PCOA 008

Intermediate Accounting II
First Semester, SY 2020-2021

Joseph Matthew A. Sierra, CPA

Instructor
Introduction
• This module is all about measurement and valuation of notes payable and bonds payable
• The module is organized as follows:
o Notes payable
o Initial measurement of notes payable
o Short- and long-term payables
o Initial measurement or Cash price equivalent of notes payable
o Subsequent measurement of notes payables – effective interest method.
o Loans payable
o Loans with origination fees using effective interest method
o Bonds payable
o Different types of bonds
o Initial and Subsequent measurement of bonds payable – Straight line method
o Issuance between interest dates
o Retirement of bonds prior to maturity date
o Acquisition of bonds (Treasury bonds)
o Reissuance of Treasury bonds at a premium or discount
o Bonds outstanding method
o Fair value option of Bonds
o Effective interest method – Initial and subsequent measurement
o Bonds with bond issue cost using effective interest method – initial and subsequent measurement
• This module tackles the initial and subsequent measurement of notes, loans, and bonds payable
• This topic requires knowledge of Time value of money, critical thinking and analysis.
• Assessment is the application of accounting standards for notes, loans and bonds payable and preparation
of amortization table.
Learning Outcomes:
At the end of this module, the students can:

• Learn the initial and subsequent measurement of notes, loans, and bonds payable.
• Learn different types of bonds payable
• Journal entries for notes, loan, and bonds payable.
• Presentation of notes, loans, and bonds payable at a discount or premium on the financial statements.
• Can prepare amortization tables using straight line or effective interest method.
Notes payable
Notes payable are obligations supported by debtor promissory notes. The accounting for notes payable is similar
to the accounting for notes receivable.
INITIAL MEASUREMENT
Notes payable are initially recognized at fair value minus transaction costs.
• Fair value – is “the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.”
For measurement purposes, notes payable are classified into the following:

• Short-term payable
 • Long-term payable that bears a reasonable interest rate
• Long-term payable that bears no interest (non-interest bearing)
• Long term payable that bears an unreasonable interest rate (‘below-market’ interest rate)
A “short-term” payable matures in 1 year or less, while a “long-term” payable matures beyond 1 year.
Short-term payable
The fair value of a short-term payable may be equal to its face amount. However, if it is clear that the arrangement
effectively constitutes a financing transaction and the imputed rate of interest can be determined without undue
cost or effort, the fair value of the short-term payable is equal to its present value.
Long-term payables
• The fair value of a long-term payable that bears a reasonable interest rate is equal to the face amount.
An interest rate is deemed ‘reasonable’ if it approximates the market rate at the transaction date.
• The fair value of a long-term payable that bears no interest (long-term noninterest bearing payable) is
equal to the present value of the future cash flows on the instrument discounted using an imputed interest
rate.
• The fair value of a long-term payable that bears an unreasonable interest rate is also equal to the present
value of the future cash flows on the instrument discounted using an imputed interest rate.
Other terms for imputed rate of interest include effective interest rate, market rate and yield rate. Effective interest
rate is the rate that exactly discounts the future cash payments over the life of the financial liability equal to its
carrying amount.
Cash price equivalent
The fair value of a payable may be measured in relation to the cash price equivalent of the noncash asset (noncash
consideration) received in exchange for the payable.
Cash price equivalent is the amount that would have been paid if the transaction was settled outright on cash
basis, as opposed to installment basis or other deferred settlement.
Illustration:
An entity purchases a TV set on a 6-month installment basis. The installment price is P120,000. However, if the
TV set is purchased outright in cash, the cash price would have been P100,000.
• The payable is initially recognized at P100,000, the cash price equivalent of the TV set. The P20,000
difference (P120,000 installment price less P100,000 cash price) will be amortized over the credit term as
interest expense using the effective interest method.
An entity purchases goods for P250,000 under a special credit period of 1 year. The seller normally sells the
goods for P220,000 with a credit period of one month or with a P5,000 discount for cash basis (outright payment
in cash).
• The initial measurement of the payable is computed as follows:
Normal purchase price with credit period of one month 220,000
Less: Discount for outright payment 5,000
Cash price equivalent of the goods purchased 215,000
Both the purchase of P250,000 (special credit) and P220,000 (normal credit) constitute a financing transaction,
they include consideration for the credit period. To compute for the cash price equivalent of the goods, the P5,000
discount for outright payment is deducted from the normal selling price of P220,000.
SUBSEQUENT MEASUREMENT
Notes payable that are initially measured at face value are subsequently measure at face amount or expected
settlement amount.
Notes payable that are initially measure at present value are subsequently measured at amortized cost.
• Amortized cost is the “amount at which the financial asset or financial liability is measure at initial
recognition minus principal repayments, plus or minus the cumulative amortization using the effective
interest method of any difference between that initial amount and the maturity amount and, for financial
assets adjusted for any loss allowance.”
The amortized cost is determined using the effective interest method.
When a note payable is initially measured at present value or cash price equivalent, the difference between that
amount and the face amount is initially recognized as a discount (or premium, in the cash of bonds payable) and
subsequently amortized as interest expense using the effective interest method.
Effective interest method is a method of calculating the amortized cost of a financial asset or a financial liability
and of allocating the interest income or interest expense over the relevant period.
SUMMARY MEASUREMENT
Type of payable Initial measurement Subsequent measurement
1. Short-term payable a. Face amount; or a. Face amount or
b. Present value (if the expected settlement
transaction clearly amount if the initial
constitutes financing measurement is face
and the imputed rate of amount.
interest can be b. Amortized cost if the
determined without initial measurement is
undue cost or effort). present value.
2. Long-term payable Face amount Face amount or
with reasonable expected settlement
interest rate amount
3. Long-term Present value Amortized cost
noninterest-bearing
payable
4. Long-term payable Present value Amortized cost
with unreasonable
interest rate
• If the cash price equivalent is determinable, the note is initially measured at this amount.
The subsequent measurement is amortized cost.

A note payable may be issued for cash, purchase of goods or services, or other noncash consideration. Regardless
of the consideration received, the accounting depends on the note’s classification form measurement purposes.
Illustration 1: Short-term note
On July 1, 20x1, ABC Co. borrowed P1,000,000 and issued a one-year note payable. The lender “discounted the
note at 12%.”
Case 1: Lump sum
The note is due in lump sum on June 30, 20x2. The effect of discounting is immaterial.
July 1, Cash 880,000
20x1 Discount on notes payable 120,000
Notes payable 1,000,000
Dec. Interest expense 60,000
31, Discount on notes payable 60,000
20x1
June Interest expense 60,000
30, Discount on notes payable 60,000
20x2
June Notes payable 1,000,000
30, Cash 1,000,000
20x2

The carrying amount of the note are determined as follows:

July 1, 20x1 Dec. 31, 20x1

Notes payable 1,000,000 1,000,000

Less: Discount on notes payable 120,000 60,000

Carrying amounts 880,000 940,000

Notes:
• ABC Co., the borrower, is referred to as the “maker” or “issuer” of the note. The lender is the “payee.”
• “Discount on notes payable” is a contra-liability account. It is deducted when determining the carrying
amount of the note.
• Theoretically, all liabilities should be measured at present value except when:
a. The effect of discounting is deemed immaterial;
b. Discounting is prohibited by a Standard (e.g., PAS 12 Income Taxes prohibits the discounting of
tax liabilities); or
c. The transaction is made in usual or customary terms.
• If the effect of discounting is not deemed immaterial, a short-term note is nonetheless measured at present
value. Judgment on materiality rests with the entity’s management.
• The standards do not require short-term notes to be measured at face amount nor prohibit their discounting.
Case 2: Installment
The note is due in equal quarterly installments starting September 30, 20x1. The effect of discounting is
immaterial.
 July 1, Cash 880,000
20x1 Discount on notes payable 120,000
Notes payable 1,000,000
Sept. Notes payable 250,000
30, Interest expense 48,000
20x1 Cash 250,000
Discount on notes payable 48,000
Dec. Notes payable 250,000
31, Interest expense 36,000
20x1 Cash 250,000
Discount on notes payable 36,000
The entries in 20x2 follow the same pattern.

Outstanding balance of the Allocation (Sum Interest

Date note of the years) expense
9/30/x1 1,000,000 120,000 x 1/2.5 48,000
12/31/x1 750,000 120,000 x .75/2.5 36,000
3/32/x2 500,000 120,000 x .5/2.5 24,000
6/30/x2 250,000 120,000 x .25/2.5 12,000
2,500,000 120,000

Illustration 2: Long-term note with reasonable – simple interest

On Oct. 1, 20x1, ABC Co. issued a two-year 12%, 1,000,000 notes payable in exchange for a piece of land.
Principal is due on October 1, 20x3 but interest is due annually.
Oct. 1, Cash 1,000,000
20x1 Notes payable 1,000,000
Dec. Interest expense 30,000
31, Interest payable 30,000
20x1
Oct. 1, Interest expense 90,000
20x2 Interest payable 30,000
Cash 120,000
Dec. Interest expense 30,000
31, Interest payable 30,000
20x2
Oct. 1, Interest expense 90,000 30,000
20x3 Interest payable 30,000
Cash
Oct. 1, Notes payable 1,000,000
20x3 Cash 1,000,000

Illustration 3: Long-term note with reasonable interest – compounded

On January 1, 20x1, ABC Co. issued a three-year, 12% 1,000,000 notes payable in exchange for a piece of land.
Principal and interest are due on December 31, 20x3.
 Jan. 1, Land 1,000,000
20x1 Notes payable 1,000,000
Dec. Interest expense 120,000
31, Interest payable 120,000
20x1
Dec. Interest expense 134,400
31, Interest payable 134,400
20x2
Dec. Interest expense 150,528
31, Interest payable 254,400
20x3 Cash 404,928
Dec. Notes payable 1,000,000
31, Cash 1,000,000
20x3

Illustration 4: Noninterest-bearing note – Lump sum

On January 1, 20x1, ABC Co. acquired equipment in exchange for 100,000 cash and a 3-year, non-interest
bearing, 1,000,000 notes payable due on January 1, 20x4. The prevailing interest rate is 12%.

Jan. 1, Equipment 811,780

20x1 Discount on notes payable 288,220
Cash 100,000
Notes payable 1,000,000
Dec. Interest expense 85,414
31, Discount on notes payable 85,414
20x1
Dec. Interest expense 95,663
31, Discount on notes payable 95,663
20x2
Dec. Interest expense 107,143
31, Discount on notes payable 107,143
20x3
Jan. 1, Notes payable 1,000,000
20x4 Cash 1,000,000

Notes:
• The difference between the present value and face amount represents the discount on note payable. The
unamortized balance of the discount is deducted from the face amount when determining the carrying
amount.
• The discount on note payable on initial recognition of a noninterest-bearing note represents the total
interest expense to be recognized over the term of the note.
• The equipment is measured at the amount of cash paid plus the present value of the note.
 Discount on
Date Payments Present value
notes payable
Jan. 1, 20x1 288,220 711,780
Dec. 31, 20x1 85,414 202,806 797,194
Dec. 31, 20x2 95,663 107,143 892,857
Dec. 31, 20x3 107,143 0 1,000,000
Total 288,220

Illustration 5: Noninterest-bearing note – Installment

On January 1, 20x1, ABC Co. Acquired equipment in exchange for 100,000 cash and a 4-year, noninterest-
bearing, 1,000,000 notes payable due in 4 equal annual installments starting December 31, 20x1. The prevailing
interest rate is 12%.
Jan. 1, Equipment 859,337
20x1 Discount on notes payable 240,663
Cash 100,000
Notes payable 1,000,000
Dec. Notes payable 250,000
31, Interest expense 91,120
20x1 Cash 250,000
Discount on notes payable 91,120
Dec. Notes payable 250,000
31, Interest expense 72,055
20x2 Cash 250,000
Discount on notes payable 72,055
Dec. Notes payable 250,000
31, Interest expense 50,702
20x3 Cash 250,000
Discount on notes payable 50,702
Dec. 1, Notes payable 250,000
20x4 Interest expense 26,785
Cash 250,000
Discount on notes payable 26,785

Interest
Date Payments Amortization Present value
expense
Jan. 1, 20x1 759,337
Dec. 31, 20x1 250,000 91,120 158,880 600,458
Dec. 31, 20x2 250,000 72,055 177,945 422,513
Dec. 31, 20x3 250,000 50,702 199,298 223,214
Dec. 31, 20x4 250,000 26,786 223,214 0

Current and non-current portion of a note payable

When the principal amount is due in installments, the carrying amount of the note includes both current and
noncurrent portions. These portions are presented or disclosed separately in the financial statements.
To determine the current and noncurrent portions, simply refer to the amortization table. The current portion is
the amortization in the immediately following year. This is the portion of the next year’s payment applied to the
principal.
For example, the carrying amount of the note on December 31, 20x1 is 600,458. The current portion and
noncurrent portion of this amount are determined as follows:

Interest
Date Payments Amortization Present value
expense
Jan. 1, 20x1 759,337
Dec. 31, 20x1 250,000 91,120 158,880 600,458
Dec. 31, 20x2 250,000 72,055 177,945 422,513
Dec. 31, 20x3 250,000 50,702 199,298 223,214
Dec. 31, 20x4 250,000 26,786 223,214 0

When disclosing in the financial statements, the discount on notes payable is allocated to both the current and
noncurrent portions of the note by deducting the present value of the portion from the related future cash
payments.
Current portion of the notes
payable:
Notes payable (250,000 due in 20x2) 250,000
Discount on notes payable (250,000 - 177,945 current portion) 72,055
Notes payable, net 177,945

Noncurrent portion of the notes payable:

Notes payable (250,000 due in 20x2 + 250,000 due in
20x3) 500,000
Discount on notes payable (500,000 - 422,513 noncurrent portion) 77,487
Notes payable, net 422,513
Total Notes payable 600,458

Illustration 6: Noninterest-bearing note – Installment in advance

On January 1, 20x1, ABC Co. acquired equipment in exchange for 100,000 cash and a 4-year, noninterest-bearing,
1,000,000 notes payable due in 4 equal annual installments. The first installment is due on January 1, 20x1. The
succeeding installment payments are due every December 31. The prevailing interest rate is 12%.
 Jan. 1, Equipment 950,458
20x1 Discount on notes payable 149,542
Cash 100,000
Notes payable 1,000,000
Jan. 1, Notes payable 250,000
20x1 Cash 250,000
Jan. 1, Notes payable 250,000
20x2 Interest expense 72,055
Cash 250,000
Discount on notes payable 72,055
Jan. 1, Notes payable 250,000
20x3 Interest expense 50,702
Cash 250,000
Discount on notes payable 50,702
Jan. 1, Notes payable 250,000
20x4 Interest expense 26,785
Cash 250,000
Discount on notes payable 26,785

Interest
Date Payments Amortization Present value
expense
Jan. 1, 20x1 850,458
Jan. 1, 20x1 250,000 0 250,000 600,458
Jan. 1, 20x2 250,000 72,055 177,945 422,513
Jan. 1, 20x3 250,000 50,702 199,298 223,214
Jan. 1, 20x4 250,000 26,786 223,214 0

The amortization table shows carrying amounts on January 1 of the subsequent years. These carrying amounts
are net of the January 1 payments. To compute for the carrying amount of the note on December 31, the amount
of payment on the following day is simply added back to the January 1 present value.
The carrying amount of the note on December 31, 20x1 is determined as follows:

Carrying amount of note payable - January 20x2 422,513

Payment on January 1, 20x2 250,000
Carrying amount of note payable - December 31, 20x1 672,513

Loans payable
Loan payable is similar to note payable; it is also supported by a formal promise to pay a certain sum of money
at specific future date(s). however, the term “loans payable” can be used to connote bank loans and similar types
of financing.
Loans payable are accounted for similar to notes payable. However, loan transactions normally involve
transactions costs. Recall that financial liabilities are initially recognized at fair value minus transaction costs.
• Transaction costs are “incremental costs that are directly attributable to the acquisition, issue or disposal
of a financial asset or financial liability. An incremental cost is one that would not have been incurred if
the entity had not acquired, issued, or disposed of the financial instrument.” (PFRS 9. Appendix A)
 • Transaction costs include fees and commissions paid to agents, advisers, brokers and dealers; levies by
regulatory agencies and securities exchange; and transfer taxes and duties.
• Transaction costs do not include debt premiums or discounts, financing costs or internal administrative or
holding costs.
Origination fees
Origination fee is an upfront fee charged by a lender to cover costs of processing the loan (e.g., evaluating the
borrower’s financial condition, evaluating and recording guarantees, collateral and other security arrangements,
negotiating the terms of the instrument, preparing and processing documents and closing the transaction).
Origination fees normally come in the form of a “service fee” which is a percentage of the principal amount and
is directly deducted from a loan proceeds released to borrower.
Origination fees are deducted when measuring the carrying amount of a loan payable. Origination fees are
subsequently amortized using the effective interest method. The subsequent amortization increases both the
interest expense and the carrying amount of the loan.
Origination fees are included in the calculation of the effective interest rate, meaning on transaction date, the
origination fees are treated as adjustment to the effective interest rate.
Illustration: Origination fees
On January 1, 20x1, ABC Co. borrowed 1,000,000 from a bank. The bank charged 3% loan origination fee. The
principal is due on January 1, 20x4 but 10% interest is due annually starting January 1, 20x2.
Jan. 1, Cash 970,000
20x1 Discount on loans payable 30,000
Loans payable 1,000,000

Subsequent measurement
The effective interest rate on the loan is not equal to the 10% stated rate because of the origination fee. We will
compute for the imputed interest rate using the “trial and error” approach.
To limit the number of “tries”. Observe the following concepts:
• If a financial instrument’s carrying amount is less than its face amount, the difference is a discount.
• If a financial instrument’s carrying amount is greater than its face amount, the difference is a premium.
• When there is a discount, the effective interest rate is higher than the nominal rate (stated rate or coupon
rate).
• When there is a premium, the effective interest rate is less than the nominal rate.
There is no discount or premium if the carrying amount is equal to the face amount. Consequently, the effective
interest rate is also equal to the nominal rate.
Continuing the illustration, we know that the loan is issued at a discount because the initial carrying amount of
970,000 is less than the face amount of 1,000,000. Therefore, the effective interest rate must be higher than the
nominal rate of 10%.
First trail (using 11%)
• (PV of 1@11% for 3 period x principal) + (PV of ordinary annuity@11% for 3 period) = 970,000
• (0.731191381 x 1,000,000) + (2.443714715 x 100,000) = 970,000
 • (731,191 + 244,371) = 975,562 is not equal to 970,000
We need a lower amount; therefore, we need to increase the rate.
Second trail (using 12%)

• (PV of 1@12% for 3 period x principal) + (PV of ordinary annuity@12% for 3 period) = 970,000
• (0.7114780248 x 1,000,000) + (2.401831268 x 100,000) = 970,000
• (711,478 + 240,183) = 951,963 is not equal to 970,000
Looking at the values derived above, we can reasonably expect that the effective interest rate is between 11%
and 12%. To approximate that rate, we need to perform interpolation using the following formula:
𝑥% 11% 970,000 975,562 (5,562) 0.2357
- = - = =
12% 11% 951,963 975,562 (23,559)

• The value substituted for ‘x%’ is 970,000, the initial carrying amount of the loan.
• We expect the effective interest rate to be higher than 11% but lower than 12%. Thus:
• 11% (the lower rate) appears on both the numerator and denominator.
• 0.2357 is added to 11% to derive the effective interest rate.
• The effective interest rate is 11.2357%

interest present
date payments amortization
expense value
Jan. 1, 20x1 970,000
Jan. 1, 20x2 100,000 108,986 8,986 978,986
Jan. 1, 20x3 100,000 109,996 9,996 988,982
Jan. 1, 20x4 100,000 111,119 11,119 1,000,101

Notice that there is still a small difference of 101. However, if this is deemed immaterial, we can regard the
computed rate as the effective interest rate.
Bonds payable
Bonds are long-term debt instruments similar to notes and loans except that bonds are usually offered to the public
and sold to many investors. A bond is intended to be broken up into various subunits (e.g., 1,000 each) which can
be issued to a variety of investors.
A debt instrument is 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. A debt instrument represents a debtor-creditor
relationship between entities.
Bond indenture is the contractual arrangement between the issuer and the bondholders. It contains restrictive
covenants intended to prevent the issuer from takin actions contrary to the interests of the bondholders. A trustee,
often a bank, is appointed to ensure compliance.
A bond indenture may specify, among other things, the following:
a. Right and duties of bondholders and issuer which may include the following:
1. Call provision – the issuer’s right to call the bonds before the scheduled maturity. If interest rates
decline, the issuer can call high-interest bonds and replace them with low interest bonds.
 2. Redemption rights – the holder’s right to redeem the bonds before the scheduled maturity. This option
is usually available if the issuer takes a stated action, for example, when the issuer greatly increased its
debt or is being acquired by another entity.
b. Restrictions and requirements on the issuer which may include the following:
1. Sinking fund that the issuer is required to establish for the protection of the bondholders.
2. Financial ratios that the issuer is required to maintain.
3. Restriction on dividends available to the issuer’s shareholders. The issuer may be required to
appropriate a portion of its retained earnings for the protection of the bondholders.
4. Restriction on incurrence of additional obligations. The issuer may be restricted from issuing new
bonds unless the currently issued bonds are settled first or restricted from issuing new bonds in excess
of a percentage of bondable property (fixed assets).
5. Appointment of independent trustee whose qualifications are stated in the bond indenture
6. Authorized amount of bonds that can be issued.
c. Interest rate, payment date(s), and maturity date(s)
Bond certificate is issued to the bondholder representing the amount of bonds he has purchased. Bonds are
normally issued in denominations, such as P1,000 and P10,000. These small amount denominations increase
the affordability of bonds enabling the issuer to obtain financing from a wider market.
Issuance of bonds
Bonds can be issued in several ways, for example, through underwriting, auction, or direct placement with
investors. Often, bonds are issued through an underwriter (e.g., investment banker) who agrees on the price of the
bonds, pays the issuer, and then resells the bonds to other investors at a higher price. The underwriter is paid a
fee for this service and may agree to purchase any unsold bonds at a specified price.
Types of bonds

• As to maturity
1. Term bonds – bonds that mature on single date.
2. Serial bonds – bonds in which the principal matures in installments.
3. Extendible and retractable bonds – bonds that have more than one maturity date permitting
investors to choose the maturity dates that meet their needs.
a. Extendible bonds – bonds that give holders the right to extend the initial maturity to a
later date.
b. Retractable bonds – bonds that give holders the right to shorten the initial maturity to an
earlier date.
Investors use extendible/retractable bonds to modify the terms of their portfolio to take
advantage of movements in interest rates.

• As to recording point of view and payment of interests

1. Registered bonds – 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.
2. Coupon (bearer) bonds – 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. However, they sell at a deep discount from their face amount. Principal and compounded
interests are due only at maturity date.
4. Income bonds – bonds that pay interest only if the issuer earns profit.
 5. Participating bonds – bonds that participate in excess earnings of the issuer as defined in the
indenture.
6. Indexed bonds (purchasing power bonds) – bonds that pay interest that is indexed to a measure
of general purchasing power, such as the Consumer Price Index (CPI).
7. Inflation-linked bonds – bonds whose principal and interest payments are adjusted in response to
inflation, providing the bondholder protection from inflation.
• As to security and risk
1. Mortgage bonds – bonds secured by real property
2. Collateral trust bonds – bonds secured by the issuer’s securities, which are held by a trustee. If
the issuer defaults, the trustee distributes the securities to the bondholders.
3. Asset-backed bonds (asset-backed securities) – bonds collateralized by a pool of assets, such as
credit card receivables and car loans. For example, the bond issuer securitizes its credit card
receivables and sells to the investors the right to receive the collections on those receivables.
4. Subordinate bonds (subordinate debentures) – bonds that have a higher yield than secured bonds
but a lower priority during liquidation.
5. Debenture bonds – bonds not secured by any collateral.
6. Junk bonds – high-risk, high-yield bonds typically issued to finance leveraged buyouts and
mergers.
• As to right of redemption
1. Callable bonds – bonds that the issuer can redeem prior to maturity date. If the rates decline, the
issuer can call high-interest bonds and replace them with low-interest bonds.
2. Convertible bonds – bonds that the holder can exchange for the issuer’s shares of stocks.
• As to issuer
1. Corporate bonds – bonds by a corporation. Bonds issued by companies with high credit rating are
considered “investment grade,” whereas bonds issued by companies with low credit rating are
considered “non-investment grade” or “junk” because of their speculative nature.
2. Government bonds (Treasury bonds) – bonds issued by a government bonds have low financial
risk because they are practically free from default.
• As to currency
1. International bonds – bonds issued by a foreign entity in a domestic market. International bonds
include the following:
a. Eurobonds – bonds denominated in a currency other than the currency of the market in
which they are offered for example, a German company that issues U.S. dollar-
denominated bonds in Japan has issued a Eurobond, more specifically; a Eurodollar bond.
Other types of Eurobonds include Euroyen and Euroswiss bonds.
b. Foreign bonds – bonds denominated in the currency of the domestic market in which they
are offered. For example, a German company that issues yen-denominated bonds in Japan
has issued a Foreign bond, more specifically, a “Samurai bond.” Foreign bonds are usually
given nicknames that refer to the domestic market in which they are being offered. Other
examples include:
i. Kangaroo bonds or Matilda bonds – Australian dollar-denominated bonds issued in
Australia by a foreign entity.
ii. Maple bonds – Canadian dollar-denominated bonds issued in Canada by a foreign
entity.
iii. Matador bonds – Euro-denominated bonds (Spain’s currency is Euro) issued by
Spain by a foreign entity.
iv. Bulldog bonds – British pound-denominated bonds issued in the British market by
a foreign entity.
 v. Yankee bonds – US dollar-denominated bonds issued in the US market by a foreign
entity.
c. Global bonds – bonds that are issued in several countries at the same time. For example,
a German company that issued U.S. dollar denominated bonds in both Japan and U.S.
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 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 bond certificate.
Thus, if bonds with face amount of P50,000,000 are sold, divided into P1,000 denominations, 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 bonds on the basis of a commission to be deducted from
the proceed 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 6 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.
Initial measurement of bonds payable
PFRS 9, paragraph 5.1.1, provides that bonds payable not designated at fair value through profit or 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 of issue price of the bonds payable in measuring initially
the bonds payable.
However, if the bonds are designated and account for “at fair value through profit or loss”, the bond issue costs
are treated as expense immediately.
Actually, the fair value of the bonds payable is the same as the issue price of 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.
Accounting for issuance of bonds
There are two approaches in accounting for the authorization and issuance of bonds payable, namely;
a. Memorandum approach
b. Journal entry approach
Illustration:
The following memorandum entry is made in the general journal and a notation of the amount authorized:
On January 1, 2020, the entity is authorized to issue P5,000,000 face amount, 10-uear 12% bonds, interest payable
January 1 and July, consisting of 5,000 units of P1,000 face amount.
To record the sale of the bonds at face amount:
Cash 5,000,000
Bonds payable 5,000,000
In the succeeding discussions, the memorandum approach of accounting for bonds will be employed, as this is
the one generally followed:
Journal entry approach
To record the authorization of the bonds:
Unissued bonds payable 5,000,000
Authorized bonds payable 5,000,000
To record the sale of the bonds at face amount:
Cash 5,000,000
Unissued bonds payable 5,000,000
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 bonds.” Thus, the sales price is P5,250,000, computed by multiplying 105% by
P5,000,000.
Journal entry
Cash 5,250,000
Bonds payable 5,000,000
Premium on bonds payable 250,000
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. The obligation of the issuing entity is limited only to the face
amount of the 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 amount of the bond certificate. 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 25,000
Interest expense (250,000/10 years) 25,000
Issuance of bonds at a discount
If the sales price of the bonds is less than the face amount, the bonds are said to be sold at a discount.
For example, an entity issued bonds with face amount of P5,000,000 at 95.
Journal entry
Cash (5,000,000 x 95%) 4,750,000
Discount on bonds payable 250,000
Bonds payable 5,000,000
the bond discount is in effect a loss to the issuing entity. However, it is not treated as an outright loss.
When bonds are sold at a discount, it means that the buyer or investor is not willing to accept simply the nominal
rate of interest.
The buyer wants to accept a rate of interest that is somewhat higher than the nominal rate.
Thus, when bonds are issued at a discount, the effective rate is higher than the nominal rate.
Accounting wise, the bond discount is amortized as loss over the life of the bonds and charges to interest expense.
Thus, if the bonds have a life of 10 years and the straight line method is used, the journal entry to record the
amortization of the bond discount is:
Interest expense (250,000/10 years) 25,000
Discount on bonds payable 25,000
Presentation of discount and premium
Discount on bonds payable and premium on bond payable are reported as adjustments to the bond liability
account.
The discount on bond payable is 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 of
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 representation in the statement of financial position.
Noncurrent liabilities:
Bonds payable 5,000,000
Discount on bonds payable (_250,000) 4,750,000
And
Noncurrent liabilities:
Bonds payable 5,000,000
Premium on bonds payable __250,000 5,250,000
Bond issue costs
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 prie 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 value through profit or loss, the bond issue costs are expensed
immediately.
Recording interest on bonds
Accounting for interest expense on bonds requires recognition of two items, namely:
a. Payment of interest during the year
b. Accrual of interest at the end of the year
Illustration
On March 1, 2020, an entity sold bonds with face amount of P5,000,000 and 12% interest payable semiannually
on March 1 and September 1.
Inasmuch as the bonds are sold on March 1, 2020, the first payment of interest will be on September 1, 2020.
Journal entries
2020
Sept. 1 Interest expense 300,000
Cash 300,000
Semiannual interest payment
(5,000,000 x 12% x ½ = 300,000)
Dec. 31 Interest expense 200,000
Accrued interest payable 200,000
Interest accrued for 4 months from September 1 to December 31, 2020
(5,000,000 x 12% x 4/12 = 200,000)
2021
Jan. 1 Accrued interest payable 200,000
Interest expense 200,000
Reversing entry
March 1 Interest expense 300,000
Cash 300,000
Semiannual interest payment

Sept. 1 Interest expense 300,000

Cash 300,000
Semiannual interest payment
Dec. 31 Interest expense 200,000
Accrued interest payable 200,000
Interest accrued for 4 months from September 1 to December 31, 2021
(5,000,000 x 12% x 4/12 = 200,000)
Issuance of bonds on interest date
On June 1, 2020, an entity issued bonds with face amount of P5,000,000 at 97.
The bonds mature in 5 years and pay 12% interest semiannually on June 1 and December 1
The straight line method is used for simplicity in amortizing discount on bonds payable.
Journal entries
2020
June 1 Cash 4,850,000
Discount on bonds payable 150,000
Bonds payable 5,000,000
Dec. 1 Interest expense 300,000
Cash 300,000
Semiannual interest payment
Dec. 31 Interest expense 50,000
Accrued interest payable 50,000
 Interest accrued for 1 month from December 1 to December 31, 2020
(5,000,000 x 12% x 1/12 = 50,000)
Dec. 31 Interest expense 17,500
Discount on bonds payable 17,500
Amortization of bond discount from June 1 and December 31, 2020
(P150,000/5 years = 30, 000 annual amortization, x 7/12 = P17,500)
The amortization of the bond discount or premium may be on every interest date or at the end of every year.
In the given example, the amortization is made at the end of the year.
2021
Jan. 1 Accrued interest payable 300,000
Interest expense 300,000
Reversing entry
June. 1 Interest expense 300,000
Cash 300,000
Semiannual interest payment
Dec. 1 Interest expense 300,000
Cash 300,000
Semiannual interest payment
Dec. 31 Interest expense 50,000
Accrued interest payable 50,000
Interest accrued for 1 month from December 1 to December 31, 2021
Dec. 31 Interest expense 30,000
Discount on bonds payable 30,000
Amortization of bond discount for one year, 2021
If a statement of financial position is prepared on December 31, 2021, the accrued interest payable of P50,000 is
classified as current liability.
The bonds payable should be classified as noncurrent liability:
Bonds payable 5,000,000
Discount on bonds payable (_102,500) 4,897,500
Issuance of bonds between interest dates
On April 1, 2020, an entity issued bonds with face amount of P5,000,000 at P5,228,000 plus accrued interest.
The bonds are dated January 1, 2020, mature in 5 years and pay 12% interest semiannually on January 1 and July
1.
To record the issue of the bonds on April 1, 2020:
Cash 5,378,000
Bonds payable 5,000,000
Premium on bonds payable 228,000
Interest expense 150,000
Issue price 5,228,000
Add: Accrued interest from January 1 to April 1, 2020 150,000
(5,000,000 x 12% x 3/12) 5,378,000
Note that if the bonds are issued between interest dates, an accrued interest is involved.
Normally, when bonds are issued between interest date, the accrued interest is paid by the buyer or investor.
The accrued interest on the date of sale for 3 months from January 1 to April 1, 2020 is paid by the investor
because on July 1 2020, three months after the sale, the investor is going to receive interest for 6 months from
January 1 to July 1, 2020.
The accrued interest “sold” is credited to interest expense.
On July 1, 2020, the journal entry to record the payment of semiannual interest is:
Interest expense (5,000,000 x 12% x ½) 300,000
Cash 300,000
Note that if at this point the interest expense account is posted, it has a debit balance of P150,000 which represents
the correct amount of interest expense form April 1 to July 1, 2020.
Another approach for interest accrued
Another approach is to credit the accrued interest on the date of sale to accrued interest payable.
Cash 5,378,000
Bonds payable 5,000,000
Premium on bonds payable 228,000
Accrued interest payable 150,000
The payment of first semiannual interest is recorded as:
Interest expense 150,000
Accrued interest payable 150,000
Cash 300,000
In either approach, the debit balance of interest expense account must be P150,000, the correct interest expense.
The approach of crediting interest expense instead of accrued interest payable is preferable.
Continuing the illustration, on December 31, 2020, the adjusting entries are:
Interest expense 300,000
Accrued interest payable 300,000
Interest accrued for 6 months from July 1 to December 31, 2020
Premium on bonds payable 360,000
Interest expense 360,000

Original life of bonds (5 years x 12) 60 months

Less: Expired life on the date of sale 3 months
Remaining life of bonds 57 months
Monthly amortization (228,000/57 months) 4,000
 Amortization for 9 months from April 1 to 36,000
December 31, 2020 (4,000 x 9)
The straight line method is used in amortizing the premium on bonds payable for simplicity.
Financial statement presentation
If a 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.
The periodic cash deposits plus the interest earned on sinking 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 fun cash to pay the
bondholders. Any excess cash 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:
Bonds payable 5,000,000
Interest expense 300,000
Sinking fund 5,300,000
If the sinking fund is not used, the payment of the bonds will come from the general cash of the issuing entity.
Bonds payable 5,000,000
Interest expense 300,000
Cash 5,300,000
Bond retirement prior to maturity date
when bonds are reacquired prior to maturity date, they may be canceled and permanently retired, or held in the
treasury 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 retire, the following procedures are followed.
1. The bond premium or bond discount should be amortized up to the date of retirement.
2. The balance of the bond premium or discount should be determined. This balance is important because
the amount related to the bonds retired is canceled.
3. The accrued interest date of retirement should be determined.
 4. The total cash payment should be computed. The is equal to the retirement price plus the accrued interest.
The retirement price is a certain percentage 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.
7. The retirement of the bonds is then recorded by canceling the bond liability together with the unamortized
premium or discount. Any accrued interest is debited to interest expense.
Illustration
On March 1, 2020, bonds with face amount of P5,000,000 are issued for P4,730,000.
The bonds are dated March 1, 2020 and mature in 5 years, and pays 12% interest semiannually on March 1 and
September 1.
The straight line method of amortization is used for simplicity.
All of the bonds are retired on July 1, 2023 at 97.
1. The amortization of the bond discount is recorded up to July 1, 2023. If the entity uses the calendar
period, presumably, the last amortization was on December 31, 2022.
Thus, an amortization of the discount for 6 months from January 1 to July, 2023 should be recorded.
Interest expense 27,000
Discount on bonds payable 27,000
(270,000/5 years = 53,000 annual amortization, 54,000 x ½ = 27,000)
2. Balance of the discount on bonds payable
Discount on bonds payable – March 1, 2020 270,000
Less: Amortization from March 1, 2020 to July 1, 2023 or 40
months (40/60 x 270,000) 180,000
Balance, July 1, 2023 90,000

3. The accrued interest on the date of retirement, July 1, 2023 is computed as P5,000,000 x 12% x 4/12
= P200,000.
The last payment of interest was March 1, 2023. Thus, the accrued interest is for 4 months, from March
1 to July 1, 2023.
4. Total cash payment
Retirement price (P5,000,000 x 97) 4,850,000
Add: Accrued interest 200,000
Total cash payment 5,050,000
 5. Carrying amount of the bonds payable
Bonds payable 5,000,000
Discount on bonds payable ( 90,000)
Carrying amount on July 1, 2023 4,910,000

6. Gain on the early retirement or extinguishment

Carrying amount of bonds payable 4,910,000
Less: Retirement price 4,850,000
Gain on early retirement 60,000
7. To record the retirement of the bonds on July 1, 2023
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
The gain on early retirement or extinguishment of bonds may be presented as component of finance cost or other
income.
Query
Suppose in the preceding illustration, not all the bonds are retired on July 1, 2023?
Suppose only bonds with face amount of P1,000,000 are retired at 97?
The same procedures discussed previously are followed.
Thus, the amortization of the discount is updated on July 1, 2023.
Interest expense 27,000
Discount on bonds payable 27,000

a. Total cash payment

Retirement price (P1,000,000 x 97) 970,000
Add: Accrued interest 200,000
Total cash payment 1,010,000
b. Carrying amount of bonds retired and gain on retirement.
Bonds payable 1,000,000
Discount on bonds payable ( 18,000)
Carrying amount on July 1, 2023 982,000
Less: Retirement price 970,000
Gain on early retirement on bonds 12,000
Note that the discount balance of P90,000 pertains to the face amount of P5,000,000.
Inasmuch as only P1,000,000 face amount is retired, necessarily the discount applicable to the P1,000,000 bonds
or 1/5 of P90,000 or P18,000 should be canceled.
Thus, the journal entry to record the retirement of the bonds with face amount of P1,000,000 is:
 Bonds payable 1,000,000
Interest expense 40,000
Cash 1,010,000
Discount on bonds payable 18,000
Gain on early retirement of bonds 12,000
In the immediately preceding illustration, the additional accounting problems would be the entries subsequent to
July 1, 2023 pertaining to the remaining P4,000,000 face amount.
Remaining journal entries for 2023
Sept. 1 Interest expense 240,000
Cash 240,000
(P4,000,000 x 12% x ½ = 240,000)
June. 1 Interest expense 160,000
Accrued interest payable 160,000
(P4,000,000 x 12% x 4/12)
Dec. 1 Interest expense 21,600
Discount on bonds payable 21,600
Amortization of bond discount for 6 months
Note that the amortization of the bond discount was updated on July 1, 2023. Thus, the amortization for 2023
shall only be for 6 months from July 1 to December 31, 2023.
The original annual amortization of P54,000, P270,000/5 years. This amount pertains to the P5,000,000 face
amount.
Only P4,000,0000 face amount remains. Thus, the annual amortization should be revised to apply to the
P4,000,000 remaining face amount.
Hence, P4,000,000/P5,000,000 x P54,000 equals P43,200, revised annual amortization. Thus, for six months from
July 1 to December 31, 2023, the amortization is P21,600.
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.
Illustration
An entity originally issued bonds with face amounts of P5,000,000 at 105 or a premium of P250,000.
Subsequently, the entity reacquired P1,000,000 face amount to be placed in the treasury at 103.
At the time of the reacquisition, the unamortized premium balance is P200,000, and accrued interest on the
treasury is P30,000 which is paid in cash.
To record the acquisition of the treasury bonds
Treasury bonds 1,000,000
Premium on bonds payable 40,000
Interest expense 30,000
Cash 1,060,000
Gain on acquisition of treasury bonds 10,000
Face amount of treasury bonds 1,000,000
Applicable premium (P1,000,000 x 5,000,000 x 200,000) 40,000
Carrying amount 1,040,000
Less: Reacquisition price (P1,000,000 x 103%) 1,030,000
Gain on acquisition of treasury bonds 10,000
Carrying amount 1,030,000
Less: Reacquisition price (P1,000,000 x 103%) 30,000
Gain on acquisition of treasury bonds 1,060,000
The treasury bonds when subsequently sold are recorded in the same manner as bonds originally issued.
Reissuance at a premium
The treasury bonds are reissued for P1,200,000
Cash 1,200,000
Treasury bonds 1,200,000
Premium on bonds payable 200,000
Reissuance at a discount
The treasury bonds are reissued for P900,000
Cash 900,000
Discount on bonds payable 100,000
Treasury bonds 1,000,000
The premium or discount on the reissue of the treasury bonds should be amortized over the remaining life of the
treasury bonds.
The treasury bonds when not subsequently sold are simply canceled against the bonds payable account on the
date of maturity.
Bonds payable 1,000,000
Treasury bonds 1,000,000
Statement presentation
Bonds payable 5,000,000
Less: Treasury bonds 1,000,000
Bonds payable issued and outstanding 4,000,000
Premium on bonds payable 160,000
Carrying amount 4,160,000
Bond refunding
Bond refunding is the floating of new bonds the proceeds from which are used in paying the original bonds.
Simply stated, the bond refunding is a premature retirement of the old bonds by means of issuing new bonds.
Bond refunding is also known as bond refinancing.
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 is no unamortized premium or discount involved.
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 loss.
Accordingly, the refunding charges are charged on loss on extinguishment.
Illustration
1. Issuance of new 10-year 10% bonds, with face amount of P1,500,000 for P1,600,000.
2. Refunding of old 12% bonds, with remaining life of 4 years, at 102.
Bonds payable – old 1,000,000
Discount on bonds payable 30,000
Retirement price (1,000,000 x 102) 1,020,000
Journal entries
To record the issuance of the new bonds payable:
Cash 1,600,000
Bonds payable 1,500,000
Premium on bonds payable 100,000
To record the retirement of the old bonds payable:
Bonds payable 1,000,000
Loss on extinguishment of bonds 50,000
Cash 1,020,000
Discount on bonds payable 30,000
The loss on extinguishment of bonds is represented by the refunding charges of P50,000.
 Unamortized discount 30,000
Redemption premium (1,000,000 x 2%) 20,000
Total refunding charges 50,000
or

Bonds payable 1,000,000

Less: Discount on bonds payable 30,000
Carrying amount 970,000
Less: Retirement price 1,020,000
Loss on extinguishment ( 50,000)
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
Straight line method
The straight line method provides for an equal amortization of bond premium or bond discount.
The procedure is simply to divide the amount of bond 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 bond 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 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 decreasing principal bond
liability.
Illustration – Accounting year and bond year coincide
Face amount of bonds 5,000,000
Issue price 5,300,000
Date of bonds January 1, 2020
Date of issue January 1, 2020
Interest rate 12%
Semiannual interest dates June 30 and December 31
The bonds mature on every December 31 of each year at the rate of P1,000,000 for 5 years.
The table of amortization following the bond outstanding method may appear as follows:

Premium
Year Bond outstanding Fraction amortization
2020 5,000,000 5/15 100,000
2021 4,000,000 4/15 80,000
2022 3,000,000 3/15 60,000
2023 2,000,000 2/15 40,000
2024 1,000,000 1/15 20,000
15,000,000 300,000

The bond outstanding is determined, every bond year.

Thus, the bond outstanding for 2020 is P5,000,000 and is decreased by the annual payment of P1,000,000.
The fractions are developed from the bond outstanding column,
The annual premium amortization is computed by multiplying the fractions by the amount of the premium.
Thus, for 2020, 5/15 times P300,000 equals P100,000.
Journal entries
2020
Jan. 1 Cash 5,300,000
Bonds payable 5,000,000
Premium on bonds payable 300,000
Issuance of bonds payable
June 30 Interest expense 300,000
Cash (5,000,000 x 12% x 6/12) 300,000
Semiannual interest payment
Dec. 31 Interest expense 300,000
Cash 300,000
Semiannual interest payment
Dec. 31 Premium on bonds payable 100,000
Interest expense 100,000
Amortization of premium for 2020.
Dec. 31 Bonds payable 1,000,000
Cash 1,000,000
Payment of first series of bonds
2021
June 30 Interest expense 240,000
Cash (4,000,000 x 12% x 6/12) 240,000
Semiannual interest payment
Dec. 31 Interest expense 240,000
Cash 240,000
Semiannual interest payment
Dec. 31 Premium on bonds payable 80,000
Interest expense 80,000
Amortization of premium for 2021
Dec. 31 Bonds payable 1,000,000
Cash 1,000,000
Payment of first series of bonds
Premature retirement of serial bonds
When serial bonds are paid on the regular maturity dates, no accounting problem arises because no unamortized
discount 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 is applicable to the serial bonds retired prior to their
maturity date?
Illustration
Using the preceding illustration, assume serial bonds with face amount of P1,000,000 scheduled to be retired on
December 31, 20222, are retired at 103 on December 31, 2020, two years prior to their redemption date.
The following procedures may be followed in determining the unamortized premium or discount related to the
prematurely retired serial bonds:
Accounting procedures
a. Get the ratio of the 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.
300,000 / 15,000,000 = .02 rate per year
b. Multiply the rate computed in (1) by the face amount of the bonds retired. The answer gives the
unamortized premium or discount per year related to the bonds retired.
P1,000,000 x .02 = P20,000 unamortized premium per year.
c. 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
canceled.
P20,000 x 2 years = P40,000 unamortized premium related to the P1,000,000 face value bonds
retired.
 Journal entry to record the retirement of the P1,000,000 face amount serial bonds on December 31, 2020.
Bonds payable 1,000,000
Premium on bonds payable 40,000
Cash (1,000,000 x 103) 1,030,000
Gain 10,000
Revised schedule of premium amortization
Original premium Revised premium
Year amortization Premium canceled amortization
2020 100,000 100,000
2021 80,000 20,000* 60,000
2022 60,000 20,000** 40,000
2023 40,000 40,000
2024 20,000 20,000
300,000 40,000 300,000

*For 2021
**For 2022

Illustration – Accounting year and bond year do not coincide

Face amount of bonds 5,000,000
Issue price 4,700,000
Date of bonds April 1, 2020
Date of issue April 1, 2020
Interest rate 12%
Semiannual interest dates April 1 and October 31
The bond mature on April 1 of each year at the rate of P1,000,000.
Amortization table

Bond year Bond Premium

From To outstanding Fraction amortization
April 1, 2020 March 31, 2021 5,000,000 5/15 100,000
April 1, 2021 March 31, 2022 4,000,000 4/15 80,000
April 1, 2022 March 31, 2023 3,000,000 3/15 60,000
April 1, 2023 March 31, 2024 2,000,000 2/15 40,000
April 1, 2024 March 31, 2025 1,000,000 1/15 20,000
15,000,000 300,000
 2020 April 1 to Dec. 31 100,000 x 9/12 = 75,000
2021 Jan. 1 to Mar. 31 100,000 = 3/12 = 25,000
April 1 to Dec. 31 100,000 x 9/12 = 60,000 85,000
2021 Jan. 1 to Mar. 31 100,000 = 3/12 = 20,000
April 1 to Dec. 31 100,000 x 9/12 = 45,000 65,000
2021 Jan. 1 to Mar. 31 100,000 = 3/12 = 15,000
April 1 to Dec. 31 100,000 x 9/12 = 30,000 45,000
2021 Jan. 1 to Mar. 31 100,000 = 3/12 = 10,000
April 1 to Dec. 31 100,000 x 9/12 = 15,000 25,000
2021 Jan. 1 to Mar. 31 100,000 = 3/12 = 5,000
300,000
Journal entries
2020
April 1 Cash 4,700,000
Discount on bonds payable 300,000
Bonds payable 5,000,000

Oct. 1 Interest expense 300,000

Cash (5,000,000 x 12% x 6/12) 300,000
Semiannual interest payment
Dec. 31 Interest expense 150,000
Cash (5,000,000 x 12% x 3/12) 150,000
Interest accrued for 3 months
Dec. 31 Interest expense 75,000
Discount on bonds payable 75,000
Amortization of discount for 2020
2021
Jan. 1 Accrued interest payable 150,000
Interest expense 150,000
Reversing entry
April 1 Interest expense 300,000
Bonds payable 1,000,000
Interest expense 1,300,000
Semiannual interest payment and payment
of the first series of bonds

Oct. 1 Interest expense 240,000

Cash (4,000,000 x 12% x 6/12) 240,000
Semiannual interest payment
Dec. 31 Interest expense 120,000
Accrued interest payable 120,000
Interest accrued for 4 months from September 1 to December 31, 2021
(5,000,000 x 12% x 4/12 = 200,000)
Dec. 31 Interest expense 85,000
Discount on bonds payable 85,000
Amortization of discount for 2020
Fair value option of measuring bonds payable
PFRS 9, paragraph 4.2.2, provides that at initial recognition, bonds payable may be irrevocably designated as at
fair value through profit or loss
In other words, under the fair value option, the bonds payable shall be measured initially at fair value and
remeasured at every year-end with any changes in fair value generally recognized in profit or loss.
There is no more amortization discount and bond premium. Any transaction cost or bond issue cost should be
expense outright.
As a matter of fact, interest expense is recognized using the nominal or stated rate.
Illustration
On January 1, 2020, an entity issued bonds with face amount of P5,000,000 and 12% stated interest rate for
P5,379,100. The bonds are sold to yield 10%. Interest is payable annually on December 31. The entity paid bond
issue cost of P100,000. On December 31, 2020, the fair value of the bonds is determined to be P5,300000.
The entity elected the fair value option of measuring the bonds payable.
Journal entries for 2020
Jan. 1 Cash 5,379,100
Bonds payable 5,379,100

Jan. 1 Transaction cost 100,000

Cash 100,000
Dec. 31 Interest expense 600,000
Cash 600,000
Dec. 31 Interest expense 79,100
Discount on bonds payable 79,100
Amortization of discount for 2020
Bonds payable – January 1, 2020 5,379,100
Fair value – December 31, 2020 5,300,000
Decrease in fair value of bonds payable – gain 79,100
Change in fair value recognized in OCI
PFRS 9, paragraph 5.7.7, provides that the gain or loss on financial 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 an 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
changes in fair value of credit risk of a financial liability designated at fair value through profit or loss shall not
be subsequently transferred to profit or loss.
However, the cumulative game or loss recognized may be transferred within equity or retained earnings.
Illustration
On January 1, 2020, an entity issued bonds payable with face amount of P5,000,000 and 10% stated interest rate
for P4,800,000.
The bonds have a 5-year term and interest is payable annually every December 31.
The entity elected the fair value option in measuring the bonds payable.
On December 31, 2020, the fair value of the bonds is P5,500,000.
It is reliably determined that the fair value increase of P700,000 comprised P200,000 attributable to credit risk
and P500,000 attributable to change in the market interest rate.
Journal entries for 2020
Jan. 1 Cash 4,800,000
Bonds payable 4,800,000
Dec. 31 Interest expense 500,000
Cash (10% x 5,000,000) 500,000
Dec. 31 Loss on credit risk - OCI 200,000
Loss from change in fair value 500,000
Bonds payable 700,000
The loss on credit risk is presented as component of other comprehensive income
The loss from change in fair value is recognized in profit or loss.
Effective Interest Method
PFRS 9 requires that discount on bonds payable, premium on bonds payable and bond issue cost shall be
amortized using the effective interest method.
The effective interest method is also known as scientific method or simply “interest method”.
This method distinguishes two kinds of interest rate, namely the nominal rate and effective rate.
The nominal rate is the coupon or stated rate.
The effective rate is the yield or market rate.
The 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.
When bonds are sold at face amount, the effective rate and the nominal rate are the same.
But when the bonds are sold at a discount or premium, the two rates differ.
When bonds are sold at a premium, the effective rate is lower than the nominal rate.
When the bonds are sold at a discount, the effective rate is higher than then nominal rate.
Under effective interest method, the effective interest expense is determined by multiplying the effective rate by
the carrying amount of the bonds.
The carrying amount of the bonds changes every year as the amount of premium or discount is amortized
periodically.
The effective interest is then compared with the nominal interest. The difference is the premium or discount.
Thus, the premium amortization is computed as follows:
Nominal interest (nominal rate x face amount) xx
Less: Effective interest (effective rate x carrying amount) xx
Premium amortization xx
Thus, discount amortization is computed as follows:
Nominal interest (nominal rate x face amount) xx
Less: Effective interest (effective rate x carrying amount) xx
Discount amortization xx
Effective amortization of discount
On January 1, 2020, an entity issued two-year 8% bonds with face amount of P1,000,000 for 964,540, a price
which will yield a 10% effective interest cost per year. Interest is payable semiannually on June 30 and December
31.
Schedule of amortization

Interest Present
Date Payments Amortization
expense value
Jan. 1, 2020 964,540
Jun. 30, 2020 40,000 48,227 8,227 972,767
Dec. 31, 2020 40,000 48,638 8,638 981,405
Jun. 30, 2021 40,000 49,070 9,070 990,475
Dec. 31, 2021 40,000 49,525 9,525 1,000,000
Interest paid
Face amount times semiannual nominal rate of 4% or P40,000.
Interest expense
Carrying amount times semiannual effective rate. Thus, for the period January 1, to June 30, 2020, the interest
expense is P964,540 times 5% P48,227.
Discount amortization
Interest expense minus interest paid. Thus, for the period January 1 to June 30, 2020, the discount amortization
is P48,227 minus P40,000 or P8,227.
Carrying amount
Preceding carrying amount plus the discount amortization. Thus, on June 30, 2020, the carrying amount of
P964,540 plus P8,227 or P972,767.
The carrying amount is actually the amortized cost contemplated in the standard.
Journal entries for 2020
Jan. 1 Cash 964,540
Discount on bonds payable 35,460
Bonds payable 1,000,000
June 30 Interest expense 48,227
Cash 40,000
Discount on bonds payable 8,227
Note that the payment of the semiannual interest and periodic amortization of the
discount are compounded in one entry. The two items can be separately recorded.
Dec. 31 Interest expense 48,638
Cash 40,000
Discount on bonds payable 8,638
Effective amortization of premium
On January 1, 2020, an entity issued three-year 12% bonds with face amount of P1,000,000 for P1,049,74, a price
which will yield a 10% effective interest cost per year. The interest is payable annually every December 31.

Interest Present
Date Payments Amortization
expense value
Jan. 1, 2020 1,049,740
Dec. 31, 2020 120,000 104,974 15,026 1,034,714
Dec. 31, 2021 120,000 103,471 16,529 1,018,185
Dec. 31, 2021 120,000 101,815 18,185 1,000,000

Interest paid – face amount P1,000,000 times the annual nominal rate of 12% or P120,000
Interest expense – carrying amount times the annual effective rate. Thus, for 2020, the interest expense is
P1,049,740 times 10% or P104,974.
Premium amortization – interest paid minus interest expense. Thus, for 2020, the premium amortization is
P120,000 minus P104,974 or P15,026.
Carrying amount – Preceding carrying amount minus the premium amortization. Thus, on December 31, 2020,
the carrying amount is P1,049,740 minus P15,026 or P1,034,714.
Journal entries for 2020
Jan. 1 Cash 1,049,740
Premium on bonds payable 49,740
Bonds payable 1,000,000
Dec. 31 Interest expense 104,974
Premium on bonds payable 15,026
Discount on bonds payable 120,000
Note again that the payment of the semiannual interest and periodic amortization of the discount
are compounded in one entry. The two items can be separately recorded.
Market price or issue price of bonds payable
The market price or issue price of bond payable is equal to the present value of the principal bond liability plus
the present value of future interest payments using the effective or market rate of interest.
In other words, the market price of bonds payable is equal to the sum of the following:
a. Present value of bonds payable
b. Present value of the total interest payments.
The present value of the principal bond liability is equal to the face amount of the bond multiplied by the present
value of 1 factor at the effective rate for a number of interest periods.
The present value of the future interest payments is equal to the periodic nominal interest multiplied by the
present value of an ordinary annuity of 1 factor at the effective rate for a number of interest periods.
Illustration
Face amount of bonds 4,000,000
Nominal rate 6%
Effective rate 8%
The bonds are issued on January 1, 2020 and mature in four years on January 1, 2024. The interest is payable
annually every December 31.
Since the interest is payable annually, there are 4 interest period. The relevant present value factors are:
PV of 1 at 8% for 4 periods. 0.7350
PV of an ordinary annuity of 1 at 8% for 4 periods. 3.3121
Computation of present value of bonds
Present value of principal (4,000,000 x 0.7350) 2,940,000
Present value of annual interest payments (240,000 x 3.3121) 794,904
Total Present value 3,734,904
The annual interest payment of P240,000 is determined by multiplying the face amount of P4,000,000 by the
nominal rate of 6%.
Face amount 4,000,000
Market price or issue price 3,734,904
Total Present value 265,096
Table of amortization

Interest Present
Date Payments Amortization
expense value
Jan. 1, 2020 3,734,904
Dec. 31, 2020 240,000 298,792 58,792 3,793,696
Dec. 31, 2021 240,000 303,496 63,496 3,857,192
Dec. 31, 2022 240,000 308,575 68,575 3,925,767
Dec. 31, 2023 240,000 314,223 74,233 4,000,000

PV factor through ordinary calculator

The PV of 1 at 5% for 6 period and the PV of an ordinary of 1 at 5% for 6 periods can be determined through the
use of an ordinary calculator.
Kindly get your calculator and try the following steps:
1. Enter 1.05
2. Press the division sign (÷) twice.
3. Press the equal sign (=) for the number of interest periods required. Press once for one period, press twice
for two periods and so on. In this case, press 6 times because there are 6 interest periods.
4. The result is the PV of 1 at 5% for 6 periods or 0.7462
5. Deduct 1.00 from the result in No. 4. The result is 0.2538
6. Press the plus/minus sign (+/-) to remove the negative in No. 5.
7. Divide the result in No. 6 by .05.
8. The result is the PV of an ordinary annuity of 1 at 5% for 6 periods or 5.0757
Illustration – serial bonds
Face amount of bonds 3,000,000
Nominal rate 12%
Effective rate 14%
Date of issue January 1, 2020
Annual payment every December 31 1,000,000
Interest is payable annually December 31
Present value of 1 at 10%
One period 0.9091
Two periods 0.8264
Three periods 0.7513
Present value of the bonds payable

Date Principal Interest Total PV Present

payment payment payment factor value
12/31/2020 1,000,000 360,000 1,360,000 0.9091 1,236,376
12/31/2021 1,000,000 240,000 1,240,000 0.8264 1,024,796
12/31/2022 1,000,000 120,000 1,120,000 0.7513 841,456
Total present value 3,102,568
Face amount 3,000,000
Premium on bonds payable 102,568

Interest payment
December 31, 2020 (3,000,000 x 12%) 360,000
December 31, 2020 (2,000,000 x 12%) 240,000
December 31, 2020 (1,000,000 x 12%) 120,000
Table of amortization

Interest Interest Premium Principal Carrying

Date
paid expense amortization payment amount
1/1/2020 3,102,568
12/31/2020 360,000 310,257 49,743 1,000,000 2,052,825
12/31/2021 240,000 205,282 34,718 1,000,000 1,018,107
12/31/2022 120,000 101,893 18,107 1,000,000 0

Journal entries for 2020

1. Issuance of bonds:
Cash 3,102,568
Bonds payable 3,000,000
Premium on bonds payable 102,568
2. Payment of interest:
Interest expense 360,000
Cash 360,000
3. Amortization of premium:
Premium on bonds payable 49,743
Interest expense 49,743
4. Payment of principal
Bonds payable 1,000,000
Cash 1,000,000
Effective interest method – bond issue cost
PFRS 9 provides that “transaction costs” that are directly attributable to the issue of a financial liability shall be
included in the initial measurement of the financial liability.
Transaction costs are defined as fees and commissions paid to agents, advisers, brokers and dealers, levies by
regulatory agencies and securities exchange, and transfer taxes and duties. Clearly, transaction costs include bond
issue costs.
The calculation of effective interest rate shall include all transaction costs, premiums and discounts.
Thus, bond issue costs will increase discount on bonds payable and will decrease premium on bonds payable.
Under the effective interest method, bond issue cost must be ”lumped” with the discount on bonds payable and
“netted against the premium on bonds payable.
Illustration – discount and bond issue cost
On January 1, 2020, an entity issued three-year bonds with face amount of P10,000,000 and 9% stated rate.
The bonds mature on January 1, 2023 and interest is payable annually on December 31.
The bonds are issued at P9,751,210 with an effective yield of 10% before considering the bond issue cost.
The entity paid bond issue cost of P239,880.
Face amount 10,000,000
Discount on bonds payable ( 794,904)
Issue price 9,751,210
Bond issue cost ( 239,880)
Net proceeds 9,511,330

The effective rate is 10% but because of the bond issue cost, the effective rate must be higher than 10%.
Thus, the problem is to find an effective rate that will equate the present value of the cash outflows for the bonds
payable to the net proceeds or P9,511,330.
The cash outflows for the bonds payable include the principal of P10,000,000 and the annual interest payment of
P900,000 for 3 years.
The effective rate cannot be computed algebraically but by means of trial and error or the interpolation process.
The calculation of the effective rate requires the use of mathematical table of present value of a single payment
and present value of an ordinary annuity.
Again, the original effective rate is 10% but because of the bond issue cost the new effective rate must be higher
than 10%
By interpolation and using an effective rate of 11%, the present value of 1 for three periods is .07312.
The present value of an ordinary annuity of 1 for three periods at 11% is 2.4437.
The present value of the bonds payable using an interest rate of 11% is determined as:
PV of principal (10,000,000 x 0.7312) 7,312,000
PV of interest payments (900,000 x 2.4437) 2,199,330
Net proceeds 9,511,330

Coincidentally, the present value of the bonds payable of P9,511,330 is the same as the net proceeds of
P9,511,330.
In conclusion, the new effective rate is 11%
Journal entries
1. To record the issuance of the bonds:
Cash 9,511,330
Discount on bonds payable 488,670
Bonds payable 10,000,000
Under the effective interest method, the bonds issue cost is added to the discount on bonds payable.

2. To record the annual interest payment:

Interest expense (10,000,000 x 9%) 900,000
Cash 900,000

3. To record the amortization of the discount on bonds payable using the effective interest method:
Interest expense 146,246
Discount on bonds payable 146,246
Interest expense (9,511,330 x 11%) 1,046,246
Interest paid (10,000,000 x 9%) 900,000
Net proceeds 146,246
EXERCISES
PROBLEM 1
On June 1, 2020, Java Company issued 10% bonds with face amount of P6,000,000 to yield 12%.
Interest is payable annually on June 1 of each year. The bonds mature in 5 years. The entity follows calendar year.
PV of 1 at 10% for 5 periods 0.62
PV of 1 at 12% for 5 periods 0.57
PV of an ordinary annuity of 1 at 10% for 5 periods 3.79
PV of an ordinary annuity of 1 at 12% for 5 periods 3.60
Required:
1. Determine the market price of issue price of the bonds.
2. Prepare an effective interest amortization table.
3. Prepare the journal entries.

PROBLEM 2
On January 1, 2020, ward company issued 9% bonds with face amount of P4,000,000, which mature on January
1, 2030. The bonds were issued for P3,756,000 to yield 10%, resulting in bond discount of P244,000.
The entity used the interest method of amortizing bond discount. Interest is payable annually on December 31.
1. On December 31, 2021, what is the balance o the discount on bonds?
2. What is the carrying amount of bonds payable on December 31, 2021?
3. Prepare an effective interest amortization table.
PROBLEM 3
On January 1, 2020, Wolf company issued 10% bonds in the face amount of P5,000,000, which mature on January
1, 2030. The bonds were issued for P5,675,000 to yield 8%, resulting in bond premium of P675,000.
The entity used the interest method of amortizing bond premium. Interest is payable annually on December 31.
1. On December 31, 2020, what is the balance of the premium on bonds payable?
2. What is the carrying amount of bonds payable on December 31. 2020?
3. Prepare an effective interest amortization table.
Reference

Millan, Z. V. B. (2019). Notes payable. In Intermediate Accounting (2019th ed., Vol. 2, pp. 54–98). Bandolin

Enterprise.

Millan, Z. V. B. (2019). Bonds payable & Other concepts. In Intermediate Accounting (2019th ed., Vol. 2, pp.

99–164). Bandolin Enterprises.

Valix, C. T., Peralta, J. F., & Valix, C. A. M. (2020). Bonds payable. In Intermediate Accounting (2020th ed.,

Vol. 2, pp. 148–204). GIC ENTERPRISES & CO., INC.

Valix, C. T., Peralta, J. F., & Valix, C. A. M. (2020). Effective Interest method: Market Price of bonds. In

Intermediate Accounting 2 (2020th ed., Vol. 2, pp. 205–275). GIC ENTERPRISES & CO., INC.