ACCOUNTING FOR FINANCIAL

LIABILITIES
(FRS 139)

Lecture 2
 ACCOUNTING FOR FINANANCIAL LIALITIES
(FRS 139)
• Learning Objectives:
After this lecture you should be able:
 Apply the effective interest methods of bond
discount and premium amortisation
 Describe the accounting for the extinguishment
of debts
 Understand the classification of discount and
premium
 Understand the process of retirement of bonds
at maturity
 Understand the accounting treatment of cost of
issuing bonds
Financial Accounting & Reporting 3
BKAF3063 2
 ACCOUNTING FOR FINANCIAL LIABILITIES
(FRS 139)

• Amortization of bond discounts and

premiums.
a) The amortization period for premiums or
discounts is the period of time that the bonds
are expected to be outstanding.
b) Bond interest expense is increased by
amortization of a discount and decreased by
amortization of a premium.

BKAF3063 Financial Accounting & Reporting 3

3
 Amortization of bond
discounts and premiums.
Bond discounts or premiums may be amortized
using the straight-line method, as was
demonstrated
However, the profession’s preferred procedure is
the effective interest method. This method
computes the bond interest using the effective
rate at which the bonds are issued.

Financial Accounting & 4

BKAF3063
Reporting 3
 ACCOUNTING FOR FINANCIAL LIABILITIES
(FRS 139)

c) The effective interest method is the

preferred procedure used to calculate
periodic interest expense.
(The carrying amount of the bonds at the
start of the period is multiplied by the
effective interest rate to determine the
interest expense.)

Financial Accounting & 5

BKAF3063
Reporting 3
 ACCOUNTING FOR FINANCIAL LIABILITIES
(FRS 139)
Effective Interest Method. 
• The following relationships are emphasized.
(1) Carrying Value of Bonds
= Face Value Plus Premium (or Less Discount).
(2)Interest Payable
= Stated Interest Rate x Face Value of Bonds.
(3) Interest Expense
= Effective Interest Rate x Carrying Value of Bonds.
Financial Accounting & 6
BKAF3063
Reporting 3
 ACCOUNTING FOR FINANCIAL LIABILITIES
(FRS 139)

4) If a premium exists
Interest ExpenseXX
Premium on Bonds Payable XX
Interest Payable XX

5) If a discount exists
Interest ExpenseXX
Discount on Bonds Payable XX
Interest Payable XX
Financial Accounting & 7
BKAF3063
Reporting 3
 ACCOUNTING FOR FINANCIAL LIABILITIES
(FRS 139)
• Amortisation: Straight-line Method

Bond Number Bond

discount or ÷ of interest = amortisation
Premium period

Interest + Discount Interest

Payable - Premium = Expense
Amortisation

Constant Constant Constant

amount amount amount

Financial Accounting & 8

BKAF3063
Reporting 3
 ACCOUNTING FOR FINANCIAL LIABILITIES
(FRS 139)

 Amortisation: Effective Interest Method

Bond Interest Expense Bond Interest paid

Carrying Effective Face Stated Amortisation

Value X X
Interest _ Amount Interest = Amount
Beginning Rate of Bond Rate
Of Period

Financial Accounting & 9

BKAF3063
Reporting 3
 Bond Issue at a Discount
Everyoung issued RM100,000 of 8% bonds on 1
January, 2007 due on 1 January 2012 with
interest payable each 1 July and 1 January.
Maturity value of bonds payable RM100,000
PV of RM100,000, in 5 years at 10%
interest payable 2 times a year RM 61,391
PV of RM4,000 interest payable
semiannually for 5 years at 10%
annually 30,887
Proceed from sale of bonds 92,278
Discount on bonds payable RM 7,722
=========

Financial Accounting & 10

BKAF3063
Reporting 3
 Schedule of Bond Discount Amortisation
5-year, 8% bonds Sold to yield 10%
Date Cash Interest Discount Carrying
Paid (RM) Expense (RM) Amortised (RM) Amount (RM)

1/1/07 92,278

1/7/07 4,000a 4,614b 614c 92,892d

1/1/08 4,000 4,645 645 93,537

1/7/08 4,000 4,677 677 94,214

1/1/09 4,000 4,711 711 94,925

1/7/09 4,000 4,746 746 95,671

Financial Accounting & 11

BKAF3063
Reporting 3
 Bond Issue at a Discount
Date Cash Interest Discount Carrying
Paid (RM) Expense (RM) Amortised (RM) Amount (RM)
1/1/10 4,000 4,783 783 96,454
1/7/10 4,000 4,823 823 97,277
1/1/11 4,000 4,864 864 98,141
1/7/11 4,000 4,907 907 99,048
1/1/12 4,000 4,952 952 100,000
40,000 47,722 7,722

a) RM4,000 = RM100,000 X 8% X 6/12c) RM614 = RM4,614 - RM4,000

b) RM4,614 = RM92,278 X 10% X 6/12d) RM92,892 = RM92,278 + RM614
Financial Accounting & 12
BKAF3063
Reporting 3
 Bond Issue at a Premium
Everyoung issued RM100,000 of 8% bonds on 1 January, 2007
due on 1 January 2012 with interest payable each 1 July and
1 January.
Maturity value of bonds payable RM100,000
PV of RM100,000, in 5 years at 6%
interest payable 2 times a year RM 74,409
PV of RM4,000 interest payable
semiannually for 5 years at 6%
annually 34,121
Proceed from sale of bonds 108,530
Premium on bonds payable RM 8,530
=========

Financial Accounting & 13

BKAF3063
Reporting 3
 Schedule of Bond Premium Amortisation
5-year,8% bonds Sold to yield 6%
Date Cash Interest Discount Carrying
Paid (RM) Expense (RM) Amortised Amount (RM)
(RM)
1/1/07 108,530
1/7/07 4,000a 3,256b 744c 107.786d
1/1/08 4,000 3,234 766 107,020
1/7/08 4,000 3,211 789 106,231
1/1/09 4,000 3,187 813 105,418
1/7/09 4,000 3,162 838 104,580
Financial Accounting & 14
BKAF3063
Reporting 3
 Bond Issue at a Discount
Date Cash Interest Discount Carrying
Paid (RM) Expense (RM) Amortised (RM) Amount (RM)
1/1/10 4,000 3,137 863 103,717
1/7/10 4,000 3,112 888 102,829
1/1/11 4,000 3,085 915 101,914
1/7/11 4,000 3,057 943 100,971
1/1/12 4,000 3,029 971 100,000
40,000 31,470 8,530

a)
RM4,000 = RM100,000 X 8% X 6/12 c) RM744 = RM4,000 - RM3,256
b)
RM3,256 = RM108,530 X 6% X 6/12 d) RM107,786 = RM108,530 - RM744
Financial Accounting & 15
BKAF3063
Reporting 3
 Classification of Discount and Premium
• Unamortized premiums and discounts are
reported with the Bonds Payable account in
the liability section of the balance sheet.
• Premiums and discounts are not liability
accounts; they are merely liability valuation
accounts.
• Premiums are added to the Bonds Payable
account and discounts are deducted from the
Bonds Payable account in the liability section
of the balance sheet.
BKAF3063
Financial Accounting &
Reporting 3
16
 Classification
Classification of
of Discount
Discount and
and Premium
Premium

Discount on bonds payable is a liability valuation account, that

reduces the face amount of the related liability (contra-account).

Balance Sheet (in tho usands)

Assets
Premium on bonds Cash RM40,000
Invento ries 95,000
payable is a liability Plant assets, net 280,000

valuation account, that

Total assets RM415,000
Liabilities and Equity

adds to the face amount Acco unts payable RM80,000

Bonds payable 140,000
of the related liability Disount o n bonds payable (15,000)
Common stock, RM1 par 150,000
(adjunct account). Retained earnings 60,000
Total liabilities and equity
RM415,000

Financial Accounting & 17

BKAF3063
Reporting 3
 Classification of Discount and Premium
• If the interest payment date does not
coincide with the financial statement’s
date, the amortized premium or
discount should be prorated by the
appropriate number of months to arrive
at the proper interest expense.

Financial Accounting & 18

BKAF3063
Reporting 3
 Costs
Costs of
ofIssuing
Issuing Bonds
Bonds
The issue of bonds involve numerous costs:
Legal and accounting expense, administrative
expense (printing doc/prospectus),
underwriting fees.

These costs do NOT represent an asset

Methods of recognition:

1. As an expense – charge to income

statement immediately
2. As a liability – debited to a deferred charge
account

BKAF3063 19
Financial Accounting & Reporting 3
 Cost of Bond Issue
• Assume that Cyber Bhd issued a
RM40,000,000 five-year bond at its par value
on 1 January 1999. The bond carries a coupon
interest of 10% and interest is payable on 31
Dec each year. Costs of issuing the bond,
which included underwriting fees, totaled
RM1,000,000. The costs were capitalized as a
deferred charge and amortized on the straight
line method. Show the entries to
(a) record the issue of bond on 1 Jan 1999
(b) recognize the amortization of the bond
issue cost and interest expense
 Solution
a) Journal entry to record the issuance of the bond
Dt Cash 39,000,000
Dt Deferred chargers bond 1,000,000
Kt Bonds Payable 40,000,000
b) Journal entry to recognize amortization of deferred charge
Dt Amortization expense 200,000
Kt Deferred charges bond 200,000
c) Journal entry to recognize interest expense
Dt Interest expense 4,000,000
Kt Cash 4,000,000
 Extinguishment
Extinguishment of
of Debt
Debt
Extinguishment before Maturity Date
Reacquisition price > Net carrying amount = Loss
Net carrying amount > Reacquisition price = Gain
At time of reacquisition, unamortized premium or
discount, and any costs of issue applicable to the
bonds, must be amortized up to the reacquisition
date.

BKAF3063 22
Financial Accounting & Reporting 3
 Extinguishment
Extinguishment of
of Debt
Debt
Illustration Three year 8% bonds of RM100,000 issued on
Jan. 1, 2007, are recalled at 105 on Dec. 31, 2008. Expenses
of recall are RM2,000. Market interest on issue date was
10%.
8% 10%
Cash Interest Discount Carrying
Date Paid Expense Amortized Amount
1/1/07 RM95,027
12/31/07 RM8,000 RM9,503 RM1,503 96,530
12/31/08 8,000 9,653 1,653 98,183

Account Balances at Dec. 31, 2008:

Bonds payable = RM98,183
Discount on bonds payable (RM4,973–1,503-1,653) = 1,817
Financial Accounting & 23
BKAF3063
Reporting 3
 Extinguishment
Extinguishment of
of Debt
Debt
Illustration Three year 8% bonds of RM100,000 issued
on Jan. 1, 2007, are recalled at 105 on Dec. 31, 2008.
Expenses of recall are RM2,000. Market interest on
issue date was 10%.

Journal entry at Dec. 31, 2007:

Bonds payable 100,000
Loss on extinguishment 8,817
Cash 107,000
Discount on bonds payable 1,817

Reacquisition price = RM105,000 + 2,000 = RM107,000

BKAF3063 24
Financial Accounting & Reporting 3
 END LECTURE 2

THANK YOU

Financial Accounting & 25

BKAF3063
Reporting 3