102,000 80,000 22,000 872,000

Carrying amounts - 12/31/x1:

Straight line (erroneous) 875,000
Effective interest method 872,000
Difference - overstatement (3,000)

EFFECT ON JANUARY 2, 20X7:

On January 2, 20x7, maturity date, there will be NO EFFECT of the
error on the carrying amount of the bonds because on this date,
the discount would have been fully amortized under both the
straight line method and the effective interest method.

10. C
 Page | 4

PROBLEM 3: EXERCISES
1. Solution:
Jan. 1, Cash 1,903,92
20x1 Discount on bonds payable 7
Bonds payable 96,073 2,000,00
0

Interest Interest Amortizatio Present

Date payments expense n value
Jan. 1, 20x1 1,903,927
Dec. 31, 20x1 200,000 228,471 28,471 1,932,398
Dec. 31, 20x2 200,000 231,888 31,888 1,964,286
Dec. 31, 20x3 200,000 235,714 35,714 2,000,000

Dec. 31, Interest expense 228,471

20x1 Cash 200,000
Discount on bonds payable 28,471
Dec. 31, Interest expense 231,888
20x2 Cash 200,000
Discount on bonds payable 31,888
Dec. 31, Interest expense 235,714
20x3 Cash 200,000
Discount on bonds payable 35,714

Bonds payable 2,000,00

Cash 0 2,000,00
0

2. Solution:
Jan. 1, Cash (2,206,168 – 106,694) 2,099,47
20x1 Bonds payable 4 2,000,00
Premium on B/P (squeeze) 0
99,474
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Interest Interest
payment expens Amortizatio Present
Date s e n value
Jan. 1, 20x1 2,099,474
Dec. 31, 20x1 240,000 209,947 30,053 2,069,421
Dec. 31, 20x2 240,000 206,942 33,058 2,036,363
Dec. 31, 20x3 240,000 203,637 36,363 2,000,000

Dec. 31, Interest expense 209,947

20x1 Premium on bonds payable 30,053
Cash 240,000
Dec. 31, Interest expense 206,942
20x2 Premium on bonds payable 33,058
Cash 240,000
Dec. 31, Interest expense 203,636
20x1 Premium on bonds payable 36,364
Cash 240,000

3. Solution:
Interest Interest Amortizatio Present
Date payments expense n value
Jan. 1, 20x1 2,151,632
Dec. 31, 20x1 240,000 215,163 24,837 2,126,795
Dec. 31, 20x2 240,000 212,680 27,320 2,099,475
July 1, 20x3 120,000 104,974 15,026 2,084,449

July Interest expense 104,974

31, Premium on bonds payable 15,026
20x3 Interest payable 120,000
July Bonds payable 2,000,000
31, Premium on bonds payable 84,449
20x3 Interest payable 120,000
Cash (2M x 102%) 2,040,00
Gain on retirement of bonds 0
164,449
 Page | 6

4. Solution:

Initial recognition:
Issue price (2M x 105%) 2,100,000
Fair value of bonds without conversion feature (a) ( 1,903,926)
Equity component 196,074

(a)
Future cash flows PV factors @12%, n=3 Present value
Principa
l 2,000,000 0.711780 1,423,560
Interest 200,000 2.401831 480,366
Fair value of bonds without conversion feature 1,903,926

Jan. Cash (2M x 105%) 2,100,00

1, Discount on bonds payable 0
20x1 (2M – 1,903,926) 96,074
Bonds payable 2,000,00
Share premium – conversion 0
feature 196,074

Subsequent measurement:
Interest Interest Amortizatio Present
Date payments expense n value
Jan. 1, 20x1 1,903,926
Dec. 31, 20x1 200,000 228,471 28,471 1,932,397
Dec. 31, 20x2 200,000 231,888 31,888 1,964,285
Dec. 31, 20x3 200,000 235,715 35,715 2,000,000

Dec. Interest expense 228,471

31, Discount on bonds payable 28,471
20x1 Cash 200,000
 Page | 7

Dec. Interest expense 231,888

31, Discount on bonds payable 31,888
20x2 Cash 200,000
Dec. Bonds payable 2,000,00
31, Discount on bonds payable 0
20x2 (2M – 1,964,285) 35,715
Share capital [(2M ÷ 1,000) x 8 1,600,00
shares x 100 par value)] 0
Share premium
to record the conversion 364,285
Dec. Share premium 20,000
31, Cash 20,000
20x2 to record the stock issuance costs
Dec. Share premium – conversion feature 196,074
31, Share premium 196,074
20x2 to transfer within equity the equity
component of the compound instrument

5. Solution:
⮚ Initial measurement:
Issue price 2,200,000
Fair value of bonds without conversion feature (a) ( 1,903,926)
Equity component 296,074

(a)
Future cash flows PV factors @12%, n=3 Present value
Principal 2,000,000 0.711780 1,423,560
Interest 200,000 2.401831 480,366
Fair value of bonds without conversion feature 1,903,926

⮚ Subsequent measurement:
Interest Interest Amortizatio Present
Date payments expense n value
Jan. 1, 20x1 1,903,926
Dec. 31, 20x1 200,000 228,471 28,471 1,932,397
Dec. 31, 20x2 200,000 231,888 31,888 1,964,285
Dec. 31, 20x3 200,000 235,715 35,715 2,000,000
 Page | 8

⮚ Retirement:
Retirement price 2,000,000
Fair value of bonds w/o conversion feature – 12.31.20x2 (1,981,982)(b)
Retirement price allocated to equity component 18,018

(b)
Future cash flows PV factors @11%, n=1 Present value
Principal 2,000,000 0.900901 1,802,802
Interest 200,000 0.900901 180,180
Fair value of bonds without conversion feature – 12.31.x2 1,981,982

❖ Journal entries:
Jan. Cash 2,200,000
1, Discount on bonds payable (2M – 1,903,926) 96,074
20x1 Bonds payable 2,000,000
Sh. premium – conversion feature 296,074
Dec. Interest expense 228,471
31, Discount on bonds payable 28,471
20x1 Cash 200,000
Dec. Interest expense 231,888
31, Discount on bonds payable 31,888
20x2 Cash 200,000
Dec. Bonds payable 2,000,000
31, Loss on extinguishment of bonds 17,697
20x2 Discount on B/P (2M – 1,964,285) 35,715
Cash 1,981,982
to record retirement of convertible bonds
Dec. Share premium – conversion feature 18,018
31, Cash 18,018
20x2 to record the allocation of retirement price to
the equity component
Dec. Share premium – conversion feature 278,056
31, (296,074 –18,018)
20x2 Share premium 278,056
to record forfeiture of the conversion feature
of retired convertible bonds
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 Page | 10

PROBLEM 4: MULTIPLE CHOICE – COMPUTATIONAL

1. D
9¾% registered debentures, callable in 2002, due in 2007 700,000
9½% collateral trust bonds, convertible into common
stock 600,000
beginning in 2000, due in 2010
1,300,00
Total term bonds
0

2. B
Interest Amortizatio
Date Payments expense n Present value
1/2/01 469,500
6/30/01 22,500 23,475 975 470,475

3. B
Interest Interest Present
Date payments expense Amortization value
Jan. 1, 20x1 3,807,852
Dec. 31,
20x1 400,000 456,942 56,942 3,864,794

4,000,000 face amount – 3,864,794 = 135,206

4. D
Interest Interest Present
Date payments expense Amortization value
Jan. 1, 20x1 3,628,536
Dec. 31, 20x1 400,000 507,995 107,995 3,736,531

5. D
Issue price of bonds (200 x 1,000 x 101%) 202,000
Accrued interest (200 x 1,000 x 9% x 5/12) 7,500
Total proceeds 209,500
 Page | 11

6. A
PV Present
Future cash flows PV @ 10%, n=3 factors value

Principal 2,000,000 PV of 1 0.751315 1,502,630

Interest 240,000 PV of ord. annuity of 1 2.486852 596,844
2,099,474

7. B
Solution:

Redemption price (5M x 98%) 4,900,000

Less: Carrying amount of bonds:
Face amount 5,000,000
Unamortized premium 30,000

Unamortized issue costs (50,000) 4,980,000

Gain on retirement 80,000

8. D
The periodic cash flows are computed as follows:
Due date Amounts due Periodic
  Principal Interest Cash flows
12/31/x1 40,000 16,000 56,000
12/31/x2 40,000 12,800 52,800
12/31/x3 40,000 9,600 49,600
12/31/x4 40,000 6,400 46,400
12/31/x5 40,000 3,200 43,200

The amortization table is prepared as follows:

Interest Present
Date expense Payments Amortization value
 Page | 12

12/31/x0 190,280
12/31/x1 19,028 56,000 36,972 153,308
12/31/x2 15,331 52,800 37,469 115,839
12/31/x3 11,584 49,600 38,016 77,823
12/31/x4 7,782 46,400 38,618 39,205
12/31/x5 3,920 43,200 39,280 (75)

9. A
⮚ Total cash flow due at maturity date: (6M x 110% x 110% x
110%) = 7,986,000
⮚ Initial measurement of bonds: 7,986,000 x PV of 1 @18%, n=3 =
4,860,526
⮚ Subsequent measurement:
i. Bonds: 4,860,526 x 118% - 600,000 interest payable =
5,135,421
ii. Interest payable: (6M x 10%) = 600,000

Alternative solution:
Interes
PV of
Interest t Amortizatio PV of
Date cash
expense payabl n bonds
flows
e
Jan. 1, 20x1 4,860,526 4,860,526
Dec. 31, 20x1 874,895 5,735,421 600,000 274,895 5,135,421
Dec. 31, 20x2 1,032,376 6,767,796 660,000 372,376 5,507,796
Dec. 31, 20x3 1,218,203 7,986,000 726,000 492,203 6,000,000

10. C
Fair value of bonds without the warrants 196,000
Face amount of bonds 200,000
Discount on bonds (4,000)

11. B
 Page | 13

Carrying amount of bonds converted 1,300,000

Par value of shares issued (50,000 x 1) (50,000)
Share premium 1,250,000

12. C
⮚ Initial measurement:
Issue price 2,200,000
Fair value of bonds without conversion feature (a) ( 1,903,926)
Equity component 296,074

(a)
Future cash flows PV factors @12%, n=3 Present value
Principal 2,000,000 0.711780 1,423,560
Interest 200,000 2.401831 480,366
Fair value of bonds without conversion feature 1,903,926

⮚ Subsequent measurement:
Interest Interest Amortizatio Present
Date payments expense n value
Jan. 1, 20x1 1,903,926
Dec. 31, 20x1 200,000 228,471 28,471 1,932,397
Dec. 31, 20x2 200,000 231,888 31,888 1,964,285

⮚ Retirement:
Retirement price 1,000,000
Fair value of bonds w/o conversion feature
(1,981,982 (b) x ½) ( 990,991)
Allocation of retirement price to equity component 9,009

(b)
Future cash flows PV factors @11%, n=1 Present value
Principal 2,000,000 0.900901 1,802,802
Interest 200,000 0.900901 180,180
Fair value of bonds w/o conversion feature - 12/31/20x2 1,981,982

Carrying amount of bonds retired (1,964,285 x

½) 982,143
 Page | 14

Retirement price allocated to bonds 990,991

Loss on retirement (8,849)

Equity component from issuance (296,074 x 1/2) 148,037

Retirement price allocated to equity component (9,009)
Net amount reclassified within equity 139,028

Supporting journal entries:

Dec. Bonds payable (2M x ½) 1,000,00
31,
20x
Loss on extinguishment of bonds 0
2 Discount on bonds payable 8,849 17,858
[(2M – 1,964,285) x ½ ] 990,991
Cash
to record the retirement of bonds
Dec. Share premium – conversion feature 148,037
31,
20x
(296,074 x ½)
2 Cash 9,009
Share premium 139,028
to transfer within equity the amount allocated
to the equity component of the compound instrument

13. D
Payment for the liability:
Cash 50,000
Carrying amount of investment
securities 375,000 425,000
Carrying amount of liability settled:
Principal 500,000
Accrued interest 75,000 575,000
Gain on settlement 150,000

14. B (28,000 – 25,000) = 3,000

 Page | 15

15. D
The modification is analyzed as follows:
  Old terms New terms
Principal 1,000,000 950,000
Accrued interest 40,000 30,000
Remaining term ('n') 1 year

The present value of the modified liability is computed as follows:

PV of 1 @10%, Present
Future cash flows
n=1 value
Principal 950,000 0.90909 863,636
Interest 30,000 0.90909 27,273
Present value of the modified liability 890,908

The difference between the old liability and the new liability is tested
for substantiality.
Carrying amount of old liability
1,040,000
(1M principal + 40,000 accrued interest)
Present value of modified liability 890,908
Difference 149,092

Difference 149,092
Divide by: Carrying amount of old liability 1,040,000
  14.34%

The modification is considered substantial because the modification

resulted to a present value of the new obligation different by at least
10% of the present value (carrying amount) of old obligation.
Therefore, the old liability is extinguished and the difference of
₱149,092 is recognized as gain on extinguishment.
 Page | 16

PROBLEM 5: CLASSROOM ACTIVITY

Solutions:
Requirement (a): Effective interest rate
Trial & Error
PV = CF x PVF

There is discount. Therefore, the EIR must be higher than 8%.

First trial: @10% per annum (5% semi-annual)

⮚ 922,782 = (1,000,000 x PV of 1 @ 5%, n=10) + (40,000 x PV
ordinary annuity @5%, n=10)
⮚ 922,782 = 613,913 + 308,869

⮚ 922,782 equals 922,782

❖ The EIR is 10% (per annum).

Requirement (b): Amortization table

Interest Interest Amortizatio Present
Date payments expense n value
7/1/x1 922,782
1/1/x2 40,000 46,139 6,139 928,921
7/1/x2 40,000 46,446 6,446 935,367
1/1/x3 40,000 46,768 6,768 942,135
7/1/x3 40,000 47,107 7,107 949,242
1/1/x4 40,000 47,462 7,462 956,704
7/1/x4 40,000 47,835 7,835 964,539
1/1/x5 40,000 48,227 8,227 972,766
7/1/x5 40,000 48,638 8,638 981,404
1/1/x6 40,000 49,070 9,070 990,474
7/1/x6 40,000 49,526* 9,526* 1,000,000*

* The last figures are ‘squeezed’ to eliminate the difference due to

rounding-offs and make the amortized cost at maturity date exactly equal to
1M.
 Page | 17

Requirement (c): Journal entries

7/1/x1
Cash 922,782
Discount on bonds payable 77,218
Bonds payable 1,000,000

12/31/x1
Interest expense 46,139
Interest payable 40,000
Discount on bonds payable 6,139
 Page | 18

PROBLEM 6: FOR CLASSROOM DISCUSSION

1. Solutions:

Requirement (a):
Issue price 4,800,000
Transaction costs (473,767)
Carrying amount - 1/1/x1 4,326,233

Requirement (b):
Face amount 5,000,000
Initial carrying amount (4,326,233)
Net discount on bonds payable 673,767

Requirement (c):

Interest Amortizatio
Date paid Interest expense n Present value
1/1/x1 4,326,233
12/31/x1 500,000 692,197 192,197 4,518,430
12/31/x2 500,000 722,949 222,949 4,741,379
12/31/x3 500,000 758,621 258,621 5,000,000

❖ Answer: Periodic interest payments are less than periodic

interest expenses.

Requirement (d):
1/1/x1
Cash 4,800,000
Discount on bonds payable 200,000
Bonds payable 5,000,000

1/1/x1
Discount on bonds payable (Bond issue costs) 473,767
Cash 473,767
 Page | 19

12/31/x1
Interest expense 692,197
Cash 500,000
Discount on bonds payable 192,197

12/31/x2
Interest expense 722,949
Cash 500,000
Discount on bonds payable 222,949

12/31/x3
Interest expense 758,621
Cash 500,000
Discount on bonds payable 258,621

Bonds payable 5,000,000

Cash 5,000,000

2. Solution:

Requirement (a):
Issue price 5,415,183

Accrued interest (5M x 14% x 3/12)

(175,000)
Carrying amount - 4/1/x1 5,240,183

Requirement (b):
4/1/x1
Cash 5,415,183
Bonds payable 5,000,000
Premium on bonds payable 240,183
Interest expense (or Interest payable) 175,000

Requirement (c):
(5,240,183 x 12% x 9/12) = 471,616
 Page | 20

3. Solution:
Cash flows PV factors Issue price

Principal
5,000,000 0.79383 3,969,161

Interest
700,000 2.57710 1,803,968
5,773,129

4. Solution:

12/31/x2
Bonds payable 5,000,000
Premium on bonds payable 277,777
Loss on derecognition 122,223
Cash (5M + 400,000) 5,400,000

Interest Interest Amortizatio Present

Date paid expense n value
1/1/x1 5,773,129
12/31/x
461,850 238,150 5,534,979
1 700,000
12/31/x
442,798 257,202 5,277,777
2 700,000
12/31/x
422,223 277,777 5,000,000
3 700,000

5. Solution:

Requirement (a):
1/1/x1
Cash 5,200,000
 Page | 21

Bonds payable 5,000,000

Premium on bonds payable [(5M x 101%) – 5M] 50,000
Share premium – conversion feature (squeeze) 150,000

Requirement (b):
Interest Amortizatio
Date paid Interest expense n Present value
1/1/x1 5,050,000
12/31/x1 600,000 585,295 14,705 5,035,295
12/31/x2 600,000 583,591 16,409 5,018,886
12/31/x3 600,000 581,689 18,311 5,000,575

1/1/x3
Bonds payable 5,000,000
Premium on bonds payable 18,886
Ordinary share capital (10,000 sh. x ₱200) 2,000,000
Share premium 3,018,886

Share premium – conversion feature 150,000

Share premium 150,000

6. Solution:
Total retirement price (5M + 200K) 5,200,000

Fair value of bonds (5M x 102)

(5,100,000)
Retirement price allocated to equity component 100,000

Interest Interest Amortizatio Present

Date paid expense n value
1/1/x1 5,050,000
12/31/x
585,295 14,705 5,035,295
1 600,000
 Page | 22

12/31/x
583,591 16,409 5,018,886
2 600,000
12/31/x
581,689 18,311 5,000,575
3 600,000

1/1/x3
Bonds payable 5,000,000
Premium on bonds payable 18,886
Loss on derecognition (squeeze) 81,114
Cash (allocation to debt component) 5,100,000

Share premium – conversion feature 150,000

Cash (allocation to equity component) 100,000
Share premium 50,000

7. Solution:

Note payable (liability being settled) 1,000,000

Carrying amount of equipment (settlement) 900,000
Gain on derecognition (settlement less than liability) 100,000

8. Solution:
Note payable (liability being settled) 600,000
Fair value of shares (settlement) 750,000

Loss on derecognition (settlement exceeds liability) (150,000)

9. Solution:
  Original terms Modified terms
Principal 2,800,000 2,500,000
Accrued interest 400,000 -
Nominal rate 14% 9%
Maturity already due 4 yrs.
 Page | 23

Present value of new liability

(Principal: 2.5M x PV of 1 @14%, n=4) +
2,135,786
(Interest: 2.5M x 9% x PV ordinary annuity @14%,
n=4)
Carrying amount of old liability (2.8M + 400K) 3,200,000
Difference 1,064,214

Difference 1,064,214
Divide by: Carrying amount of old liability 3,200,000
Change in liability - Substantial 33%

Dec. 31, 20x1

Loan payable (old) 2,800,000
Interest payable 400,000
Discount on loan payable (new) 364,214
(2.5M – 2,135,786)
Loan payable (new) 2,500,000
Gain on modification 1,064,214