ACC 108: Intermediate Accounting 3

Module #6 Student Activity Sheet

Name: _________________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________________ Date: ________________

Lesson title: Bonds Payable & Other Concepts Materials:

Learning Targets: Columnar, notebook, non-scientific
At the end of the module, students will be able to: calculator, ballpen, pencil, Student Activity
1. Explain the initial and subsequent measurement of Sheets
bonds payable.
2. Account for compound financial instruments and References:
derecognition of liabilities. Intermediate Accounting 2
2020 edition by Zeus Vernon B. Millan

A. LESSON PREVIEW/REVIEW

Introduction

For this module, related standards are:

PAS 32 Financial Instruments: Presentation
PFRS 7 Financial Instruments: Disclosure
PFRS 9 Financial Instruments

B. MAIN LESSON

Content and Skill-Building

Bonds Payable – long-term debt instruments usually offered to the public and sold to many investors.

Long-term debt instruments - any contract that represents a right upon the holder to receive cash from the
issuer thereof or an obligation upon the issuer to pay cash to the holder thereof.

Bond indenture - contractual arrangement between issuer and the bondholder which contains restrictive
covenants intended to prevent issuer from taking actions contrary to the interest of the bondholder.

Types of Bonds are as follows:

A. As to maturity
1. Term bond - bonds that mature on a single date.
2. Serial Bond -bonds that have series of maturity dates. These bonds are payable in installments.
3. Extendible and Retractable bond - bonds that have more than one maturity date permitting
investors to choose the maturity dates that meet their needs.

B. As to recording point of view and payment of interest

1. Registered bond - bonds issued in the name of the holder (owner). Interests are paid directly to
the holder. When the holder sells registered bonds, the bond certificate must be surrendered and
a new certificate is issued.

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 ACC 108: Intermediate Accounting 3
Module #6 Student Activity Sheet

Name: _________________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________________ Date: ________________

2. Coupon (bearer) bond - bonds that can be freely transferred and have a detachable coupon for
each interest payment
3. Zero-coupon bonds (strip bonds or deep-discount bonds) - bonds that do not pay periodic
interests. Principal and compounded interests are due only at maturity date.
4. Income bonds - bonds that pay interest only if the issuer earns profits.
5. Participating bonds - bonds that participate in excess earnings of the issuer as defined in the
indenture
6. Indexed bonds - bonds that pay interest that is indexed to a measure of general purchasing
power.
7. Inflation-linked bonds - bonds that provide protection against inflation in that the principal is
increased by the change in inflation over a period.

C. As to security and risk

1. Mortgage bonds - bonds secured by real property.
2. Collateral Trust bonds - bonds secured by the issuer’s financial assets or the issuer’s own equity
instruments which are deposited and held by a trustee for the bondholders.
3. Asset-backed bonds - bonds based on underlying pools of assets.
4. Subordinated bonds - bonds that normally have a higher yield than secured bonds. They are
subordinated (inferior) to the claims of other general creditors, secured parties, and parties with
priorities in bankruptcy.
5. Debenture bonds - long-term bonds not secured by specific property.
6. Junk bonds - bonds that are very high-risk, high-yield securities issued to finance leveraged
buyouts and mergers. They are issued by troubled companies.

D. As to right of redemption
1. Callable bonds - bonds that contain call provisions giving the issuer thereof the right to redeem
the bonds prior to their maturity date.
2. Convertible bonds - bonds that give the holder thereof the option of exchanging the bonds for
shares of stocks of the issuer.

E. As to issuer
1. Corporate bonds - bonds issued by private companies.
2. Government Bonds - bonds issued by a government and backed by its full faith and credit.

F. As to Currency
1. International Bonds -Eurobonds, foreign Bonds, Global bonds

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 ACC 108: Intermediate Accounting 3
Module #6 Student Activity Sheet

Name: _________________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________________ Date: ________________

Initial and Subsequent Measurement

Bonds are accounted for in much the same way as notes and loans payable. However, bonds normally are
long-term, bear interest, issued at a premium or discount and entail transaction (issue) costs.

Cash proceeds
Effective Interest rate Effect of
(Carrying amount)
If Bonds are issued at: compared to Nominal amortization on
compared to Face
Interest rate interest expense
Amount
Cash proceeds (Carrying Effective interest rate is Interest expense is
Discount amount) is less than face higher than Nominal greater than Interest
amount interest rate. Paid
Premium Cash proceeds (Carrying Effective interest rate is Interest expense is
amount) is greater than lower than Nominal lower than Interest
face amount interest rate. Paid

Additional concepts to remember when accounting for bonds are:

➢ Transaction cost - cost incurred in the issuance of bonds.
▪ Deducted when determining the carrying amount of the bonds
▪ Amortized using effective interest method (accounting is similar to discount on bond
payable)

• Issuance of Bonds between interest payments

o accrued interest is not included in the initial measurement of the bonds
o credited to interest payable or interest expense

Case 1: Bonds issued at a discount

On January 1, 20x1, ABC co. issued 1,000, P1,000, 10%, 3-year bonds for P951,963. Principal is due at
maturity but interest is due annually every year-end. The effective interest rate is 12%.

Initial measurement:
Bonds Payable (1,000 x P1,000) 1,000,000
Discount on bonds payable, Jan 1, 20x1 (48,037)
Carrying amount of bonds payable Jan. 1, 20x1 951,963

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 ACC 108: Intermediate Accounting 3
Module #6 Student Activity Sheet

Name: _________________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________________ Date: ________________

Subsequent Measurement: Amortization table

Date Interest Interest Amortization Present Value/Carrying
Payments Expense (payment less interest Amount
(P1,000,000 x (Present Value x expense) (balance plus amortization)
10%) 12%
Jan 1, 20x1 951,963
Dec 31, 20x1 100,000 114,236 14,236 966,199
Dec 31, 20x2 100,000 115,944 15,944 982,143
Dec 31, 20x3 100,000 117,857 17,857 1,000,000

Entries:
20x1
Jan 1 Cash 951,963
Discount on bonds payable (1,000,000 – 951,963) 48,037
Bonds Payable 1,000,000

Dec 31 Interest Expense 114,236

Cash 100,000
Discount on bonds payable 14,236
20x2
Dec 31 Interest Expense 115,944
Cash 100,000
Discount on bonds payable 15,944
20x3
Dec 31 Interest Expense 117,857
Cash 100,000
Discount on bonds payable 17,857

Bonds payable 1,000,000

Cash 1,000,000

The unamortized balance of a discount or premium is computed through

Face amount xx
Less: Carrying amount (xx)
Discount/Premium of bond payable xx

Case 2: Bonds issued at a premium

On January 1, 20x1, ABC co. issued 1,000, P1,000, 12%, 3-year bonds for P1,049,737. Principal is due at
maturity but interest is due annually every year-end. The effective interest rate is 10%.

Initial measurement:
Bonds Payable (1,000 x P1,000) 1,000,000
Premium on bonds payable, Jan 1, 20x1 49,737
Carrying amount of bonds payable Jan. 1, 20x1 1,049,737

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 ACC 108: Intermediate Accounting 3
Module #6 Student Activity Sheet

Name: _________________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________________ Date: ________________

Subsequent Measurement: Amortization table

Date Interest Interest Amortization Present Value/Carrying
Payments Expense (payment less interest Amount
(P1,000,000 x (Present Value x expense) (balance less amortization)
12%) 10%
Jan 1, 20x1 1,049,737
Dec 31, 20x1 120,000 104,974 15,026 1,034,711
Dec 31, 20x2 120,000 103,471 16,529 1,018,182
Dec 31, 20x3 120,000 101,818 18,182 1,000,000

Entries:
20x1
Jan 1 Cash 1,049,737
Premium on bonds payable 49,737
Bonds Payable 1,000,000

Dec 31 Interest Expense 104,974

Premium on bonds payable 15,026
Cash 120,000
20x2
Dec 31 Interest Expense 103,471
Premium on bonds payable 16,529
Cash 120,000
20x3
Dec 31 Interest Expense 101,818
Premium on bonds payable 18,182
Cash 120,000

Bonds payable 1,000,000

Cash 1,000,000

Case 3: Bonds issued at a discount – with transaction costs

On January 1, 20x1, ABC co. issued 1,000, P1,000, 10%, 3-year bonds for P951,963. Principal is due at
maturity but interest is due annually every year-end. In addition, ABC incurred bond issue costs of P44,829.
The effective interest rate is 12% before adjustment for bond issue costs and 14% after adjustment for bond
issue costs.

Initial measurement:
Bonds Payable (1,000 x P1,000) 1,000,000
Less: Discount on bonds payable, Jan 1, 20x1 (48,037)
Issue costs (44,829)
Carrying amount of bonds payable Jan. 1, 20x1 907,134

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 ACC 108: Intermediate Accounting 3
Module #6 Student Activity Sheet

Name: _________________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________________ Date: ________________

Subsequent Measurement: Amortization table

Date Interest Interest Amortization Present Value/Carrying
Payments Expense (payment less interest Amount
(P1,000,000 x (Present Value x expense) (balance plus amortization)
10%) 14%
Jan 1, 20x1 907,134
Dec 31, 20x1 100,000 126,999 26,999 934,133
Dec 31, 20x2 100,000 130,779 30,779 964,912
Dec 31, 20x3 100,000 135,088 35,088 1,000,000

Case 4: Straight-line vs. Effective Interest

On January 1, 20x1, ABC co. issued 1,000, P1,000, 10%, 3-year bonds for P951,963. Principal is due at
maturity but interest is due annually every year-end. The effective interest rate is 12%. ABC Co. incorrectly
used the straight-line method instead of the effective interest method to amortize the discount.

Requirements: Determine the effects of the error on the following:

a) Carrying amount of the bonds on Dec. 31, 20x1
b) Profit for 20x1

Solution:
• Erroneous amortization using straight-line

Face amount 1,000,000

Cash proceeds (951,963)
Discount on bonds payable – Jan 1, 20x1 48,037
Divide by: Terms of bonds (in years) 3
Annual amortization (straight-line method) 16,012

Interest payment (1,000,000 x 10%) 100,000

Annual amortization 16,012
Interest expense under straight-line method 116,012

Carrying amount – Jan. 1, 20x1 951,963

Annual amortization 16,012
Carrying amount under straight-line method Dec 31, 20x1 967,975

• Amortization using effective interest method:

Date Interest Interest Amortization Present Value/Carrying
Payments Expense Amount
Jan 1, 20x1 951,963
Dec 31, 20x1 100,000 114,236 14,236 966,199
Dec 31, 20x2 100,000 115,944 15,944 982,142
Dec 31, 20x3 100,000 117,857 17,857 1,000,000

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 ACC 108: Intermediate Accounting 3
Module #6 Student Activity Sheet

Name: _________________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________________ Date: ________________

Requirement (a): Effect on carrying amount

Carrying amount on Dec 31, 20x1 – straight-line 967,975
Carrying amount on Dec 31, 20x1 – effective interest 966,199
Difference – overstatement under straight-line 1,776

Requirement (b): Effect on 20x1 profit

20x1 interest expense – straight-line 116,012
20x1 interest expense – effective interest 114,236
Difference – overstatement under straight-line 1,776
Consequently, the profit under straight-line is understated by P1,776.

Case 5: Issuance of bonds between interest payment dates

The accrued interest prior to the issuance date is not included in the initial measurement of the bonds, but
rather credited to interest payable or interest expense. Moreover, the interest expense recognized for the
period represents only the post-issuance interest expense.

Illustration 1: On April 1, 20x1, ABC co. issued 12%, P1,000,000 bonds dated January 1, 20x1. The bonds
were issued at 97 including accrued interest.

Initial measurement:
Cash proceeds including accrued interest (1,000,000 x 97%) 970,000
Less: Accrued interest sold (1,000,000 x 12% x 3/12) (30,000)
Carrying amount of bonds payable Apr. 1, 20x1 940,000

Entries:
Apr 1, 20x1 Cash (1,000,000 x 97%) 970,000
Discount on bonds payable (1,000,000-940,000) 60,000
Bonds Payable 1,000,000
Interest expense (or Interest Payable) 30,000
(1,000,000 x 12% x 3/12)

Illustration 2: On April 1, 20x1, ABC co. issued 12%, P1,000,000 bonds dated January 1, 20x1. The bonds
were issued at 97 excluding accrued interest.

Initial measurement:
Cash proceeds excluding accrued interest (1,000,000 x 97%) 970,000

Entries:
Apr 1, 20x1 Cash (1,000,000 x 97%) + (1,000,000 x 12% x 3/12) 1,000,000
Discount on bonds payable (1,000,000-970,000) 30,000
Bonds Payable 1,000,000
Interest expense (or Interest Payable) 30,000

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 ACC 108: Intermediate Accounting 3
Module #6 Student Activity Sheet

Name: _________________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________________ Date: ________________

Issue price of bonds – can be estimated by discounting the future cash flows of the bonds at a specified
effective interest rate.

Illustration: ABC Co. plans to issue 12%, 3-year, P1,000,000 bonds dated January 1, 20x1. Principal is due at
maturity but interest is due annually. The current market rate is 10%.

Solution:
Issue price of bonds = Present value of future cash flows; or
Issue price of bonds = Future cash flows x PV factor

Future cash flows PV of 10%. N=3 PV Factors Present

Value
Principal 1,000,000 PV of P1 0.751315 751,315
Interest 120,000 PV of ordinary annuity of P1 2.486852 298,422
1,049,737

Skill-Building Activity
TRUE OR FALSE
____________1. Zero-interest bonds sell at a significant discount that provides an investor with a total interest
payoff at maturity.
____________2. Callable bonds may be redeemed prior to maturity at the option of the issuer
____________3. The term "junk bonds" is frequently applied to low-yield bonds.
____________4. If the stated interest rate for a bond issue exceeds the effective interest rate, the bonds will
sell at a discount.
____________5. Bond issuance costs must be reported separately as deferred charges and charged to
expense over the life of the bond issue.
____________6. Convertible bonds can be exchanged for another form of security, such as common stock, at
the option of the issuer.
____________7. The amortization of bond discount reduces interest expense to an amount less than the
interest actually paid to bondholders.
____________8. When debt is retired prior to its maturity date, a gain or loss must be recognized, for the
difference between the carrying amount of the debt security and the amount paid.
____________9. Under generally accepted accounting principles, gain or loss must be recognized on the
conversion of bonds into equity securities.
____________10. In-substance defeasance is a process of transferring assets to an irrevocable trust, using
the assets and earnings therefrom to satisfy the long-term debt as it comes due.

Check for Understanding

1. On January 1, 20x1, an entity issues bonds with face amount of P5,000,000 for P4,800,000. The
bonds mature on December 31, 20x3 and pay annual interest of 10% every December 31. The entity
incurs bond issue costs of P473,767. The effective interest rate adjusted for bond issue costs is 16%.

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 ACC 108: Intermediate Accounting 3
Module #6 Student Activity Sheet

Name: _________________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________________ Date: ________________

Requirement:
a. Compute for the initial carrying amount of the bonds.
b. Compute for net discount or a net premium (including the effect of the bond issue cost) from the
issuance on initial recognition.
c. Are the periodic interest payments greater than or less than the periodic interest expenses?
d. Prepare all the journal entries during the term of the bonds.

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 ACC 108: Intermediate Accounting 3
Module #6 Student Activity Sheet

Name: _________________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________________ Date: ________________

2. On April 1, 20x1, an entity issues bonds with face amount of P5,000,000 for P5,415,183, including
accrued interest. The bonds are dated January 1, 20x1 and pay annual interest of 14% every
December 31. The effective interest rate is 12%.

Requirements:
a. Compute for the initial carrying amount of the bonds.
b. Provide the entry on April I, 20x1 to record the issuance of the bonds.
c. Compute for the interest expense in 20x1.

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 ACC 108: Intermediate Accounting 3
Module #6 Student Activity Sheet

Name: _________________________________________________________________ Class number: _______

Section: ____________ Schedule: ________________________________________ Date: ________________

C. LESSON WRAP-UP
Summary / Frequently Asked Questions
1. What are reason why some will buy a bond at premium?
A person would buy a bond at a premium (pay more than its maturity value) because the bond's stated interest
rate (and therefore its interest payments) are greater than those expected by the current bond market. It is also
possible that a bond investor will have no choice

2. Which is better, discount bond or premium bond?

A premium bond has a coupon rate higher than the prevailing interest rate for that particular bond maturity and
credit quality. A discount bond by contrast, has a coupon rate lower than the prevailing interest rate for that
particular bond maturity and credit quality.

Thinking about Learning

What are your challenges in learning the concepts in this module? If you do not have challenges, what is your
best learning for today?
________________________________________________________________________________________
________________________________________________________________________________________

What are the questions/thoughts you want to share to your teacher today?
________________________________________________________________________________________
________________________________________________________________________________________

Answer Key
Skill-Building

1. TRUE 6. FALSE
2. TRUE 7. FALSE
3. FALSE 8. TRUE
4. FALSE 9. FALSE
5. FALSE 10. TRUE

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