DEFINITION OF BOND

Whenever funds being borrowed can be obtained from a gmall

number of sources, mortgages or notes are usually used.

However, when large amounts are needed ,an entity may

have to borrow from the general investing public through

the use of a bond issue.

Bonds are used primarily by corporations and government

units.

A bond is a formal unconditional promise, made under seal,

to pay a specified sum at a determinable future date,

and to make periodic interest payment at a stated rate until

the principal sum is paid.

In simple language, a bond is a contract of debt whereby one

party called the issuer borrows funds from another party

called the investor.

A bond is evidenced by a certificate and the contractual

agreement between the issuer and investor is contained in

a document known as “bond indenture”.

Term and serial bonds

Term bonds are bonds with a single date of maturity.

Term bonds may require the issuing entity to establish a

sinking fund to provide adequate money to retire the bond

188ue at one time.

Serial bonds are bonds with a series of maturity dates instead

of a single one.the bonds by installments.

of a single one.

Secured and unsecured bonds

Mortgage bonds are bonds secured by a mortgage on real

properties.
Collateral trust bonds are bonds secured by shares and bonds

of other corporation.

Debenture bonds are unsecured or bonds without collateral

security.

Registered and bearer bonds.

Registered bonds require the registration of the name of the

bondholders on the books of the corporation.

JYf the bondholder sells a bond, the old bond certificate is

surrendered to the entity and a new bond certificate is'issued

to the buyer. Interest is periodically paid by the issuing entity

to bondholders of record.

Coupon or bearer bonds are unregistered bonds in the sense

that the name of the bondholder is not recorded on the entity

books.

The issuing entity does not maintain a record of who' owns

the bonds at any point in time.

Thus, interest on coupon bonds is paid to the person

submitting a detachable interest coupon.

Other types of bonds

Convertible bonds are bonds that can be exchanged for shares

of the issuing entity.

Callable bonds are bonds which may be called in for

,redemptien prior to the maturity date.

Guaranteed, bonds are bonds issued whereby another party

promises to make payment if the borrower fails to do so.

Collateral trust bonds are bonds secured by shares and bonds

that are heavily indebted or otherwise in weak financial

condition.

Zero-coupon, bonds are bonds that pay no interest but the

discount from the face amount.

properties.

Features of bond issue

A bond indenture or deed of trust is the document which

8 shows in detail the terms of the loan and the rights and

duties of the borrower and other parties to the contract.

b. Bond certificates are used. Each bond certificate

represents a portion of the total loan.The usual minimum

denomination in business practice is P1,000, although

smaller denominations may be issued occasionally.

c. If property is pledged as security for the loan, a trustee is

named to hold title to the property serving as security.

The trustee acts as the representative of the bondholders

and is usually a bank or trust entity.

d. A bank or trust entity is usually appointed as registrar

or disbursing agent. The borrower deposits interest and

principal payments with the disbursing agent, who then

distributes the funds to the bondholders.

Contents of bond indenture

The bond indenture is the contract between the bondholders

and the borrower or issuing entity. Normally, the bond

indenture contains the following items:

a. Characteristics of the bonds

b. Maturity date and provision for repayment

c. Period of grace allowed to issuing entity

d. Establishment of a sinking fund and the periodic deposit

therein.
e. Deposit to cover interest payments

f. Provisions affecting mortgaged property, such as taxes,

insurance coveráge, collection of interest or dividends

on collaterals

g. Access to corporate books and records of trustee

h. Certification of bonds by trustee

Minimum working capital to be maintained, if any.

Sale of bonds

The bonds needed for the issuance of bonds are usually too

large for one buyer to pay. Thus, very often, the bonds are

divided into various denominations of say P100,P1,000,

P10,000, thus enabling more than one buyer or investor to

purchase the bonds.

Quite often, however, instead of selling bonds of various

denominations, the bonds are sold in equal denominations

of say P1,000 only. The P1,000 denomination is called the

face amount of the bonds. Each bond is evidenced by a

certificate called a bond certificate.

Thus, if bonds with/face amount of P50,000,000 are sold,

divided into P1,000 denomination, there shall be 50,000 bond

certificates containing a face amount of P1,000.

The sale of the bonds may be undertaken by the entity itself.

Normally however, the issuing entity does not attempt to

sell the bonds directly to the public.

Instead, the entire bond issue is sold to an underwriter or

investment bank that assumes responsibility for reselling

the bonds to investors.

Sometimes, the underwriter merely undertakes, to sell the

proceeds of sale.

When an entity sells a bond issue,.it undertakes to pay the

face amount of the bond issue on maturity date and the

periodic interest.

Interest is usually payable semiannually or every six months

as follows:

a. January 1 and July 1

b. February 1 and August 1

c. March 1 and September 1

d. April 1 and October 1

e. May 1 and November 1

f. June 1 and December 1

Of course,there are certain bonds that pay interest annually

or at the end of every bond year.

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Initial measurement of bonds payable “+c=Bond 15svc co3)

PFRS 9, paragraph 5.1.1, provides that bonds payable not

designated at fair value through___________loss shall be

measured initially at fair value minus transaction costs that

are directly attributable to the issue of the bonds payable.

The fair value of the bonds payable is equal to the present

value of the future cash payments to settle the bond liability.

Bond issue costs shall be deducted from the fair value or

issue price of the bonds payable in measuring initially the

bonds payable.

However, if the bonds are designated and accounted for "at

treated as expense immediately.

Actually, the fair value of the bonds payable is the same as

the issue. price or net proceeds from the issue of the bonds,

excluding accrued interest.

Subsequent measurement of bonds payable

PFRS 9, paragraph 5.3.1, provides that after initial

recognition,bonds payable shall be measured either:

a. At amortized cost, using the effective interest method

b. At fair value through profit or loss

Amortized cost of bonds payable

The amortized cost of bonds payable is the amount at which

the bond liability is measured initially minus principal

repayment, plus or minus the cumulative amortization using

the effective interest method of any difference between the

face amount and present value of the bonds payable.

Actually,the difference between the face amount and present

value is either discount or premium on the issue of the bonds

payable.

Issuance of bonds at a premium

If the sales price is more than the face amount of the bonds,.

the bonds are said to be sold at a premium.

For example, an entity issued bonds with face amount of

p5,000,000 at 105. The quoted price of 105 means “105% of

the face amount of the bonds.” Thus, the sales price is

P5,250,000, computed by multiplying 105% by P5,000,000.

Journal entry

Cash
Bonds payable

Premium on bonds payable

5,250,000

5,000,000

250,000

The bond premium is in effeçt a gain on the part of the issuing

entity because it receives more than what it is obligated to.

pay under the terms of the bond issue. The obligation of the

issuing entity is limited only to the face amount ofthe bonds.

The bond premium however is not reported as an outright gain.

When the bonds are sold at a premium, it means that the investor

or the buyer is amenable to receive interest that is somewhat

less than the nominal or stated rate of interest.

Thus, in such a case, the effective rate is less than the nominal.

rate of interest.

The nominal rate of interest is the rate appearing on the

face of the bond certificatè. It is that interest which the

issuing entity periodically pays to the buyer or bondholder.

Because of the relationship of the premium to the interest,

the bond premium is amortized over the life of the bonds.

and credited to interest expense.

Accordingly, if the bonds have a 10-year life and the straight

line method is used for simplicity, the entry to record the

amortization of the bond 'premium is:

Premium on bonds payable

Interest expense (250,000/10 years)

25,000

25,000
Presentation of discount and premium

Discount on bond payable and premium on bond payable are

reported as adjustments to the bond liability account.

The discount on bond payable is a deduction from the bond

payable and the premium on bond payable is an addition to.

the bond payable.

This treatment is on the theory that the discount represents

an amount that the issuer cannot borrow because óf interest

differences, and the premium represents an amount in

excess of face amount that the issuer is able to borrow.

The discount on bonds payable and the premium on bonds

payable shall not be considered separate from the bonds

payable account. Both accounts shall be treated consistently

as valuation accounts of the bond liability.

Observe the following presentation in the statement of

financial position.

Noncurrent liabilities:

Bonds payable

Discount on bonds payable

Noncurrent liabilities:

Bonds payable

Premium on bonds payable

Bond issue costs

and

5,000,000

(250,000)

5,000,000

250,000

4,750,000
5,250,000

Bond issue costs are transaction costs directly attributable

to the issue of bonds payable.

Such costs include printing and engraving cost, legal and

accounting fee, registration fee with regulatory authorities,

commission paid to agents and underwriters and other

similar_ charges.

Under PFRS 9, bond issue costs shall be deducted from the

fair value or issue price of bonds payable in measuring

initially the bonds payable.

Under the effective interest method of amortization, the bond

issue cost must be "lumped" with the discount on bonds payable

and "netted" against the premium on bonds payable.

However,if the bonds are measured at fair yạlue through

profit or loss, the bond issue costs are expensed immediately.

Bonds payable

Financial statement presentation

Ifa statement of financial position is prepared on December

31,2020,the accrued interest payable of P300,000 is classified

as current liability. The bonds payable should be classified

as noncurrent liability.

Bonds payable,due January 1,2025 5,000,000

Premium on bonds payable 192,000

Carrying amount 5,192,000

Bond retirement on maturity date

To make a bond issue more attractive, an entity may agree

in the bond indenture to establish a sinking fund exclusively

for use in retiring the bonds at maturity.

fund securities should cause the fund to approximately equal

the amount of bond issue on maturity date.

When the bonds approach maturity date, the trustee sells the

securities and uses the sinking fund cash to pay the bondholders.

Any excess cásh is returned to the issuing entity.

Illustration

An entity sold bonds with face amount of P5,000,000 on

March 1,2020 with 12% interest payable March 1 and

September 1 and the bonds mature on March.1,2025.

On March 1, 2025, the journal entry to retire the bonds

together with the payment of the last semiannual interest

out of a sinking fund is:

5,000,000

Bonds payable 300,000

Interest expense

Sinking fund

5,300,000

If a sinking fund is not used,the payment of the bonds will

come from the general cash of the issuing entity.

Bonds payable

Interest expense

Cash

5,000,000

300,000

5,300,000

Bond retirement prior to maturity date

When bonds are reacquired prior to maturity date,they may

for future reissue when the need for fund arises.

The retirement of bonds prior to maturity date may present

some complex accounting problems.

If the reacquired bonds are canceled and permanently

retired, the following procedures are followed.

1. The bond premium or bond discount should bé amortized

up to the date of retirement.

2. The balance of the bond premium or bond discount should

be determined. This bálance is important.because the

amount related to the bonds retired is canceled.

3. The accrued interest to date of retirement should be

determined.

4. The total cash payment should be computed. This is equal

to the retirement price plus the accrued interest. The

retirement price is a certain percent of the face amount

of the bonds.

5. The carrying amount of the bonds retired is determined.

The face amount of the bonds plus the unamortized

premium or minus the unamortized·discount gives the

carrying amount of the bonds.

6. The gain or loss on the retirement of the bonds is

.computed.

This is the difference between the retirement price and.

the carrying amount of the bonds.

If the retirement price is more than the carrying amount

of the bonds, there is loss.

If the retirement price is less than the carrying amount

of the bonds, there is gain.

the bond liability together with the unamortized premium

or discount. Any accrued interest is debited to interest

expense.

Treasury bonds

Treasury bonds are an entity's own bonds originally issued

and reacquired but not canceled. The acquisition of treasury

bonds calls for the same accounting procedures accorded to

a formal retirement of bonds prior to the maturity date.

In other words, the treasury bonds should be debited at face

amount and any related unamortized premium or discount

should be canceled. Any accrued interest paid is charged to

interest expense.

The difference between the acquisition cost and the carrying

amount of the treasury bonds is treated as gain or loss on

the acquisition of treasury bonds.

Bond refunding

Bond refunding is the floating of new bonds the proceed8

from which are used in paying the original bond8.

Simply stated, bond refunding is a premature retirement of

the old bonds by means of issuing new bond8. Bond refunding

is also known as bond refinanċing.

Refunding may be made on or before the date of maturity of

the old bonds.

Where refunding is made on the date of maturity of the old

bonds, no accounting problem arises as this would simply

call for the cancelation of the bond liability. There i8 no

The retirement is handled in the usual manner and the new

bond issue is recorded in the normal. way.

However,where refunding is made prior to the maturity date

of the old bonds, consideration must be given to the refunding

charges pertaining to.the old bonds.

The refunding charges include the unamortized bond discount

or premium and redemption premium on the old bonds being

refunded.

The accounting problem is the treatment of these refunding

charges.

Bond refunding shall be accounted for as an extinguishment

of a financial liability.

The difference between'the carrying amount of the financial

liability extinguished and the consideration paid shall be

included in profit or 1088.

Accordingly,the refunding charges are charged to loss on

extinguishment.

Amortization of bond discount or premium

There are three approaches in amortizing bond premium or

bond discount,namely:

a. Straight line

b. Bond outstanding method

c. Effective interest method or simply "interest method"

or scientific method

PFRS 9 requires the use of the effective interest method in

amortizing discount, premium and bond issue cost.

Straight line method

of bond premium or bond discount.

The procedure is simply to divide the amount ofbon premium

or bond discount by the life of the bonds to arrive at the periodic

amortization.

The life of the bonds is that period commencing on the date of

sale of the bonds up to the maturity date.

Bond outstanding method

The bond outstanding method is applicable to serial bonds

whether issued at discount or premium.

Serial bonds are those with a series of maturity dates.

For example,bonds with face amount of P5,000,000 are issued

and mature at the rate of P1,000,000 every year for 5 years.

As the name implies,the bond outstanding amortization

approach gives recognition to the diminishing balance of the

bonds.

It is based on the theory that interest expense shall decrease

every year by reason of the decreasing principal bond liability.

Premature retirement of serial bonds

When serial bonds are paid on the regular maturity dates,

no accounting problem arises because no unamortized

disçount or premium is related to such serial bonds retired.

The problem occurs when the serial bonds are retired prior

to their scheduled maturity dates.

In this case, the retirement calls for the cancelation of any

unamortized discount or premium related to the serial bonds

retired.

The question is how much unamortized premium or discount

date?

Change in fair value recognized in OCI

PFRS 9, paragraph 5.7.7, provides that the gain or loss on

inancial liability designated at fair value through profit or

loss shall be accounted for as follows:

a. The change in fair value attributable to the credit risk

of the liability is recognized in other comprehensive

income.

Credit risk is the risk that the issuer of the liability

would cause a financial loss to the other party by failing

to discharge the obligation.

Credit risk does not include market risk such as interest

risk, currency risk and price risk.

b. The remaining amount of the change in fair value is

recognized in profit or loss.

However, Paragraph 5.7.8 provides that if presenting the

change in fair value attributable to credit risk would create

or enlarge____accounting mismatch, all gains and losses

including the effects of changes in credit risk are recognized

in profit or loss.

An accounting mismatch would be created or enlarged if

presenting the effects of changes in the credit risk in other

comprehensive income would result in a material or greater

difference in profit or loss than if those amounts were

presented in profit or loss.

Application Guidance B5.7.9 provides that amounts

recognized in other comprehensive income resulting from

designated at fair value through profit or loss shall not be

subsequently transferred to profit, or loss.

However, the cumulative gain or loss recognized may be

transferred within equity or retained earnings.