CHAPTER

BLUE NOTES
28 S
L
A bond is a formal unconditional promise, made under seal, to pay a specified sum of money at a determinable future
date, and to make a periodic interest payment at a stated rate until the principal sum is paid.
 It is a contract a debt whereby one party called issuer borrows money from another party called investor.
 A bond is evidenced by a certificate and the contractual agreement between the issuer and investor is
contained in another document known as bond indenture.

Features of Bonds Issue

 A bond indenture or deed of trust is the document which shows in detail the terms of the loan and the rights
and duties of the borrower and other parties to the contract.
 Bond certificates represent a portion of the total loan.

Types of Bonds
 Term bonds are bonds with a single date of maturity.
 Serial bonds are bonds with a series of maturity dates instead of a single one.
 Mortgage bonds are bonds secured by a mortgage on real properties.
 Collateral bonds are bonds secured by stocks and bonds of other corporation.
 Debenture bonds are bonds without collateral security.
 Registered bonds require registration of the name of the bondholders on the books of the corporation.
 Coupon or bearer bonds are unregistered bonds in the sense that the name of the bondholder is not recorded
on the company books.
 Convertible bonds are bonds that can be exchange for shares of the issuing entity.
 Callable bonds are bonds which may be called in for redemption prior to maturity date.
 Guaranteed bonds are bonds issued whereby another party promises to make payment of the borrower fails
to do so.
 Junk bonds are high-risk, high-yield bonds issued by entities that are heavily indebted or otherwise in weak
financial condition.

Accounting for Issuance of Bonds

 Memorandum approach – No entry is made upon the authorization of the entity to issue bond. Authorized
bonds payable account is not maintained.
 Journal entry approach – Journal entry is made to record the authorized bonds payable.

Issuance at a Premium
 The bond premium is in effect 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.
 Effective rate is less than the nominal rate of interest.
Issuance at a Discount
 The bond discount is in effect a loss to the issuing entity.
 Effective interest rate is higher than the nominal rate.

Measurement
 After initial recognition, bonds payable shall be measured at amortized cost using the effective interest

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method.
 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

Bond issue costs

 Incremental costs that are directly attributable to the issue of bonds payable.
 Such costs include printing and engraving cost, legal and accounting fee, registration with regulatory
authorities, commission paid to agents and underwriters and other similar charges.
 They are amortized over the life of the bond issue.

BOND RETIREMENT PRIOR TO MATURITY DATE

Procedures
 Amortized bond premium or discount and issue costs up to the date of retirement.
 Determine balance of the bond premium or bond discount and issue cost.
 Determine the accrued interest to date of retirement.
 Compute the total cash payment.
(Retirement price + the accrued interest)
 Determine the book value of the bonds retired.
(Face value of the bonds + the unamortized premium or - the unamortized discount and issue)
 Compute the gain or loss on retirement of the bonds.
(Retirement price - Book value)
 Cancel the bond liability together with the unamortized premium or discount and issue cost.
 Any accrued interest is debited to interest expense.

Illustration
On March 1, 2010, 5, 000, 000 face value bonds are sold for 4, 370, 000. The bonds are dated March 1,
2010 and mature in 5 years, and pay 12% interest semi-annually on March 1 and September 1. The straight line
method of amortization is used.
All the bonds are retired on July 1, 2013 at 97. The procedures for the retirement of the bonds on July
1, 2013 are:

1. The amortization of the bond discount is recorded up to July 1, 2013. If the entity uses the calendar period,
presumably, the last amortization was on December 31, 2012. Thus, amortization of the discount for 6 months
from January 1 to July 1, 2013 should be recorded as follows:

Interest expense 27, 000

Discount on bonds payable 27, 000
(270, 000 / 5 years = 54, 000 annual amortization)
(54, 000 x 1 / 2 = 27, 000)

2. The balance of the discount on bonds payable is computed as follows:

Discount on bonds payable – March 1, 2010 270, 000

Amortization from March 1, 2010 to July 1, 2013
Or 40 months (40 / 60 x 270, 000) 180, 000

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104 USL Blue Notes Chapter 28 – Bonds Payable

Balance, July 1, 2013 90, 000

3. The accrued interest on the date of retirement, July 1, 2013 is computed as follows: 5, 000, 000 x 12% x 4 /
12 = 200, 000. The last payment of interest was March 1, 2013. Thus, the accrued interest is for 4 months,
from March 1 to July 1, 2013.

4. The total cash payment is computed as follows:

Retirement price (5, 000, 000 x 0.97) 4, 850, 000

Accrued interest 200, 000
Total cash payment 5, 050, 000

5. The book value of the bonds is computed as follows:

Bonds payable 5, 000, 000

Discount on bonds payable (unamortized) 90, 000
Book value on July 1, 2013 4, 910, 000

6. Gain or loss on the early retirement or extinguishment is computed as follows:

Book value of the bonds 4, 910, 000

Retirement price of the bonds 4, 850, 000
Gain on early retirement 60, 000

7. The entry to record the early retirement of the bonds on July 1, 2013, is as follows:

Bonds payable 5, 000, 000

Interest expense 200, 000
Cash 5, 050, 000
Discount on bonds payable 90, 000
Gain on early retirement of bonds 60, 000

Treasure Bonds
Treasure bonds are entity’s own bonds originally issued and reacquired but not cancelled. The accounting of treasure
bonds calls for the same accounting procedures accorded to a formal retirement of bonds prior to maturity date.

Bonds Issued with Share Warrants

Bonds issued with share warrants are considered as compound financial instrument. PAS 32 mandates that the issuer
of a compound financial instrument shall classify the liability and equity components separately.
Allocation
 Bonds are assigned an amount equal to the “market value of the bonds ex-warrants, regardless of the market
value of the warrants. The residual amount or remainder of the issue price shall then be allocated to the
warrants.

Illustration
An entity sells 5, 000 10-year bonds, face value 1, 000, at 105. Each bond is accompanied by one warrant that
permits the bondholder to purchase 20 shares of capital, par 50, at 55 per share moa a total of 100, 000 shares, 5, 000
x 20. The market value of the bonds ex-warrants at the time of issuance is 98.
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Chapter 28 – Bonds Payable USL Blue Notes 105

1. To record the issuance of the bonds:

Cash (5, 000, 000 x 105) 5, 250, 000

Discount on bonds payable 100, 000
Bonds payable 5, 000, 000
Share warrants outstanding 350, 000

Issue price of bonds with warrants 5, 250, 000

Market value of bonds ex-warrants
(5, 000, 000 x 0.98) 4, 900, 000
Residual amount allocated to warrants 350, 000

2. To record the exercise of 60% of the warrants:

Cash (60, 000 x 55) 3, 300, 000

Share warrants outstanding (60% x 350, 000) 210, 000
Share capital (60, 000 x 50) 3, 000, 000
Share premium 510, 000
3. To record the expiration of the remaining warrants:

Share warrants outstanding 140, 000

Share premium – unexercised warrants 140, 000

Market Value Of Bond Ex-Warrants Unknown

Using the preceding illustration but the market value of the bonds ex-warrant is not given and assuming that
the interest is payable annually at a nominal rate of 10% per annum. When the bonds are issued, the prevailing market
rate of interest for similar bonds without warrants is 12% per annum.

PV of Principal (5, 000, 000 x 0.322) 1, 610, 000

PV of interest payments (5, 000, 000 x 10% x 5.65) 2, 825, 000
Total PV 4, 435, 000

Issue price of bonds with warrants 5, 250, 000

PV of Bonds payable 4, 435, 000
Residual amount allocated to warrants 815, 000

Cash 5, 250, 000

Discount on bonds payable 565, 000
Bonds payable 5, 000, 000
Share warrants outstanding 815, 000

Convertible Bonds

On December 31, 2010, the statement of financial position showed the following balances:
Bonds payable – 12% convertible 5, 000, 000
Premium on bonds payable 200, 000
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106 USL Blue Notes Chapter 28 – Bonds Payable

Share capital, 40 par, 400, 000 shares

Authorized and 250, 000 issued 10, 000, 000
Share premium – issuance 3, 000, 000
Share premium – conversion privilege 500, 000

On the same date, the bonds are converted into share capital. The conversion ratio is 20 shares for each 1, 000
bond or a total of 100, 000 shares. Cost incurred in connection with the conversion amounts to 100, 000. The accrued
interest on the bonds payable on the date of conversion is 150, 000 which is paid in cash.

Bonds payable 5, 000, 000

Premium on bonds payable 200, 000
Share premium – conversion privilege 500, 000
Total consideration 5, 700, 000
Par value of shares issued
(100, 000 x 40) 4, 000, 000
Share premium 1, 700, 000

Bond Refunding
Bond refunding is the floating of new bonds the proceeds from which are used in paying the original bonds. It is a
premature retirement of the old bonds by means of issuing new bonds. It is also known as bond refinancing.

Amortization Of Discount Or Premium

Straight line method
 periodic amortization = discount or premium
life of the bonds
 Life of the bonds = date of sale of bonds up to the date of maturity
Bonds outstanding method
Premature retirement of serial bonds
Procedures:
1. Get the ratio of total premium or discount to the common denominator of the fractions developed, total of
bond outstanding column. This ratio represents the amortization rate per year.
2. Multiply the rate computed in (1) by the face of the bonds retired. The answer gives the unamortized premium
or discount per year related to the bonds retired.
3. Multiply the unamortized premium or discount per year computed in (2) by the period from date of retirement
to the scheduled maturity date of the retired bonds. The answer is the unamortized premium or discount applicable to
the bonds retired which should be cancelled.
Effective interest method
 Effective rate is the rate that exactly discounts estimated cash future payments through the expected life of
the bonds payable or when appropriate, a shorter period to the net carrying amount of the bonds payable.
 Effective interest expense = effective rate x book value of bonds.
 Premium or discount amortization = Nominal interest – effective interest

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