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Bonds Payable
Bonds Payable
Nature of Bonds
Term bonds- Bonds that mature in one lump sum on a specified future date.
Serial bonds- Bonds that mature in a series of installments at future dates.
Collateral trust bonds- Bonds usually secured by stocks and bonds of other corporations owned by the issuing
company.
Unsecured (debenture) bonds- Bonds for which no specific collateral has been pledged.
Bonds Shares
Issuer’s point of view
a) interests/dividends payments - tax deductible items - not tax deductible items
- constitute a legal & fixed - paid only when sufficient funds
obligation that must be paid and retained earnings are available
b) maturity date - have specific maturity date - do not have maturity date
c) return on investment - lower - higher
What are the primary distinctions between a debt security and an equity security?
Answer: The primary distinctions between debt and equity securities are:
a. Debt security—fixed principal and interest; no voting privileges; fixed maturity date; cash flow dates and
amounts are fixed.
b.Equity security—no fixed principal and interest; voting privileges (common stock); fixed cash flow amounts and
dates.
Explain the difference between the stated rate of interest and the effective rate on a long-term debt security.
Answer: Stated rate of interest—contractual rate specified on the debt instrument; it determines the amount of cash
interest each interest period.
The effective rate of interest is the true interest rate on a debt security. It is determined by the market and it is
based on the resources received currently and the future resource flows. The effective rate is often called
the market rate of interest.
Briefly explain the effects on interest recognized when the stated and effective rates of interest are different.
Answer: An effective interest rate above the stated rate causes a discount and the opposite cause, a premium on the
debt. A discount increases interest reported on the income statement and a premium decreases interest reported
on the income statement (compared with the effects of the stated rate).
Distinguish between the par amount and the price of a bond. When are they the same? When different?.
Answers:
The face (i.e., par) amount of a bond is the maturity amount specified on the bond certificate.
The bond price represents the present value of the future cash flows (principal plus all interest payments) at the
effective rate of interest.
The face amount of bond and its price are the same if the bond has the same stated and effective rates of
interest when issued; otherwise, they will be different.
Bond Issue Costs (or Transaction Costs) – are incremental costs that are directly attributable to the issue of bonds
payable, which include printing and engraving cost, legal and accounting fee, registration fee with regulatory authorities,
commission paid to agents and underwriters and other similar charges.
- PAS 39 (Financial instruments – recognition and measurement) provides that bond issue costs as transaction
costs shall be included in the initial measurement of a financial liability.
- Is not outright expense but amortized over the life of the bonds.
- Lumped with discount on bonds payable or netted against the premium on bonds payable.
Bonds:
normally are long-term
bear interest
issued at a premium or discount
entail transaction (issue) cost
Computation of the market price or issues price of bonds (Bond prices are quoted as a percentage of face value, e.g.
98 or 98%; 105 or 1.05%)
Example: On January 1, 2020, Barney Company issued a 10-yearbonds with a face amount of ₱5,000,000 and a stated
interest rate of 8% payable annually at every year-end. The bonds were price to yield 10%.
PV of 1 for 10 periods at 10% 0.3855
PV of an ordinary annuity of 1 for 10 periods at 10% 6.145
Required: Compute for the market price of the bonds.
Solution:
PV of principal (₱5,000,000 x .3855) ₱1,927,500
PV of annual interest payments [(₱5,000,000 x 8%) x 6.145] 2,458,000
Total present value or market price ₱4,385,500
Required: Prepare all indicated journal entries including any adjustments relating to the issuance of the bonds for 2017
and 2018. Use memorandum approach and the straight line method of amortization.
Solution:
2017
April 1 Cash (₱5M x 98%) - ₱50,000 ₱4,850,000
Discount on bonds payable 100,000
Bond issue cost 50,000
Bonds payable ₱5,000,000
Issuance of the bonds
2018
Jan. 1 Accrued interest payable 150,000
Interest expense 150,000
Reversing entry
Required: Prepare all indicated journal entries including any adjustments relating to the issuance of the bonds for 2017
and 2018. Use memorandum approach and the straight line method of amortization.
Solution:
2017
April 1 Cash (₱5M x 103%) - ₱50,000 ₱5,100,000
Premium on bonds payable ₱ 100,000
Bonds payable 5,000,000
Issuance of the bonds
2018
Jan. 1 Accrued interest payable 150,000
Interest expense 150,000
Reversing entry
Required: Give entries for the issuer and the investor for the following dates: September 1, 2019; December 31, 2019;
and June 30, 2020. Assume that the difference between the interest method and straight-line method amortization
amounts is not material; therefore, use straight-line amortization. Youngblood intends to hold the bonds to maturity.
Answer:
Issuer-Alpha Company Investor-Stay@Home Company
September 1, 2019:
Cash ₱32,770 Investment in bonds ₱32,320
Bonds payable ₱30,000 Interest receivable 450
Interest payable 450* Cash ₱32,770
Premium on bonds payable 2,320
*Accrued interest
/(₱30,000 x 4½ x 2/6) ₱ 450
Price of bonds 32,320
Total cash ₱32,770
2. Problem:
Ryan Corporation sold and issued ₱75,000 of three-year, 8% (payable semi-annually) bonds payable for ₱78,200 plus
accrued interest. Interest is payable each February 28 and August 31. The bonds were dated March 1, 2019, and were
sold on July 1, 2019. The accounting period ends on December 31.
Required:
1. How much accrued interest should be recognized at date of sale?
2. How long is the amortization period?
3. Give entries for Ryan Corporation through February 2019. Use straight-line amortization.
4. Would the above amounts also be recorded by the investor if the intent was to hold the bonds to maturity?
Explain.
Answers:
Requirement 1
Accrued interest for March-June: ₱75,000 x 4% x 4/6 = P2,000.
Requirement 2
Amortization period: 3 years - 4 months = 32 months.
Requirement 3
Gross method and straight-line amortization:
July 1, 2019:
Cash ₱80,200*
Bonds payable. ₱75,000
Premium on bonds payable 3,200
Interest payable (per Requirement 1) 2,000
P75,000 x 4% = ₱3,000.
P3,200 x 2/32 = ₱ 200 (amortization for July and August).
Requirement 4
Yes, the above amounts would be recorded by the investor in the accounts that parallel those for the issuer, Ryan
Corporation. Asset and revenue accounts would be used instead of liability and expense accounts.
On March 1, 2019, Pyne Furniture Co. issued ₱700,000 of 10% bonds to yield 8%. Interest is payable semi-
annually on February 28 and August 31. The bonds mature in ten years. Pyne Furniture Co. is a calendar-year
corporation.
Required:
(1) Determine the issue price of the bonds. Show your computations.
(2) Prepare an amortization table through the first two interest periods using the effective-interest method.
(3) Prepare the journal entries to record bond-related transactions as of the following dates:
(a) March 1, 2019
(b) August 31, 2019
(c) December 31, 2019
(d) February 28, 2020
ANS:
1. Calculation of bond sales price: i = 4% n = 20
Present value of the face amount (₽700,000 x .4564) ₽319,480
Present value of the interest (P35,000 x 13.5903) 475,661
₽795,141
2. Amortization table:
Interest Interest Interest Amortization Carrying
Date Payment Expense of Premium Value
3/01/2019 ₱795,141
8/31/2019 ₱35,000 ₱31,806* ₱3,194 791,947
2/28/2020 35,000 31,678** 3,322 788,625
Computations:
* ₱795,141 x 4% = ₱31,806
** ₱791,947 x 4% = ₱31,678
3. Journal entries:
Problem:
The December 31, 2019, statement of financial position of Far Imports includes the following items:
9% bonds payable due 12/31/2029 ₱800,000
Discount on bonds payable 21,600
The bonds were issued on December 31, 2019, at 97, with interest payable on June 30 and December 31 of each year.
The straight-line method is used for discount amortization. On March 1, 2020, Far Imports retired ₱400,000 of these
bonds at 98 plus accrued interest. Prepare the journal entries to record retirement of the bonds, including accrual of
interest since the last payment and amortization of the discount.
ANS:
3/1/2020 Interest Expense ₱6,000
Interest Payable ₱6,000
(₱400,000 x 9% x 2/12)
Serial Bonds – are bonds in which the principal matures in installments. The periodic payments on serial
bonds consist of payments for both interest and principal.
Problem:
On January 1, 2020, ABC Co. issued 10%, ₽3,000,000 bonds for ₽2,900,305. The principal matures in three
equal annual installments, payable at each year-end, plus interest on the outstanding principal balance. The
effective interest rate is 12%.
Required: Prepare pertinent journal entries and amortization table.
Answer:
Amortization table
Amount
Int. on Total Interest Discount applied to Present
Principal outstanding Interest payments expense Amortization principal Value
(f-d)
Date Payments balance payments (b+d) (I x .12) (b-g) (i-h)
(g)
(a) (b) (c ) (d) (e) (f) (h) (i)
Jan. 1, 2020 2,900,305
Dec. 31, 2020 1,000,000 3,000,000 x 10% 300,000 1,300,000 348,037 48,037 951,963 1,948,342
Dec. 31, 2021 1,000,000 2,000,000 x 10% 200,000 1,200,000 233,801 33,801 966,199 982,143
Dec. 31, 2022 1,000,000 1,000,000 x 0% 100,000 1,100,000 117,857 17,857 982,143 -
3,000,000 99,695
======== ======
2020
Jan. 1 Cash 2,900,305
Discount on bonds payable 99,695
Bonds payable 3,000,000
Problem: On January 1, 2020, ABC Co. issued 10% ₽3,000,000 bonds at a yield to maturity interest of 18%.
Principal and interest are due on December 31, 2022.
Solution:
Amortization Table
Interest Discount on Present
Date Interest payments Expense bonds payable Value of cash flow
(e x 18%) (c-b) (e)
(a) (b) (c) (d)
Jan. 1, 2020 2,430,263
Dec. 31, 2020 (3M x 10%) = 300,000 437,447 137,447 2,867,710
Dec. 31, 2021 (3M + 300,000) x 10% = 330,000 516,188 186,188 3,383,898
Dec. 31, 2022 (3M + 300,000+330,000) x 10% = 363,000 609,102 246,102 3,993,000
Entries:
2020
Jan. 1 Cash 2,430,263
Discount on bonds payable 569,737
Bonds payable 3,000,000
2021
Dec. 31 Interest expense 516,188
Discounts on bonds payable 186,188
Interest payable 330,000
2022
Dec. 31 Interest expense 609,102
Discounts on bonds payable 246,102
Interest payable 363,000