Bonds Payable

Chapter 5 - 7

INTERMEDIATE ACCOUNTING 2
Jimelyn H. Evangelista, CPA, MBA
Learning outcomes:
 Understand the nature, purpose and measurement of
bonds payable;
 Describe and apply the methods of amortizing bond
discount or premium;
 Apply the fair value option of measuring bonds;
 Distinguish effective rate and nominal rate;
 Understand the effective interest method of
amortizing premium and discount;
 Compute the market or issue price of the bonds;
 Know the accounting treatment for a compound
financial instrument
Bond
 A formal unconditional promise, made under seal,
to pay a specified sum of money at a determinable
future date, & to make periodic interest payment at
a stated rate until the principal sum is paid.
 Is a contract of debt whereby one party called the
issuer borrows fund from another party called the
investor.
 Evidenced by a certificate and a bond indenture
that contains the contractual agreement.
Types of Bonds

 Term vs. Serial Bonds

 Secured vs. Unsecured Bonds
 Registered vs. Bearer Bonds
 Convertible Bonds
 Callable Bonds
 Junk Bonds
Initial measurement

At FV through P/L at FV not through P/L

 At fair value which is usually the  At fair value less transaction
transaction price at the costs that are directly
acquisition. attributable to the acquisition.
 Transaction costs (BIC)
attributable to the acquisition
are expensed immediately.

Transaction costs include fees and commission

paid to agents, advisers, brokers and dealers, levies
by regulatory authorities and security exchanges,
and transfer taxes and duties.
Initial Measurement of Bonds
 Fair value =
present value of future cash payments
Or
 Fair value =
Issue price or net proceeds from the issue
excluding accrued interest
Subsequent Measurement

At Fair value At amortized cost

 Measured at fair  Measured at
value through amortized cost
profit or loss or OCI using effective
 Not necessary to interest method.
amortize any
premium or
discount.
Issuance of Bond Payable

On interest date Between interest

dates
 no accounting  the issuance of
problem because bonds includes an
the purchase price accrued interest.
is initially
recognized at the
acquisition cost.
Illustration – at fair Value
April 1 Issues P1,000,000 12% bond at 96 plus
accrued interest. Interest is payable January 1 and
July 1. The bonds are issued for trading purposes.
April 1
Cash 990,000
Interest Expense (P1M x 12% x 3/12) 30,000
Bonds Payable 960,000
July 1
Interest Expense 60,000
Cash 60,000
Dec 31 Recorded the accrued interest from July 1 to
December 31 on the bonds.

Interest Expense 60,000

Accrued Interest Expense 60,000
(1,000,000 x 12% x 6/12)

Dec 31 The bonds are quoted at 98 at the end of the year.

Loss from change in FV 20,000

Bonds Payable 20,000

Market value (1,000,000 x 98) 980,000

CA of remaining bonds (960,000
Loss 20,000
20x0
April 1 Issued P1,000,000 face value 12% bonds at 94. Bonds pay interest
semi-annually April 1 and October 1 and mature on April 1, 2025.
Cash 940,000
Discount on Bonds Payable 60,000
Bonds Payable 1,000,000

Oct 1 Paid semi-annual interest

Interest Expense 60,000
Cash 60,000

Dec 31 Adjustment for accrued interest for three months

Interest Expense 30,000
Accrued Interest (1,000,000x12%x3/12) 30,000
Dec 31 Amortization of the bond discount for 9 months
from April 1 to December 31,2020.
Interest Expense 9,000
Discount on BP (60,000/5 x 9/12) 9,000
2021
Jan 1 Reversal of the adj. for accrued interest
Accrued Interest Expense 30,000
Interest Expense 30,000
Apr 1 Paid semi-annual interest
Interest Expense 60,000
Cash 60,000
Oct 1 Paid semi-annual interest
Interest Expense 60,000
Cash 60,000

Dec 31 Adjustment for accrued interest for three months.

Interest Expense 30,000

Accrued Interest Expense 30,000

31 Adjustment for amortization of bond discount for 1

year.

Interest Expense 12,000

Discount on Bonds Payable 12,000
In succeeding years, similar entries will be prepared. If proper
amortization are made, the bonds payable will appear as follows:
Carrying Amount
April 1, 20x0 Cost 940,000
Dec. 31, 20x0 Amortization 9,000
Dec. 31, 20x1 Amortization 12,000
Dec. 31, 20x2 Amortization 12,000
Dec. 31, 20x3 Amortization 12,000
Dec. 31, 20x4 Amortization 12,000
April 1, 20x5 Amortization 3,000
1,000,000
To record the repayment of the bonds.
Bonds Payable 1,000,000
Cash 1,000,000
Methods of Amortization
a. Straight line method – provides for an equal
amount of premium or discount amortization
each accounting period.
b. Bond outstanding method – applicable in serial
bonds, whether acquired at a premium or
discount.
c. Effective interest method – classification of rate
of interest:
Nominal/Coupon/Stated rate - rate of interest
appearing on the face of the bonds.
Effective/ Yield/Market rate - the actual rate of
interest which bondholder earns on the
investment.
Illustration – Straight line method

Face value of bonds 2,000,000

Issue price on January 1, 20x0 1,850,000
Date of bonds January 1, 20x0
Date of maturity January 1, 20x3
Interest payable on June 30 and Dec. 31 12%

Tasks:
Prepare the pertinent journal entries.
ILLUSTRATION: STRAIGHT-LINE METHOD
Entries for 20x0:
1. Acquisition on January 1.
Cash 1,850,000
Discount on BP 150,000
Bonds Payable 2,000,000
2. Payment of semi-annual interest on June 30.
Interest Expense 120,000
Cash 120,000
3. Payment of semi-annual interest on Dec. 31
Interest Expense 120,000
Cash 120,000
4. Amortization of Discount
Interest Expense 50,000
Discount on BP 50,000
ILLUSTRATION:
BOND OUTSTANDING METHOD
Face value of bonds 4,000,000
Issue price on January 1, 20x0 4,200,000
Premium on bonds 200,000
Annual installment on December 31,20x0
and every December thereafter 1,000,000
Date of bonds January 1, 20x0
Interest payable annually on December 31 12%
Tasks:
a. Prepare Journal entries
b. Schedule of Amortization
ILLUSTRATION:
BOND OUTSTANDING METHOD

Schedule of annual premium amortization:

Year Bond outstanding Fraction Amortization
20x0 4,000,000 4/10 80,000
20x1 3,000,000 3/10 60,000
20x2 2,000,000 2/10 40,000
20x3 1,000,000 1/10 20,000
10,000,000 200,000
Entries for 20x0:
Jan 1 Cash 4,200,000
Bonds Payable 4,000,000
Premium on Bonds Payable 200,000
Dec 31 Bonds Payable 1,000,000
Interest Expense * 480,000
Cash 1,480,000
* (4,000,000x12%)
Dec 31
Premium on Bonds Payable 80,000
Interest Expense 80,000
ILLUSTRATION:
EFFECTIVE INTEREST METHOD

Face value of bonds 4,000,000

Issue price on January 1, 20x0 4,171,810
Premium on bonds 171,810
Annual installment on December 31,20x0
and every December thereafter 1,000,000
Date of issue January 1, 20x0
Nominal interest rate payable
annually every December 31 10%
Effective interest rate 8%
 Illustration:
Effective interest method
Interest Interest Premium Principal Carrying
Date
Paid Expense amortization payment amount

01/01/x0 4,171,810
12/31/x0 400,000 333,745 66,255 1,000,000 3,105,555
12/31/x1 300,000 248,444 51,556 1,000,000 2,053,999
12/31/x2 200,000 164,320 35,680 1,000,000 1,018,319
12/31/x3 100,000 81,681 18,319 1,000,000 -
Interest Paid = Face value x nominal rate
Interest Expense = Carrying amount x effective rate.
Premium amortization = interest paid - interest expense.
Carrying amount = preceding amount - principal payment - premium
amortization.
Entries for 20x0
Jan 1 Cash 4,171,810
Premium on Bonds Payable 171,810
Bonds Payable 4,000,000

Dec 31 Bonds Payable 1,000,000

Interest Expense 400,000
Cash 1,400,000
31 Premium on Bonds Payable 66,255
Interest Expense 66,255
 Exercise–
Effective interest method
Face value of bonds 2,000,000
Issue price on January 1, 2020 1,929,080
Date of issue January 1 ,20x0
Nominal interest rate payable
semi-annually every Jan. 1 & July 1 8%
Effective interest rate 10%
Maturity date January 1, 20x2
 Exercise – Effective interest method

Interest Interest Discount Carrying

Date
Paid Expense amortization amount

01/01/x0 1,929,080
06/30/x0 80,000 96,454 16,454 1,945,534
12/31/x0 80,000 97,277 17,277 1,962,811
06/30/x1 80,000 98,141 18,141 1,980,952
12/31/x1 80,000 99,048 19,048 2,000,000
Entries for 20x0
Jan 1 Cash 1,929,080
Discount on BP 70,920
Bonds Payable 2,000,000
July 1 Interest Expense 80,000
Cash 80,000
* July 1Interest Expense 16,454
Discount on BP 16,454
Dec. 31 Interest Expense 80,000
Accrued Interest Expense 80,000
*Dec. 31 Interest Expense 17,277
Discount on BP 17,277
*Dec. 31 Interest Expense 33,731
Discount on BP 33,731
Entries for 20x1
Jan 1 Accrued Interest 80,000
Interest expense 80,000
Interest Expense 80,000
Cash 80,000
Or Accrued interest 80,000
Cash 80,000
July 1 Interest Expense 80,000
Cash 80,000
* July 1 Interest Expense 18,141
Discount on BP 18,141
Dec. 31 Interest Expense 80,000
Accrued Interest Expense 80,000
*Dec. 31 Interest Expense 19,048
Discount on BP 19,048
Or *Dec. 31 Interest Expense 37,189
Discount on BP 37,189
Entries for 20x2:
Jan 1 Accrued Interest 80,000
Interest expense 80,000

Interest Expense 80,000

Cash 80,000

Or Accrued interest 80,000

Cash 80,000

Bonds Payable 2,000,000

Cash 2,000,000
 ISSUE PRICE OR MARKET PRICE OF BOND
Procedures for the computation of the purchase price of
bonds.
1. Using the effective rate, find the present value of an
ordinary annuity of 1 for the number of interest periods
involved.
2. Multiply the nominal rate by the face value of the bonds
for one interest period. Also multiply the effective rate
by the face value for one interest period then get the
difference between the two product.
3. The difference computed in no. 2 is multiplied by the
present value factor determined in no. 1. the answer
represents either a discount or premium.
 ISSUE PRICE OR MARKET PRICE
Procedures for the computation of the purchase price of
bonds.
3. The difference computed in no. 2 is multiplied by the
present value factor determined in no. 1. the answer
represents either a discount or premium.

➢ If the effective rate is more than the nominal rate,

the answer in no. 3 is a discount.
➢ If the effective rate is less than the nominal rate,
the answer in no. 3 is a premium.

4. The face value of the bond plus premium or minus

discount equals the purchase price of the bond.
Illustration:
Issue Price of Bond
Face value of the bonds P 3,000,000
Date of issue of bonds January 1, 20x0
Nominal rate 6%
Effective rate 8%
Interest payable annually December 31
Date of Maturity January 1, 20x3

What is the purchase price of the bonds on

January 1, 20x0?
1. PV factor for 3 interest periods using the annual
effective rate of 8% is 2.5771.
2. Annual nominal rate x face value (6%x3M) 180,000
Annual effective rate x face value (8%x3M) 240,000
Difference 60,000
3. 2.5771 times P60,000 equals P154,626. This amount is
a discount because the effective rate is higher than the
nominal rate.
4. Issue price = P3,000,000 - P154,626
= P2,845,374
Chapter 7
COMPOUND FINANCIAL INSTRUMENT
FINANCIAL INSTRUMENT
Financial instrument
➢ Any contract that gives rise to both a financial asset
o one entity and a financial liability or equity
instrument of another entity.
Financial liability
➢ any liability that is a contractual obligation to:
deliver cash or other financial asset or to exchange
FI with another entity under conditions that are
potentially unfavorable.
Equity instrument
➢ Any contract that evidences a residual interest in the
assets of an entity after deducting all of its liabilities.
 COMPOUND FINANCIAL INSTRUMENT

➢ A financial instrument that contains both a

liability and an equity element from the
perspective of the issuer.
Examples:
a. Bonds payable with warrants
b. Convertible bonds payable
 Accounting for Financial Instrument

➢ Shall be accounted for separately

Apply “split accounting”

FV of Allocated to
Consideration Liability Equity
received component component
 BONDS PAYABLE ISSUED W/ WARRANTS:
ILLUSTRATION 1
An entity issued 2,000 10-year bonds, face
amount P1,000 per bond, at 105. Each bond is
accompanied by one warrant that permits the
bondholder to purchase 20 equity shares, par
P50, at P55 per share. The market value of the
bonds ex-warrant at the time is 98.

Tasks:
1. Record the issuance of the bonds.
2. Record the exercise of 60% of the warrants.
3. Record the expiration of the remaining
warrants.
Issuance:
Cash 2,100,000
Discount on BP 40,000
Bonds Payable 2,000,000
Share warrants outstanding 140,000

Exercise of 60%:
Cash 1,320,000
Share warrants outstanding 84,000
Share Capital 1,200,000
Share premium 204,000

Expiration of 40%:

Share warrants outstanding 56,000

Share Premium – unexercised warrants 56,000
 BONDS PAYABLE ISSUED W/ WARRANTS:
ILLUSTRATION 2

Suppose the market value of the bonds ex-

warrants is not known:
➢ The amount allocated to the bonds is equal to
the PV of the principal bond liability plus the
PV of future interest payments using the
effective interest rate for similar bonds
without the warrants.

PV of Bonds Allocated to
Issue price
payable Warrants
 BONDS PAYABLE ISSUED W/ WARRANTS:
ILLUSTRATION 2
An entity issued 2,000, 10%, 10-year bonds, face
amount P1,000 per bond, at 105. Each bond is
accompanied by one warrant that permits the
bondholder to purchase 20 shares, par P50, at P55
per share. The market value of the bonds ex-warrant
at the time is not known. The prevailing market rate
for similar bonds without warrants is 12%

Tasks:
1. Record the issuance of the bonds.
2. Record the exercise of 60% of the warrants.
3. Record the expiration of the remaining warrants.
1. PV of Principal (2M x 0.322) 644,000
PV of Interest (200,000 x 5.650) 1,130,000
Total Present value 1,774,000
2. Issue price of the bonds w/ warrants 2,100,000
Total PV of Bonds 1,774,000
Residual amount alloc. to warrants 326,000

Cash 2,100,000
Discount on BP 226,000
Bonds Payable 2,000,000
Share warrants outstanding 326,000
 CONVERTIBLE BONDS

➢ Are those which give the holders the right to

convert their bondholding into share capital
or other securities of the issuing entity within
a specified period of time.

Amount
Price w/o
Allocated to
Issue price Conversion
Conversion
Privilege
Privilege
 CONVERTIBLE BONDS :
ILLUSTRATION 1
An entity issued 2,000 5-year bonds, face
amount P1,000 per bond, at 105. Each bond
contains a conversion privilege that provides
for an exchange for a 20 equity shares with
P50 par. It is reliably determined that the
bonds would sell at 99 without conversion
privilege.

Tasks:
1. Journal entry to record the issuance of the
bonds
 CONVERTIBLE BONDS: ILLUSTRATION 1

Issue price of the bonds w/ privilege 2,100,000

Market value of the bonds w/o privilege 1,980,000
Amount allocated to conversion privilege 120,000

Cash 2,100,000
Discount on BP 20,000
Bonds Payable 2,000,000
Share Premium - conversion 120,000
CONVERTIBLE BONDS PAYABLE:
ILLUSTRATION 2
An entity issued 2,000, 5-year bonds, face amount
P1,000 per bond, at 105. Each bond contains a
conversion privilege that provides for an exchange
for a 20 equity shares with par value of P50. The
interest is payable semiannually at a rate of 8%. The
market value bonds without conversion privilege is
unknown. The prevailing rate of interest for similar
bonds is 10% per annum.

Tasks:
1. Journal entry to record the issuance of the
bonds
The semi-annual effective rate is 5%, n = 10 periods
PV of P1 = 0.61; PVOA = 7.72

1. PV of Principal (2,000,000 x 0.61) 1,220,000

PV of Interest (80,000 x 7.7217) 617,600
Total Present value 1,837,600

2. Issue price of the bonds w/ privilege 2,100,000

Total PV of Bonds 1,837,600
Amount allocated to conversion privilege 262,400

Cash 2,100,000
Discount on BP 162,400
Bonds Payable 2,000,000
Share Premium – conversion privilege 262,400
CONVERSION OF BONDS
❖ The carrying amount of the bonds is the measure
of the share capital issued
❖ There is no gain or loss on conversion at maturity.
❖ Any cost incurred shall be deducted from share
premium or debited to “share issue cost”
❖ Carrying amount:
Face amount xx
Accrued interest xx
Unamortized Premium xx
unamortized discount (xx)
unamortized bond issue cost (xx)
Carrying amount xx
 CONVERSION OF BONDS

Accounting procedures:

• Update the amortization of

a. premium/discount and issue cost

• The face of the bonds converted together

with unamortized premium/discount and
b. issue cost shall be canceled.

• If the interest is not paid, it is added to the

c. face amount to get the carrying amount.
 CONVERTIBLE BONDS : ILLUSTRATION
At the beg. of the year, an entity issued 2,000, 5-year
bonds, face amount P1,000 per bond, at 105. Each bond
contains a conversion privilege that provides for an
exchange for a 20 equity shares with P50 par. The interest
is payable every June 30 and Dec. 31 at an annual rate of
8%. The market value of bonds without conversion
privilege is unknown. When the bonds are issued, the
prevailing rate for similar bonds is 10% per annum. Half of
the bonds were converted at the end of current year.

Tasks:
1. Journal entry to record the issuance of the bonds,
interest payment, amortization and conversion.
 CONVERTIBLE BONDS
Jan. 1
Cash 2,100,000
Discount on BP 162,400
Bonds Payable 2,000,000
Share Premium – conversion privilege 262,400

June 30
Interest expense (1,837,600x05) 91,880
Discount on BP 11,880
Cash 80,000

Dec. 31
Interest expense (1,849,480x.05) 92,474
Discount on BP 12,474
Cash 80,000
 CONVERSION OF BONDS
Face amount of converted bonds 1,000,000
Unamortized discount (138,046 x ½) (69,023)
Carrying amount 930,977
Share premium – conversion 131,200
Total consideration 1,062,177
Par value (20,000 x P50) 1,000,000
Share Premium 62,177

Dec. 31
Bonds payable 1,000,000
Share premium – conversion 131,200
Discount on BP 69,023
Share Capital 1,000,000
Share premium – issuance 62,177
PAYMENT OF CONVERTIBLE BONDS
AT MATURITY

• Since the bonds already matured, the

premium or discount is already fully
a. amortized

• The convertible bonds are not converted but

b. fully paid by the issuer.

•The payment at maturity is equal to the

c. face amount (plus interest).

•Then close the share premium –

d conversion to share premium - issuance
CONVERTIBLE BONDS : ILLUSTRATION
At the beg. of the year, an entity issued 2,000, 5-year
bonds, face amount P1,000 per bond, at 105. Each bond
contains a conversion privilege that provides for an
exchange for a 20 equity shares with P50 par. The interest
is payable every June 30 and Dec. 31 at an annual rate of
8%. The market value of bonds without conversion
privilege is unknown. When the bonds are issued, the
prevailing rate for similar bonds is 10% per annum.
The convertible bonds are not converted but fully paid
on maturity.
Tasks:
1. Journal entries
 Payment of Convertible Bonds
at maturity

Bonds Payable 2,000,000

Interest expense 80,000
Cash 2,080,000
to record payment at maturity

Share premium- conversion privilege 262,400

Share premium 262,400
to close the SP – conversion privilege
 PAYMENT OF CONVERTIBLE BONDS
BEFORE MATURITY

• Compute the FV of the bonds w/ conversion

1. privilege
• Determine the FV of Bonds w/o conversion
2. privilege

• Get the difference, it is the FV of the equity component (Share

3. premium - conversion to be debited)

• Determine any gain or loss on debt extinguishment, it is equal to

the difference between the FV of bonds w/o conversion privilege
4 and carrying amount of the bonds.

• Then close the share premium – conversion to share premium -

5. issuance
 CONVERTIBLE BONDS : ILLUSTRATION
At the beg. of the year, an entity issued 2,000, 5-year
bonds, face amount P1,000 per bond, at 105. Each bond
contains a conversion privilege that provides exchange for
a 20 equity shares with P50 par. The interest is payable
every June 30 and Dec. 31 at an annual rate of 8%. The
market value of bonds without conversion privilege is
unknown. When the bonds are issued, the prevailing rate
for similar bonds is 10% per annum.
The convertible bonds are not converted but fully paid
at the end of year 1. On that date, the quoted price of the
convertible bonds is 95 which is the payment to the
bondholders plus interest. However the quoted price of the
bonds w/o conversion privilege is 92.

Tasks:
1. Journal entries
 CONVERSION OF BONDS

FV w/ conversion privilege 1,900,000

FV w/o conversion privilege (1,840,000)
FV of equity component 60,000

Bonds Payable 2,000,000

Discount on BP (138,046)
Total consideration 1,861,954
Payment (2,000,000 x .92) 1,840,000
Gain on extinguishment of debt 21,954
 Payment of Convertible Bonds
before maturity

Bonds Payable 2,000,000

Share premium – conversion 60,000
Discount on bonds payable 138,046
Cash (2,000,000x.95) 1,900,000
Gain on debt extinguishment 21,954
to record payment before maturity

Share premium- conversion privilege 202,400

Share premium (262,400 – 60,000) 202,400
to close the SP – conversion privilege

*FV with conversion privilege – 95%

**FV w/o conversion privilege – 92%
 THANK YOU!
End of
Chapter 7

Do you have any questions?

email@jhevangelista@bpsu.edu.ph
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