1. LEONISA GUERRERO TORINO
BSA 2
INTERMEDIATE ACCOUNTING 2
CHAPTER 5
1. Define a bond.
Wheneverfundsbeingborrowedcanbe obtainedfromasmall numberof sources,mortgagesornotes
are usuallyused.However,whenlarge amountsare needed,anentitymayhave toborrow from the general
investingpublicthroughthe use of a bondissue.
Bondsare usedprimarilybycorporationsandgovernmentunits.A bondisa formal unconditional
promise,made underseal,topaya specifiedsumof moneyata determinablefuture date,andtomake periodic
interestpaymentata statedrate until the principal sumispaid.
In simple language,abondisa contract of debtwherebyone partycalledthe issuerborrowsfundsfrom
anotherparty calledthe investor.A bondisevidencedbyacertificate andthe contractual agreementbetween
the issuerandinvestoriscontainedinadocumentknownas"bondindenture".
2. Explain some featuresof a bond.
a. A bondindenture ordeedof trustisthe documentwhichshowsindetail the termsof the loanand
the rightsand dutiesof the borrowerandotherpartiesto the contract.
b. Bondcertificatesare used.Eachbond certificate representsaportionof the total loan.The usual
minimumdenominationinbusinesspractice isP1,000,althoughsmallerdenominationsmaybe
issuedoccasionally.
c. If propertyispledgedassecurityfor the loan,a trustee isnamedto holdtitle tothe propertyserving
as security.The trustee actsas the representativeof the bondholdersandisusuallyabankor trust
entity.
d. A bankor trust entityisusuallyappointedasregistrarordisbursingagent. The borrowerdeposits
interestandprincipal paymentswiththe disbursingagent,whothendistributesthe fundstothe
bondholders.
3. What are some contentsof a bondindenture?
The bond indenture isthe contractbetweenthe bondholdersandthe borrowerorissuingentity.
Normally,the bondindenture containsthe followingitems:
a. Characteristicsof the bonds
b. Maturity date and provisionforrepayment
c. Periodof grace allowedtoissuingentity
d. Establishmentof a sinkingfundandthe periodicdeposittherein.
e. Deposittocoverinterestpayments
f. Provisionsaffectingmortgagedproperty,suchastaxes,insurance coverage,collectionof interest or
dividendsoncollaterals
g. Accessto corporate booksand recordsof trustee
h. Certificationof bondsbytrustee
i. Requireddebttoequityratio
j. Minimumworkingcapital tobe maintained,if any.
4. Define the followingbonds:
a. Term bonds - are bondswitha single date of maturity.Termbondsmay require the issuingentityto
establishasinkingfundtoprovide adequatemoneytoretire the bondissue atone time.
b. Serial bonds - are bondswitha seriesof maturitydatesinsteadof asingle one.Inotherwords,serial bonds
allowthe issuingentitytoretire the bondsbyinstallments.
c. Mortgage bonds - are bondssecuredby a mortgage onreal properties.
d. Collateral trustbonds - are bondssecuredbysharesandbondsof othercorporation.
e. Debenture bonds - are unsecuredorbondswithoutcollateral security
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COLLEGE OF BUSINESSANDACCOUNTANCY
2. f. Registeredbonds - require the registrationof the name of the bondholdersonthe booksof the corporation.
If the bondholdersellsabond,the oldbondcertificate issurrenderedtothe entityanda
newbondcertificate isissuedtothe buyer.Interestisperiodicallypaidbythe issuing
entitytobondholdersof record
g. Couponor bearerbonds - are unregisteredbondsinthe sensethatthe name of the bondholderisnot
recordedonthe entitybooks.The issuingentitydoesnotmaintainarecordof
whoowns the bondsat anypointin time. Thus,interestoncouponbondsis
paidto the personsubmittingadetachable interestcoupon.
h. Convertiblebonds - are bondsthat can be exchangedforsharesof the issuingentity.
i. Callable bonds - are bondswhichmaybe calledinforredemptionpriortothe maturitydate.
j. Guaranteedbonds - are bondsissuedwherebyanotherpartypromisestomake paymentif the borrower
failstodo so.
k. Junkbonds - are high-risk,high-yieldbondsissuedbyentitiesthatare heavilyindebtedorotherwiseinweak
financial condition.
5. Describe the process inthe sale of bonds.
The bondsneededforthe issuance of bondsare usuallytoolarge forone buyerto pay.Thus, veryoften,
the bondsare dividedintovariousdenominationsof sayP100, P1, 000, P10, 000, thusenablingmore thanone
buyeror investortopurchase the bonds.
Quite often,however,insteadof sellingbondsof variousdenominations,the bondsare soldinequal
denominationsof sayP1,000 only.The P1,000 denominationiscalledthe face amountof the bonds. Each bond
isevidencedbyacertificate calledabondcertificate.Thus,if bondswithface amountof P50,000,000 are sold,
dividedintoP1,000denomination,there shall be 50,000 bondcertificatescontainingaface amountof P1,000.
The sale of the bondsmay be undertakenbythe entityitself.Normallyhowever,the issuingentitydoes
not attempttosell the bondsdirectlytothe public.
Instead,the entire bondissue issoldtoanunderwriterorinvestmentbankthatassumesresponsibility
for resellingthe bondstoinvestors.Sometimes,the underwritermerelyundertakestosell the bondsonthe
basisof a commissiontobe deductedfromthe proceedsof sale.
Whenan entitysellsabondissue,itundertakestopaythe face amountof the bondissue onmaturity
date and the periodicinterest.
Interestisusuallypayablesemiannuallyoreverysix monthsasfollows:
a. January 1 and July1
b. February1 and August1
c. March 1 andSeptember1
d. April 1 and October1
e. May 1 and November1
f. June 1 and December1
Of course,there are certainbondsthatpay interestannuallyoratthe endof everybondyear.
6. Whenis interestonbonds usuallypayable?
PFRS9, paragraph5.1.1, providesthatbondspayable notdesignatedatfairvalue throughprofitorloss
shall be measuredinitiallyatfairvalue minustransactioncoststhatare directlyattributabletothe issue of the
bondspayable.The fairvalue of the bondspayable isequal tothe presentvalue of the future cashpaymentsto
settle the bondliability.
Bondissue costsshall be deductedfromthe fairvalue orissue price of the bondspayable inmeasuring
initiallythe bondspayable.However,if the bondsare designatedandaccountedfor"at fairvalue throughprofit
or loss",the bondissue costsare treatedasexpense immediately.Actually,the fairvalue of the bondspayable is
the same as the issue price ornetproceedsfromthe issue of the bonds, excludingaccruedinterest.
7. Explain the two approaches ofrecording the issuance of bonds.
There are twoapproachesinaccountingfor the authorizationandissuance of bonds,namely:
a. Memorandumapproach
b. Journal entryapproach
IllustrationOnJanuary 1,2020, an entityisauthorizedtoissue 10-year,12% bondswithface amountof
P5,000,000, interestpayable January1andJuly1, consistingof 5,000 unitsof P1,000 face amount.The bonds
are soldat face amountto an underwriter.
Memorandumapproach
The followingmemorandumentryismade inthe general journalanda notationof the amount
authorized:
On January1, 2020, the entityisauthorizedtoissue P5,000,000 face amount,10-year 12% bonds,
interestpayable January1and July,consistingof 5,000 unitsof P1,000 face amount.
To record the sale of the bondsat face amount:
3. Cash 5, 000, 000
Bondspayable 5,000,000
Journal entry approach
To record the authorizationof the bonds:
Unissuedbondspayable 5,000,000
Authorizedbondspayable 5,000,000
To record the sale of the bondsat face amount:
Cash 5,000,000
Unissuedbondspayable 5,000,000
8. Explain the issuance ofbonds at a premium.
If the salesprice ismore than the face amountof the bonds,the bondsare saidto be soldat a premium.
For example,anentityissuedbondswithface amountof P5,000,000 at 105. The quotedprice of 105 means
"105% of the face amountof the bonds."Thus,the salesprice isP5,250,000, computedbymultiplying105%by
P5,000,000.
Journal entry
Cash 5,250,000
Bondspayable 5,000,000
Premiumonbondspayable 250,000
The bond premiumisineffectagainon the part of the issuingentitybecauseitreceivesmore thanwhat
it isobligatedtopayunderthe termsof the bondissue.The obligationof the issuingentityislimitedonlytothe
face amountof the bonds.The bond premiumhoweverisnotreportedasan outrightgain.Whenthe bondsare
soldat a premium,itmeansthatthe investororthe buyerisamenable toreceive interestthatissomewhatless
than the nominal orstatedrate of interest.
Thus,in sucha case,the effectiverate islessthanthe nominal rate of interest.The nominal rate of
interestisthe rate appearingonthe face of the bond certificate.Itisthatinterestwhichthe issuingentity
periodicallypaystothe buyeror bondholder.
Because of the relationshipof the premiumtothe interest,the bondpremiumisamortizedoverthe life
of the bonds.andcreditedtointerestexpense.
Accordingly,if the bondshave a10-year life andthe straightline methodisusedforsimplicity,the entry
to recordthe amortizationof the bondpremiumis:
Premiumonbondspayable 25,000
Interestexpense (250,000/10 years) 25,000
9. Explain the issuance ofbonds at a discount.
If the salesprice of the bondsislessthan the face amountthe bondsare saidto be soldat a discount.
For example,anentityissuedbondswithface amountof P5,000,000 at 95.
Journal entry
Cash (5,000,000 x 95% )
Discountonbondspayable
Bondspayable
The bond discountisineffectalossto the issuingentity.However,itisnottreatedasan
outrightloss.Whenbondsare soldat a discount,itmeansthatthe buyeror investorisnotwillingto
accept simplythe nominal rate of interest.
The buyerwantsto accept a rate of interestthatissomewhathigherthanthe nominal rate.
Thus,whenbondsare issuedata discount,the effective rate ishigherthanthe nominal rate.
Accountingwise,the bonddiscountisamortizedaslossoverthe life of the bondsandchargedto
interestexpense.Thus,if the bondshave alife of 10 yearsand the straightline methodisused,the
journal entrytorecord the amortizationof the bonddiscountis:
Interestexpense (250,000/10 years) 25,000
Discountonbondspayable 25,000
10. Explainthe measurementofbonds payable.
PFRS9, paragraph5.3.1, providesthatafterinitial recognition,bondspayableshall be measuredeither:
a. At amortizedcost,usingthe effective interestmethod
b. At fairvalue throughprofitorloss
4. 11. What is a bond issue cost?
Bondissue costsare transactioncostsdirectlyattributable tothe issue of bondspayable.Suchcosts
include printingandengravingcost,legal and accountingfee,registrationfee withregulatoryauthorities,
commissionpaidtoagentsandunderwritersandothersimilarcharges.
12. Explain the treatment of a bond issue cost.
Under PFRS9, bond issue costsshall be deductedfromthe fairvalue orissue price of bondspayable in
measuringinitiallythe bondspayable.Underthe effectiveinterestmethodof amortization,the bondissue cost
mustbe "lumped"withthe discountonbondspayable and"netted"againstthe premiumonbondspayable."
However,if the bondsare measuredatfairvalue throughprofitor loss,the bondissue costsare expensed
immediately.
13. What are treasury bonds?
Treasurybondsare an entity'sownbondsoriginallyissuedandreacquiredbutnot cancelled.The
acquisitionof treasurybondscallsforthe same accountingproceduresaccordedtoa formal retirementof bonds
priorto the maturitydate.
14. Explain the treatment of treasury bonds.
In otherwords,the treasurybondsshouldbe debitedatface amountandany relatedunamortized
premiumordiscountshouldbe cancelled.Anyaccruedinterestpaidischargedtointerestexpense..The
difference betweenthe acquisitioncostandthe carryingamountof the treasurybondsistreatedas gainor loss
on the acquisitionof treasurybonds.
15. What is bond refunding?
Bondrefundingisthe floatingof new bondsthe proceedsfromwhichare usedinpayingthe original
bonds.Simplystated,bondrefundingisapremature retirementof the oldbondsbymeansof issuingnew
bonds.Bondrefundingisalso knownasbondrefinancing.
Refundingmaybe made onor before the date of maturityof the oldbonds.Where refundingismade
on the date of maturityof the oldbonds,no accountingproblemarisesasthiswouldsimplycall forthe
cancelationof the bondliability.There isnounamortizedpremiumordiscountinvolved.
The retirementishandledinthe usual mannerandthe new bondissue isrecordedinthe normal way.
However,where refundingismade priortothe maturitydate of the oldbonds,consideration mustbe givento
the refundingchargespertainingtothe oldbonds.The refundingchargesincludethe unamortizedbond
discountor premiumandredemptionpremiumonthe oldbondsbeingrefunded.
16. Explain the treatment of bond refundingcharges.
The accountingproblemisthe treatmentof these refundingcharges.Bondrefundingshall be accounted
for as an extinguishmentof afinancial liability.The difference betweenthe carryingamountof the financial
liabilityextinguishedandthe considerationpaidshallbe includedinprofitorloss.Accordingly,the refunding
chargesare chargedto losson extinguishment.
17. What are the methodsof amortizing discountor premiumon bondspayable?
There are three approachesinamortizingbondpremiumorbonddiscount,namely:
a. Straight line - The straightline methodprovidesforanequal amortizationof bondpremiumorbond
discount.The procedure issimplytodividethe amountof bondpremiumorbonddiscountbythe
life of the bondsto arrive at the periodicamortization.The lifeof the bondsisthatperiod
commencingonthe date of sale of the bondsup to the maturitydate.
b. Bond outstanding method- The bond outstandingmethodisapplicabletoserial bondswhether
issuedatdiscountor premium. Serial bondsare those withaseriesof maturitydates.
c. Effective interestmethodorsimply"interestmethod"orscientificmethodPFRS9requiresthe use
of the effective interestmethodinamortizingdiscount,premiumandbondissue cost.
18. Explain the fair value optionof measuringbonds payable.
PFRS9. paragraph4.2.2, providesthatat initial recognition,bondspayablemaybe irrevocably
designatedasatfair value throughprofitorloss.
In otherwords,underthe fairvalue option,the bondspayable shallbe measuredinitiallyatfairvalue
and remeasuredateveryyear-endwithanychangesinfairvalue generallyrecognizedinprofitorloss.There is
no more amortizationof bonddiscountandbondpremium.
Anytransactioncost or bondissue costshouldbe expensedimmediately.Asamatterof fact,interest
expense isrecognizedusingthe nominal orstatedrate.
5. 19. What is the treatmentin the change in fair value ofa financial liabilitydesignatedat fair value through profit
or loss?
PFRS9, paragraph5.7.7, providesthatthe gainor losson financial liabilitydesignatedatfairvalue
throughprofitor lossshall be accountedforas follows:
a. The change infairvalue attributable tothe creditriskof the liabilityisrecognizedinotherincome.
b. The remainingamountof the change in fairvalue isrecognizedinprofitorloss.
However,Paragraph5.7.8 providesthatif presentingthe change infairvalue attributable tocredit
riskwouldcreate or enlarge anaccountingmismatch,all gainsandlossesincludingthe effectsof
changesincreditriskare recognizedinprofitorloss.
An accountingmismatchwouldbe createdorenlargedif presentingthe effectsof changesinthe
creditriskin othercomprehensiveincome wouldresultinamaterial or greaterdifference inprofitor
lossthan if those amountswere presentedinprofitorloss.
ApplicationGuidance B5.7.9providesthatamountsrecognizedinothercomprehensive income
resultingfromchangesinfairvalue of creditriskof a financial liabilitydesignatedatfairvalue through
profitor lossshall notbe subsequentlytransferredtoprofitorloss.However,the cumulative gainorloss
recognizedmaybe transferredwithinequityorretainedearnings.
20. What is a credit risk?
Creditriskisthe risk that the issuerof the liabilitywouldcause afinancial losstothe otherpartyby
failingtodischarge the obligation.Creditriskdoesnotinclude marketrisksuchasinterestrisk,currencyriskand
price risk.
REFERENCES:
BOOK - Valix,C.T.,Peralta,J.F.,&Valix,C.A.M.(2020). Intermediate AccountingVolume 2:Chapter5:
BONDS PAYABLE:GIC ENTERPRISES& CO., INC
