TOPIC 3: BONDS PAYABLE & OTHER CONCEPTS

Related standards:
PAS 32 Financial Instruments: Presentation
PFRS 7 Financial Instruments: Disclosures
PFRS 9 Financial Instruments

Learning Objectives:
1. State the initial and subsequent measurements of bonds payable.
Bonds  are usually long-term debt instruments similar to notes and loans except the bonds are usually offered
to the public and sold to many investors. It is 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.

Bond indenture – is a contractual arrangement between the issuer and the bondholders. It contains restrictive
covenants intended to prevent the issuer from taking actions contrary to the interests of the bondholders. It
may specify the ff:
a. Rights and duties of bondholders and issuer
 Call provision – right to the issuer to call the bonds before the scheduled maturity.
 Redemption rights – right of the holder to redeem the bonds before the scheduled maturity.
b. Restrictions and requirements on the issuer
 Establishment of sinking fund
 Financial ratios that the issuer is required to maintain
 Restriction on dividends available to the issuer’s shareholders.
c. Interest rate, payment date(s), and maturity date(s)

Types of bonds:
 As to maturity
1. Term bonds – bonds that mature on a single date.
2. Serial bonds – bonds in which the principal matures in installment
3. Extendible and retractable bonds – bonds that have more than one maturity date permitting investors to
choose maturity dates that meet their needs.

 As to recording point of view and payment of interests

4. Registered bonds – bonds issued in the name of the holder (owner).
5. Coupon (bearer) bonds – bonds that can be freely transferred and have a detachable coupon for each
interest payment.
6. Zero-coupon bonds – bonds that do not pay periodic interest. Both the principal and compounded interest
are due only at maturity date.
7. Income bonds – bonds that pay interest only if the issuer earns profit.
8. Participating bonds- bonds that participate in excess earnings of the issuer as defined in the indenture.

 As to security and risk

9. Mortgage bonds – bonds secured by real property.
10. Collateral trust bonds – bonds secured by the issuer’s securities, which are held by a trustee.
11. Debenture bonds – bonds not secured by any collateral.

 As to right of redemption
12. Callable bonds – bonds that the issuer can redeem prior to maturity date.
13. Convertible bonds – bonds that the holder can exchange for the issuer’s shares of stocks.

 As to issuer
14. Corporate bonds – bonds issued by a corporation.
 15. Government bonds (Treasury bonds) – bonds issued by the government.

Initial measurement:
 FV of the financial liability minus transaction costs (bond issue cost) which is normally equal to the net proceeds
from the issuance of the bonds (in the case of issuance at interest date). Fair value is determined in the order of
priority:
a. Quotation from an active market
b. Present value of all principal and interest payments

Transaction cost or bond issue cost that is directly attributed to the issuance of bonds payable is treated as an
adjustment to premium (deducted from) or discount (added to) on bonds payable and not treated as an outright
expense.

Classification Initial Subsequent Amortized? FV changes Interest expense is based on

Financial FVPL FV FV No Yes Stated rate
Liabilities AC FV - TC AC Yes No Effective rate

Subsequent measurement:
 At amortized cost

Amortized cost – The amount at which the financial liability is measured plus or minus the cumulative amortization
using effective interest method of any difference between the initial carrying amount and the maturity amount.
 There is a discount if the net cash proceeds (initial carrying amount) is less than (<) face amount of the bonds.
(Effective rate > nominal or stated rate)
 There is a premium if the net cash proceeds (initial carrying amount) is greater than (>) face amount of the
bonds. (Effective rate < nominal or stated rate)
 The discount or premium and transaction costs (bond issue cost) are considered in the computation of
effective interest method.

Accounting for Bonds

1. Issuance of bonds
Case 1: There is a discount (Effective rate > stated rate)
On interest date Between interest date
Cash xx Cash (including the accrued interest) xx
Discount on B/P xx Discount on B/P xx
Bonds payable xx Bonds payable xx
Interest expense xx

Case 2: There is a premium (Effective rate < stated rate)

On interest date Between interest date
Cash xx Cash (including the accrued interest) xx
Premium on B/P xx Premium on B/P xx
Bonds payable xx Bonds payable xx
Interest expense xx

Case 3: Issued at par but incurred transaction cost

On interest date Between interest date
Cash (FV – TC) xx Cash (including the accrued interest - TC) xx
Bond issue cost xx Bond issue cost xx
Bonds payable xx Bonds payable xx
Interest expense xx

2. Payment of interest (based on stated or nominal rate)

Interest expense xx
Cash or interest payable if accrued xx
3. Amortization of the difference between carrying amount and face amount (discount or premium)
Case 1: There is a discount
Interest expense xx
Discount on B/P xx
Case 2: There is a premium
Premium on B/P xx
Interest expense xx

4. Payment of installment (in case of serial bonds)

Bonds payable xx
Cash xx

Amortization table – term bonds (lump sum)

Date Interest paid Interest expense Amortization Carrying amount/Amortized cost
(stated rate x face (Effective rate x
value) Carrying amount)

Amortization table – serial bonds (installment)

Date Interest paid Interest expense Amortization Principal repayments Amortized cost/C.A

RETIREMENT OF BONDS PRIOR TO MATURITY

Retirement is the process of extinguishing the bond liability. If the bonds are retired at maturity, there is no
accounting problem since there is no gain or loss on retirement. The entity involves debiting the carrying amount of
the bonds payable and crediting cash.

Accounting problem arises when bonds are retired before maturity. Gain or loss on retirement can be computed as
follows:
Retirement price xxx
Less: Carrying amount of the bonds on the date of retirement xxx
Gain or loss on retirement of bonds xxx

Bond refunding is the floating of new bonds payable, the proceeds from which are used in paying the original bonds
payable. Simply stated, it is the premature retirement of the old bonds through the issuance of new bonds payable.

2. Account for compound financial instruments.

Compound financial instruments (PAS 32) – It is an instrument that includes both a liability and equity from the
point of view of the issuer. Common examples include:
a. Bonds payable issued with share warrants
b. Convertible bonds payable

Share warrants – are rights granted to the holder to acquire shares of the issuer at a specified price during a
specified period.

Accounting for compound instrument (split accounting):

Fair value of the whole instrument (equal to cash proceeds from issuance of compound FI) ----- xxx
Less: FV of the liability without equity feature ---------------------------------------------------------------- xxx
Equity component - residual amount xxx
Journal entries:
a. Bonds payable issued with share warrants
 On issuance:
Cash (net proceeds from issuance of CFI) XXX
Discount on bonds payable, if any XXX
Bonds payable at face value XXX
Premium on bonds payable, if any XXX
Share warrants outstanding XXX

 On exercise of share warrants:

Cash XXX
Share warrants outstanding XXX
Share capital at par value XXX
Share premium XXX
 On expiration:
Share warrants outstanding XXX
Share premium – unexercised warrants XXX

Accounting procedures – bonds with share warrants:

On exercise:
- Considered ordinary issuance of share capital by the corporation.
- The liability is not derecognized.

On expiration:
- The share warrants outstanding is reclassified to share premium account.

b. Convertible bonds payable

 On issuance:
Cash (net proceeds from issuance of CFI) XXX
Discount on bonds payable, if any XXX
Bonds payable at face value XXX
Premium on bonds payable, if any XXX
Share premium – conversion privilege XXX

 On conversion:
Bonds payable at face value XXX
Unamortized premium, if any XXX
Share premium – conversion privilege XXX
Share capital at par value XXX
Unamortized discount, if any XXX
Share premium XXX

 On retirement in lieu of conversion:

Bonds payable at face value XXX
Share premium – conversion privilege XXX
Loss on retirement, if any XXX
Cash XXX
Share premium XXX
Gain on retirement, if any XXX

Accounting procedures – Convertible bonds:

On conversion:
- The liability component is derecognized (in part or in full)
- The unamortized discount or premium is derecognized (in part or in full)
 - The amount of shares converted at par value and the difference is either share premium or retained
earnings
- The equity component is reclassified within equity (from one share premium account to another share
premium) (in part or in full)
- No gain or loss is recognized.

On retirement in lieu of conversion:

- The retirement price is compared to the fair value of the liability without conversion feature on retirement
date. Gain or loss is recognized.
- Since it is a compound instrument, it must be noted that on retirement, the retirement price must be
allocated to the liability and equity components for purposes of determining gain or loss on extinguishment
of debt.

3. Explain the accounting for derecognition of liabilities.

A financial liability is derecognized “when it is extinguished, i.e., when the obligation is discharged or cancelled
or expires. A liability is extinguished in many ways, for example through:
a. Repayment in cash
b. Transfer of non-cash assets or rendering of services
c. Issuance of equity securities
d. Replacement of the existing obligation with a new obligation
e. Waiver or cancellation by the creditor
f. Expiration, e.g., a warranty obligation expires after the warranty period

Debt Restructuring
Debt restructuring – is a situation where the creditor for economic or legal reasons related to the debtor’s financial
difficulties grants to the debtor concession that would not otherwise be granted in a normal business relationship.

Forms of debt restructuring:

A. Asset swap – is the transfer by the debtor to the creditor of any asset in full payment of an obligation.
 Difference between carrying amount of liability extinguished and the carrying amount of the non-cash asset
is recognized as gain or loss on extinguishment.

Format:
Total liability (includes accrued interest) xxx
Less: Carrying amount of the asset given xxx
Gain or loss on extinguishment (P/L) xxx

Under US GAAP, asset swap results to 2 economic events namely, transfer or exchange of assets and
restructuring of liability. Thus, US GAAP requirement is to divide gain on extinguishment into gain or loss on
exchange and gain or loss on restructuring which can be computed based on the below format:
Fair value of the asset given xxx
Carrying amount of the asset given xxx
Gain or loss on exchange xxx

Total liability (includes accrued interest) xxx

Less: Fair value of the asset given xxx
Gain or loss on restructuring xxx

B. Equity swap – is a transaction whereby a debtor and creditor may renegotiate the terms of a financial liability
with the result that the liability is fully or partially extinguished by the debtor issuing equity instruments to the
creditor.
 Difference between carrying amount of liability extinguished and the fair value of the equity instruments
issued (or if unknown, FV or CA of the liability – see IFRIC 19) is recognized as gain or loss on
extinguishment.
 Format:
Total liability (includes accrued interest) xxx
Less: Initial measurement of equity instrument* xxx
Gain on extinguishment (P/L) xxx

*The equity instruments issued to extinguish a financial liability shall be measured in the order of priority: (IFRIC 19)
1. FV of the equity instruments issued
2. FV of the liability extinguished
3. CA of the liability extinguished

C. Modification of terms
Modification of terms of a financial liability may involve either the interest or maturity value or both. Modification
can be done either through:
a. Reduction of the interest or forgiveness of unpaid interest or a moratorium on interest payment
b. Extension of the maturity date or reduction of the amount to be paid at maturity.

 PFRS 9 provides that modification of terms is considered substantial if the PV of cash flows under new terms
discounted at original effective rate is at least 10% different from the carrying amount of the liability
extinguished. In such a case, the existing financial liability shall be accounted for as an extinguishment of the old
financial liability and the recognition of a new financial liability.
Format used to determine whether the gain or loss on modification satisfies the 10% test:
Total liability (includes accrued interest) xxx
Present value of modified liability (using original effective rate) xxx
Gain or loss on modification (P/L) xxx

 Difference between the carrying amount of the old liability and the fair value of the new liability is recognized as
gain or loss on extinguishment. Any transaction cost incurred is included in the computation of gain (deduction)
or loss (addition).
Format:
Total liability (includes accrued interest) xxx
Present value of modified liability (using prevailing market rate) xxx
Gain on extinguishment (P/L) xxx

4. State the requirements for the offsetting of financial assets and financial liabilities.
 A financial asset and a financial liability are offset and only the net amount is presented in the SOFP when
the entity has both:
a. A legal right of set-off; and
b. An intention to settle the amounts on a net basis or simultaneously.

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