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Dalubhasaan ng Lungsod ng Lucena

Intercompany Accounting Part 3


Faye Margaret P. Rocero, CPA

Module 1 - Bonds Payable

 RELATED STANDARDS: IFRS 9 - Financial Instruments; IAS 32 - Financial Instruments: Presentation

 Definition of Term
Effective interest method - The method that is used in the calculation of the amortized cost of a financial asset or a
financial liability and in the allocation and recognition of the interest revenue or interest expense in profit or loss
over the relevant period.
Effective interest rate - The rate that exactly discounts estimated future cash payments or receipts through the
expected life of the financial asset or financial liability to the gross carrying amount of a financial asset or to the
amortized cost of a financial liability.
Equity instrument - Any contract that evidences a residual interest in the assets of an entity after deducting all of its
liabilities.
Financial instrument - Any contract that gives rise to a financial asset of one entity and a financial liability or equity
instrument of another entity.
Financial asset - Any asset that is:
a. Cash
b. An equity instrument of another entity
c. A contractual right:
i. to receive cash or another financial asset from another entity; or
ii. to exchange financial assets or financial liabilities with another entity under conditions that are
potentially favorable to the entity; or
d. A contract that will or may be settled in the entity’s own equity instruments and is:
i. a non-derivative for which the entity is or may be obliged to receive a variable number of the
entity’s own equity instruments
ii. a derivative that will or may be settled other than by the exchange of a fixed amount of cash or
another financial asset for a fixed number of the entity’s own equity instruments.
Financial liability - Any liability that is:
a. A contractual obligation:
i. to deliver cash or another financial asset to another entity
ii. to exchange financial assets or financial liabilities with another entity under conditions that are
potentially unfavorable to the entity
b. A contract that will or may be settled in the entity’s own equity instruments and is:
i. a non-derivative for which the entity is or may be obliged to deliver a variable number of the
entity’s own equity instruments
ii. derivative that will or may be settled other than by the exchange of a fixed amount of cash or
another financial asset for a fixed number of the entity’s own equity instruments.
Transaction costs - Incremental costs that are directly attributable to the acquisition, issue or disposal of a financial
asset or financial liability.

 Basic principles of bonds


 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 periodic interest payment at a stated rate until the principal sum is paid.
 Bonds are fixed-income debt securities.
 A bond is evidenced by a bond certificate which represents a portion of the total debt. The contractual
agreement is contained in a document called bond indenture.
 Types of debt securities issued (bonds)
1. Term bonds – Single maturity
2. Serial bonds – Series of maturity, payable in installments
3. Debenture bonds – No security/collateral
4. Asset-backed bonds – With collateral/security (i.e. mortgage bonds, collateral trust bonds)
5. Registered bonds – With registration of bondholders
6. Coupon bond/bearer bonds – Unregistered bonds, payable to holder
7. Convertible bonds – Convertible into other form of securities such as shares of stocks.
8. Callable bonds – May be called in for redemption prior to maturity.

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 Initial measurement of bonds payable
 Bonds payable measured at fair value through profit or loss = fair value of the bonds at the time of issuance.
 Bonds payable measured at amortized cost = fair value of the bonds at the time of issuance minus transaction
cost (bond issue cost).
 The fair value of the bonds payable is equal to the present value of future cash payment to settle the
liability.
 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.
 Net proceeds from bonds = Par value +/- premium/discount (market price) minus bond issue cost plus
accrued interest

 Subsequent measurement of bonds payable


1. Bonds payable at amortized cost
 Amortized cost of the bonds payable = initial measurement minus principal repayment, and plus discount
amortization (if any), or minus premium amortization (if any).
 Difference between the face amount and the present value of the bonds payable is treated as discount or
premium.
 Discount or premium on bonds payable is amortized to interest expense using effective interest method.

2. Bonds payable at fair value through profit or loss (irrevocable designation)


 An entity shall present a gain or loss on a bonds payable that is designated as at fair value through profit or
loss as follows:
a. The amount of change in the fair value that is attributable to changes in the credit risk of the bonds
payable shall be presented in other comprehensive income.
b. The remaining amount of change in the fair value of the bonds payable shall be presented in profit or
loss.
 Amount recognized in other comprehensive income shall not be subsequently transferred to profit or loss.
Cumulative gain or loss in other comprehensive income may be transferred within equity (retained
earnings).

 Premium or discount on bonds


Premium Discount
Issue price Market price > Par value Market price < Par value
Interest rate Effective rate < Stated rate Effective rate > Stated rate
Amortization Credited to interest expense Debited to interest expense

 Bond issue cost and accrued interest


 Bond issue cost is deducted from fair value of the bonds payable if it is classified as a financial liability at
amortized cost. This transaction cost is lumped with the discount on bonds payable and netted against the
premium on bonds payable.
 Bond issue cost is expensed immediately if the bonds payable is classified as financial liability at fair value
through profit and loss.
 Since the issuing corporation will pay the full periodic interest on all bonds outstanding at an interest date, the
bondholder is usually required to purchase the interest that has accrued from the most previous interest date
to the date of sale.
 This accrued interest is added to the issue price of the bond to determine the total cash proceeds from the
bond issuance.

 Retirement of Bonds
a. Retirement of bonds at maturity:
 If bonds retire at their maturity date, any premium or discount will have been completely amortized.
 The retirement is recorded as an ordinary payment of debt, and no gain or loss is recognized upon the
retirement on maturity date.
 The amount of cash paid to the bondholders equals the face value of the bonds.
b. Retirement of bonds before maturity:
 Retirement price is less than the carrying amount of the bonds, a gain on retirement of debt.
 If the retirement price is greater than the carrying value, loss on retirement of debt.
 Gain or loss on the retirement of bonds is reported in profit or loss as an operating gain or loss.

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 If bonds are retired before maturity date, the following must be observed:
o The amortization of premium or discount must be updated to determine the carrying amount of the
bonds at the date of retirement.
o Any accrued interest on the retired bonds from the most recent interest payment date up to date of
retirement must be recorded and paid.

 Treasury bonds
 Treasury bonds are an entity’s own bonds originally issued and reacquired but not canceled.
 When treasury bonds are acquired, the “treasury bonds account” is debited at face value and any related
unamortized premium or discount or issue cost is canceled.
 Acquisition cost is less than the carrying amount of the bonds, gain on acquisition of treasury bonds.
 Acquisition cost is greater than the carrying amount of the bonds, loss on acquisition of treasury bonds.
 Treasury bonds are reported in the statement of financial position as a deduction from bonds payable.

 Bond refunding
 Bond refunding is the floating of new bonds payable the proceeds from which are used in paying the original
bonds payable.
 Bond refunding is the premature retirement of the old bonds payable through the issuance of new bonds
payable.
 The refunding charges include the unamortized bond discount or premium, unamortized bond issue cost and
redemption premium on the bonds being refunded.
 IFRS 9, provides that bond refunding is an extinguishment of a financial liability. Further provides that the
difference between the carrying amount of the financial liability extinguished and the consideration paid shall
be included in profit or loss.
 Accordingly, the refunding charges shall be accounted for as loss on early extinguish of debt.

 Compound financial instruments


 The issuer of a non-derivative financial instrument shall evaluate the terms of the financial instrument to
determine whether it contains both a liability and an equity component. Such components shall be classified
separately as financial liabilities, financial assets or equity instruments. (IAS 32)
 According to IAS 32, an entity recognizes separately the components of a financial instrument that:
a. Creates a financial liability of the entity.
b. Grants an option to the holder of the instrument to convert it into an equity instrument of the entity.
 The issue price of the convertible component is comprised of two components: a financial liability and an
equity instrument.
 The total issue price to be bifurcated using the residual approach.
 The carrying amount of the equity instrument represented by the option to convert the instrument into
ordinary shares is then determined by deducting the fair value of the financial liability from the fair value
of the compound financial instrument as a whole. (IAS 32)

1. Bonds with warrants


 Corporations may issue bonds that allow creditors to ultimately become shareholders by either
attaching share warrants to the bonds or including a conversion feature in the bond indenture.
 In either case, the investor has acquired a dual set of rights, namely: the right to receive interest and
principal payment on the bonds and the right to acquire ordinary shares and participate in the
potential appreciation of the market value of the shares.

2. Convertible bonds
 Convertible bonds give the holders thereof the right to exchange their bondholding into ordinary
shares or other securities of the issuing company within a specified period of time.
 The principle of splitting the issue price of a compound financial instrument to its debt component and
equity component is applied.

Reference: Intermediate Accounting Vol. 2 (2019) by Conrado T. Valix, Jose T. Peralta & Christian Aris M. Valix

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