BONDS PAYABLE

I. Bonds Payable are issued by the government and publicly listed corporations. Bonds payable
can be characterized as follows:

 Undertaking a debt to the public.

 These borrowings are for exceptionally large amounts.
 Long-term maturity period.

II. Issuance of Bonds Payable

 The issue price is computed as a percentage of the face value (ex. an issue price at 109 is
109% of face value). The issue price of bonds payable depends factors like the market rate
of interest, credit rating of the borrower and term of the bonds issued.

 If bonds are issued in between interest date the accrued interest from the last interest
date increases the amount received from the investor. However, the interest received is
credited to interest payable and not included in the carrying amount of the bonds payable.
Accrued interest is not part of the issue price. Alternatively, interest expense may also be
credited for accrued interest received for bonds issued in between interest dates similar to
a “reversing entry”.

 Direct cost to issue the bond is included in the carrying amount of the bonds as a deduction
if the “amortized cost” method is used. This “bond issue cost” will be an addition to the
discount as a contra account or deducted from the premium from issuance.

 Under the Fair Value Method, Direct Cost is an expense. Under the fair value method,
the bonds shall be measured at fair value and the changes in fair value recognized in profit
or loss. Any premium or discount on the issuance shall not be amortized.

III. Subsequent carrying amount of Bonds Payable

a. The net premium or total discount is amortized using the effective interest method under
amortized cost method. The following relevant formulas apply for amortization:

 Interest expense / Effective Interest = CA x Effective rate

 Interest paid or payable / Nominal Interest = Face value x Nominal rate

 Effective interest less nominal interest equals amortization.

 Amortization of the discount increases the CA while amortization of the premium decreases
the CA.

 The amount of amortization always increases whether the bonds are issued at a discount
or at a premium

 Interest expense increases if there is a discount and decreases if the bonds were issued at
a premium.

b. Under FV option, the difference in the FV and previous CA is recognized in profit or loss unless
the change is a result of credit risk.

 Gains and losses arising from credit risk are included in Other Comprehensive Income.

 Amortization of the premium or discount is not applied under the fair value method.

 Only the nominal interest or interest paid/payable is recognized as interest expense

 IV. Bonds as Compound Financial Instruments

 Bonds that are issued with ordinary share warrants regardless whether detachable or non-
detachable and bonds that can be converted into ordinary shares are identified as
compound financial instruments. This means that the bonds issued have the characteristics
of both financial liabilities and equity instruments.

 Ordinary share warrants give the holder the right to acquire ordinary shares at a specific
exercise price, meanwhile convertible bonds can be exchanged into ordinary shares.

 The issue price from compound financial instruments is required to be allocated between
the liability and equity components and each component shall be presented separately in
the statement of financial position.

 The issue price for compound financial instruments shall be allocated to the bonds payable
based on the fair value of the bonds ex-warrants (without the warrants) or the fair value of
the bonds without the conversion option.

 The difference of the issue price after deducting the fair value of the bonds shall be the
equity component and recorded as share premium in shareholders’ equity.

 If the fair value of the bonds ex-warrants or fair value without the conversion option is not
determinable, the fair value can be alternatively computed by discounting the future cash
flows of interest and face value using the effective rate without the warrant and conversion
option.

V. Exercise of Warrant or Conversion of Bonds

 When warrants are exercised, the total amount credited to equity will be the exercise price
for the shares issued plus the equity component cancelled or debited representing the
warrants that are exercised. Share capital shall be credited for the par value of the shares
issued and the excess will be credited to share premium from issuance.

 If convertible bonds are exchanged for ordinary shares, the carrying amount should be
adjusted until the date of conversion, which will require the amortization of the premium or
discount until the date of the conversion. The adjusted carrying amount plus the equity
component from the issuance of the convertible bonds minus the par value of the shares
issued shall be the share premium from issuance.

VI. Retirement of Bonds Payable

 Similarly, any retirement of bonds payable before the maturity date shall require the
adjustment of the carrying amount of the bonds at the date of retirement.

 The difference between the redemption or retirement price and the adjusted carrying
amount of the bonds payable is recognized in profit or loss as a component of income from
continuing operation.

PROBLEMS:

1. On March 1, 2023, Vitaly Company issued 5,000 of its P1,000 face value bonds at 110 plus accrued
interest. Vitaly Company paid bond issue cost of P100,000. The bonds were dated November 1,
2022, mature on November 1, 2030, and bear interest at 12% payable semiannually on November
1 and May 1. What is the net amount received by Vitaly from the bond issuance?
a. 5,500,000
b. 5,700,000
c. 5,600,000
d. 6,000,000
2. On January 1, 2023, Trump Company issued 10,000 of its 12%, P1,000 face value bonds for
P10,600,000, including accrued interest. The bonds are dated October 1, 2022, mature on October
1, 2028, and pay interest annually on October 1. The bonds were issued through an underwriter to
whom Trump paid bond issue cost of P150,000. On January 1, 2023, what should Trump Company
report as bonds payable?
a. 10,000,000
b. 10,450,000
c. 10,150,000
d. 10,300,000

3. On January 1, 2023, Clinton Company issued eight-year bonds with a face value of P500,000 and
a stated interest rate of 6%, payable semiannually on June 30 and December 31. The bonds were
sold to yield 8%. Table values are:

Present value of 1 for 8 periods at 6% ................................ .627

Present value of 1 for 8 periods at 8% ................................ .540
Present value of 1 for 16 periods at 3% .............................. .623
Present value of 1 for 16 periods at 4% .............................. .534
Present value of annuity for 8 periods at 6% ....................... 6.210
Present value of annuity for 8 periods at 8% ....................... 5.747
Present value of annuity for 16 periods at 3% ..................... 12.561
Present value of annuity for 16 periods at 4% ..................... 11.652

i. What is the present value of the principal?

a. 267,000 c. 311,500
b. 270,000 d. 313,500

ii. What is the present value of the interest?

a. 172,410 c. 186,300
b. 174,780 d. 188,415

iii. What is the issue price of the bonds?

a. 441,780 c. 444,780
b. 442,410 d. 499,800

4. On December 31, 2023, Miriam Company issued serial bonds with face value of P4,000,000 and
a stated 10% interest rate, payable annually every December 31. The bonds are issued on this
date with a 12% effective yield. The bonds mature at an annual installment of P1,000,000 every
December 31, starting December 31, 2023. The rounded present value of 1 at 12% for:

One period 0.89

Two periods 0.80
Three periods 0.71
Four periods 0.64

What is the carrying amount of the serial bonds on December 31, 2023?
a. 2,903,000
b. 3,842,000
c. 2,829,000
d. 3,903,000

5. On January 1, 2023, Lucian Company issued 9% bonds in the amount of P5,000,000 which mature
on December 31, 2030. The bonds were issued for P4,800,000 but Lucian had to pay for a
P107,000 bond issuance cost. The effective rate determined by Lucian is 10%. Interest is payable
annually on December 31. Lucian uses the interest method of amortizing bond discount. In its
December 31, 2023, statement of financial position, what amount should Lucian report as bonds
payable?
a. 5,000,000 c. 4,712,300
b. 4,693,000 d. 4,723,700
6. On January 1, 2023, Christian Company issued its 5-year, 5,000, 8% bonds that will mature on
December 31, 2025, and pay interest annually at 110. Christian however had to incur P80,000 of
bond issue cost. The effective rate on the same date was 6%. If Christian uses the effective interest
method of amortization, what is the carrying amount of this bonds payable on December 31, 2023?
a. 5,345,200 c. 5,420,000
b. 5,300,000 d. 5,375,600

7. On December 31, 2023, Michelle Company issued 5,000 of its 12%, 10-year P1,000 face value
bonds with detachable stock warrants at 110. Each bond carried a detachable warrant for ten
shares of Michelle's P100 par value ordinary shares at a specified option price of P120.
Immediately after issuance, the market value of the bonds ex-warrants was P4,800,000 and the
market value of the warrants were ascertained to be P1,200,000. For the issuance of the bonds,
what amount should be the increase in shareholders’ equity?
a. 600,000 c. 700,000
b. 1,100,000 d. 1,200,000

8. On December 31, 2023, Armor Company issued P5,000,000 face value, 5-year bonds at 109. Each
P1,000 bond was issued with 10 non-detachable stock warrants, each of which entitled the
bondholder to purchase one share of P100 par value common at P120. Immediately after the
issuance, the market value of each warrant was P5. The stated interest rate on the bonds is 11%
payable annually every December 31. However, the prevailing market rate of interest for similar
bonds without the warrants is 12%. The present value of 1 at 12% for 5 periods is 0.57 and the
present value of an ordinary annuity of 1 at 12% for 5 periods is 3.60. On December 31, 2023,
what amount should Armor record as increase in stockholders’ equity as a result of the bond
issuance?
a. 620,000 c. 440,000
b. 250,000 d. 0

9. Hoover Company issued 4,000 convertible bonds on January 1, 2023. The bonds have a four-year
term and are issued at 110 with a face value of P1,000 per bond. Interest is payable annually in
arrears at a nominal 6% interest rate. Each bond is convertible at any time up to maturity into 100
ordinary shares with par value of P5. When the bonds are issued, the prevailing market interest
rate for similar debt instrument without conversion option is 8%. What is the equity component of
the issuance of convertible bonds on January 1, 2023? (Round off present value factors to two
decimal places).
a. 245,600
b. 312,800
c. 645,600
d. 0

10. On July 1, 2023, after recording interest and amortization for half a year, Kennedy Company
converted P5,000,000 of its 12% convertible bonds into 60,000 shares of P50 par value ordinary
shares. On the conversion date the carrying amount of the bonds was P6,000,000, the market
value of the bonds was P6,500,000, and Kennedy’s ordinary shares was publicly trading at P150
per share. Kennedy paid P300,000 in connection with the conversion and other share issue costs.
The equity component on issue date of the bonds was P800,000. What is the share premium from
issuance should Kennedy record because of the conversion?
a. 3,000,000
b. 2,000,000
c. 2,700,000
d. 3,500,000