LAGUNA STATE POLYTECHNIC UNIVERISTY SINILOAN CAMPUS Auditing and Assurance: Specialized Industry May, 2021 Handout 08: Bonds Payable Instructor: John Bo S. Cayetano LEARNING OBJECTIVES: Classification of Bonds payable Initial measurement of the Bonds payable Total net cash receipt from issuance of Bonds payable ‘Subsequent measurement of Bonds payable Interest Expense Interest Payable Gaiin or loss from extinguishment of Bonds payable Straight-line amortization REVIEW NOTES: BONDS PAYABLE A contract of debt between two parties, the debtor (borrower) and investor (lender). Generally, bonds payable is a long-term lability and incur periodic interest. Bondspayable = Notespayable = Loans payable Buyer of goods or Company who are in Borrower of funds from Usually issued by need of funds. covet I another a bank, eneralinvering Usualyissuedto | pubteany company | Seleretgoodsor | Banks ox facia wih excess und The creditor can sell or ‘The creditor can The bank usually does Transferability. trade its investment in discount the notes to Not transfer its loans bonds the bank receivable Way beret ornare iret Awayabear rest | MAYBE METS! 9°FOO Tatas nearest CLASSIFICATION OF BONDS 1. Asto principal: a. Term bonds — Principal is payable on a lump-sum (one-time) basis on maturity date. b. Serial bonds ~ Principal is payable on an instalment (series) basis and mature on multiple dates. 2. As to security or collateral: ‘a, Mortgage bonds — The bonds is secured by a real property. b. Collateral bonds — The bonds is secured by an investment (e.g., shares). ©. Chattel mortgage bonds ~ The bonds is secured by a personal property. dd. Debenture — Unsecured bonds (ie., no collateral) 3. As to holder of bond: ‘a. Registered bonds — The new holder of the bonds is required to register in the books of issuing entity and Notify the issuing company upon acquisition of the bonds. b. Bearer bonds — The new holder is not required to register in the books of the issuing entity, any interest will be coursed through the underwriter. 4. Other classification of bonds: ‘a. Convertible bonds ~ Bonds in which the holder possess the right to convert the its bonds receivable into ownership or shares of the issuing entity at its option. . Callable bonds — Bonds are bonds in which the issuing entity can retire the bonds in advance (even before maturity date. Guaranteed bonds - Bonds in which the holder can collect to a guarantor in case of default of the issuing entity Page 1 of 1. Junk bonds ~ Bonds issued by a low credit rating entity but possess a high stated interest (high risk, high retum bonds). INITIAL MEASUREMENT Financial liabilities including bonds payable are measured at fair value less transaction cost. Fair value of the bonds is equal to the issue price (selling price), While transaction cost are payment for services related to issuance of bonds, such as: + Commission fee + Accounting fee ~ Underwriter's fee ~ Legal fee + Agent foo + Documentary stamp tax Computation: Issue price Po Xx Less: Transaction cost x) Initial measurement ~ Carrying amount at issue date Px Present Value of Bonds Payable {Incase the fair value of the bonds is unknow, it can be computed by computing he present value of cash payments. ‘rom the bonds payable. The present value of future cash payment which includes the principal and the nominal interest is equal to the fair value of the bonds. ‘Nominal interest Is the interest stated in the contract in which will be paid periodically by the issuing entity (debtor) to the bond holder (creditor). The payment could be annual, semi-annual, quarterly or monthly. Principal amount Po Xx Times: Nominal rate (NR) a.k.a. stated, coupon rate —_X% Nominal interest Px Present Value Factor (PVF) a. Present value of 1 — are used to present value one time payment (e.g., principal of term bonds). b. Present value of annuity ~ are used to present value a series equal payment (e.g, principal of serial bonds ‘and nominal interest of term bonds). = Ordinary annuity —is used ifthe first payment is made after one period. = Annuity due —is used ifthe first payment is made in advance (on day 1) Present Value of Term Bonds: PV of Principal (Principal x PVF of 1) Po Xx ‘Add: PV of Nominal Int, (Principal x NR x PVF of annuity) Xx PV of Bonds (Equal to Fair value px Present Value of Serial Bonds: PV of Principal (Principal per installment x PVF of annuity) Po Xx ‘Add: PV of Nominal Int, (Remaining Principal x NR x PVF of 1 for one period) x ‘Add: PV of Nominal Int, (Remaining Principal x NR x PVF of 1 for two period) xx ‘Add: PV of Nominal Int, (Remaining Principal x NR'x PVF of 1 for three period) xx ‘Add: And so on. Xx PV ol Bonds (Equal to Fair value Px Premium on honds (Selling Price > Face Amaun!) is a gain from sale of bonds. The gain is not recorded immediately but instead stretch out over the term of the bonds. It is recorded as a deduction to interest expense. Premium is an adjunct account and should be added to “Bonds Payable” account to get the carrying amount. Initial measurement of bonds Po Xx Page 2 of 11Less: Principal amount Premium — at issuance date‘Discount on bonds (Selling Price < Face Amount) {Is a loss from sale of bonds. The loss is not recorded immediately but instead stretch out over the term of the bonds. It is recorded as an addition to interest expense. Premium is an adjunct account and should be added to “Bonds Payable” account to get the carrying amount. Initial measurement of bonds, Po Xx Less: Principal amount (x) Discount ~ at issuance date (2109 TOTAL NET CASH RECEIPT FROM ISSUANCE OF BONDS The following are the cash that the company will received upon issuance of the bonds: Fair value of the bonds Po Xx ‘Add: Accrued interest (interest receivable sold) xX Total issue price P XX Less: Transaction cost Xx) Total net cash receipt from issuance of bonds Po xx Bonds issued in between interast date: I the bonds were issued in between interest dates, two financial instrument are being sold, the bonds and the accrued interest. If that is the case, the accrued interest should be deducted to the total issue price to arrive at the issue price for the bonds alone which represent its fair value. Computation of the accrued interest is: Principal amount of the bonds P xXx Times: Nominal interest rate x% Times: Number of mos. from issuance date to the last interest payment date over 12. _X/12. Accrued interest (interest receivable sold) ex SUBSEQUENT MEASUREMENT Bonds payable are generally measured at amortized cost. The amortized cost can be computed adding the ‘amortization of the discount or deducting the amortization of the premium fromthe carrying amount. Amortization of discount or premium is equal to the difference of effective interest and nominal interest. Computation of the subsequent measurement or the carrying amount at year-end: 1. Compute the effective interest (interest income): Carrying amount at the beginning of the period Po Xx Times: Erfective interest rate X2% Effective interest Px 2. Compute the nominal interest (interest paid/payable): Principal amount Po XxX Times: Nominal interest rate XX Nominal interest P___xx 3. Compute the amortization: Effective interest Po Xx Less: Nominal interest Lx Amortization B__xx 4. Compute the canying amount at year-end Carrying amount at the beginning Po Xx ‘Add: Amortization of discount xx Less: Amortization of premium x, Carrying amount at the ending Px Page 4 of 11Alternative amortization method = term bonds: Carrying amount at the beginning Pox Times: 1 + Effective interest rate XX Less: Nominal interest (paid or unpaid) Lx Carrying amount at the ending Po Xx Alternative amortization method = serial hands: Carrying amount at the beginning Po Xx Times: 1 + Effective interest rate xx Less: Nominal interest (paid or unpaid) Cm Less: Principal payment (for serial bonds) LX Carrying amount at the ending Px INTEREST EXPENSE Interest expense is equal tothe effective interest. It can be computed using the following formulas: Carrying amount at the beginning of the period Pox Times: Effective interest rate —& Effective interest Bx Altemative: Nominal interest Po Xx ‘Add: Amortization of discount (Increase in C.A.) Xx Less: Amortization of premium (Decrease in C.A.) (x, Effective interest Bx INTEREST PAYABLE Interest payable is equal to the unpaid portion of the nominal interest. It can be computed by: Principal amount Po x Times: Nominal interest rate X% Times: Months unpaid (from Dec. 31 back to the last interest date) /12 x2. Nominal interest Px RETIREMENT OF BONDS On Maturity Date Payment of bonds maybe on maturity date or earlier than maturity date in the case of callable bonds. If the Payment is made on maturity date, the company will have to pay the maturity value (MV), that is the principal amount. At maturity date the premium and discount is fully amortized, thus, the carrying amount of the bonds is equal to the principal amount. Since the payment is equal to the carrying amount, no gain or loss is recorded. Before Maturity Date (Advance Retirement) Ifthe payment is made on in advance, the company will have to pay the fair value (FV) of the bonds at the date of payment. At the retirement date the premium and discount is not fully amortized, thus, the carying amount (CA) of the bonds is not equal to the principal amount. Since the payment (a.k.a. retirement price) is equal to FV and the CA is equal to amortized cost. The difference is recorded as gain or loss on retirement. Page 5 of 11Computation of the gain or loss on retirement: 1. Allocate the retirement price — Ifthe retirement price includes the retirement price ofthe interest payable. The payment for the interest payable should be remove from the total retirement price and the residual is the retirement price of the bonds that will be used to compute for the gain or loss on retirement: Total retirement price (bonds and interest payable) Po Ox Less: Interest payable (1 Retirement price of the bonds P__xx Principal of the bonds retired P XX Times: Nominal interest rate X% Times: Months unpaid (Retirement date back to the last interest date) /12 2. Interest payable Px! 2. Compute the carying amount on the date of retirement ~ From the initial measurement, amortize until you arrive at the carrying amount on the date of retirement. Initial measurement Po Xx Times: 1 + Effective interest rate X%, Less: Nominal interest Continue until retirement date, e) Times: Portion of the bonds retired (for partial retirement), —— Carrying amount on retirement date Px 3. Compute the gain or loss on retirement ~ If the price paid is higher than the bonds extinguished, there is a loss on retirement. Ifthe price paid is lower than the bonds extinguished, there is gain on retirement. Carrying amount of the bonds payable Po xxe Less: Retirement price of the bonds: (01 Gain (loss) on retirement px STRAIGHT-LINE METHOD OF AMORTIZATION Under this method, the amortization of premium and discount are equal every period. 1. Compute the total premium or discount on issuance date: Initial measurement of bonds Po Xx Less: Principal amount (__x&) Total premium (discount) Px 2. Compute the annual amortization: Total premium (discount) Poo Divide: Term (life) of the bonds xx ‘Annual amortization xX 3. Interest expense: Nominal interest (Principal x NR) Po XxX ‘Add; Amortization of discount Xx? Less: Amortization of premium {xe Annual amortization Px 4. Carrying amount at year-end Initial measurement of the bonds Po XX ‘Add: Amortization of discount Xx! Less: Amortization of premium x2 Carrying amount — ending Px Page 6 of 11DISCUSSION: 1. IT Corporation December 31, 2019 balance sheet contained the following items in the long-term liabilities section: 9.25% registered debentures, callable in 11 years, due in 16 years 700,000 9.25% collateral trust bonds, convertible into common stock beginning in 2028, due in 19 years 600,000 10% subordinated debentures (P30,000 maturing annually beginning in 2020) 300,000, What is the total amount of IT's term bonds? ‘A. 600,000 c. 700,000 B. 1,000,000 D. 1,300,000 2. IT Corporation December 31, 2018 balance sheet contained the following items in the long-term liabilities section: 10% registered bonds, callable in 2019, due in 2028, secured by machinery 3,000,000 119% bonds, convertible into common stock beginning in 2018, due in 2025, secured by realty 5,000,000 12% collateral rust bonds (50,000 maturing annually) 7,000,000, What are the total amounts of IT’s secured bonds? ‘A. 15,000,000 C. 12,000,000 B. 10,000,000 D. 8,000,000 3. Ava Company issued 10-year bondspayable with face amount of P,000,0000n January 1,2023. The interest is payable annually on December 31 at the 6% stated interest rate. The bonds were issued to yield 9%, The present value of 1 at 6% for 10 periods is 0.56 The present value of an ordinary annuity of 1 at 6% for 10 periods Is 7.26. The present value of 1 at 9% for 10 periods is 0.42 The present value of an ordinary annuity of 1 at 9% for 10 periods is 6.42. What is the market price of the bonds on January 1, 2023? ‘A. 1,680,000 c. 3,220,800 B. 3,991,200 D. 4,000,000 4, Downing Company issues 5,000,000, 6%, 5-year bonds dated January 1, 2022 on January 1, 2022. The bonds pay interest semiannually on June 30 and December 31. The bonds are issued to yield 5%, Present value of 1 PVofannuityof _—Presentvalueof PV of annuity of, Periods 25% 1at25% Lats% Lats% 5 0.884 4.646 0.784 4.330 10 0.781 8.752 o614 7.722 What are the proceeds from the bond issue? A, 6.531.618 C. 5,217,800 B. 5,216,494 D. 5,218,050 5, Kim Chui Company issued bonds with face amount of Pé,000,000 on January 1, 2021, The nominal rate of 6% is payable annually on December 31. The bonds are issued with an 8% effective yield ‘The bonds mature on every December 31 each year at the rate of P2,000,000 for the three years, Present value of 1 at 896 One period 0.9259 Two periods 0.8573 ‘Three periods o7ess Determine the market price or issue price of the bonds: A. 8,788,532 ©. 4,762,800 B. 5,690,555, D. 5,960,555, Page 7 of 1110. 1" 12, 13, ‘On May 1, 2019, Raiders Company issued P2,000,000, 10 years, 9% bonds at 108 including accrued interest. These bonds are dated January 1, 2019. Interest is payable semi-annually on January 1 and July 1. Transaction costs of P10,000 were paid by Raiders. What is the carrying amount of bonds payable on May 1, 2019? ‘A. 2,090,000 ©. 2,030,000 B. 2,150,000 D. 2,160,000 ‘On March 1, 2019, Madine Corporation issued at 103 plus accrued interest, 1,000 of its 15%, 1,000, bonds. The bonds are dated January 1, 2019 and mature on January 1, 2024. Interest is payable semi- annually on January 1 and July 1. Madine paid transaction costs of P60,000. Based on the given information, how much would Madine realize as net cash receipts from the bond issuance? A. 995,000 C. 1,055,000 B. 1,030,000 D. 1,095,000 On January 1, 2016, Quilladin Company issued 5-year bonds with face value of P5,000,000 at 110. ‘The company paid bond issued cost of P80,000 on same date. The stated interest rate on the bonds is 8% payable annually every December 31. After consideration of bond issue costs to be initially measured, the bonds were determined to yield 6% per annum, ‘On December 31, 2016, what should Quilladin report as carrying amount of the bonds payable? ‘A. 5,430,800 C. 5,414,800 B. 5,345,200 D. 5,000,000 ‘On January 1, 2021, Classroom Company issued 10% bonds in the face amount of P5,000,000 that mature on Januaty 1, 2026. The bonds were issued for P4,580,000 to yield 12%, resulting in bond discount of P420,000. Classroom Company used the interest method. Interest is payable ‘semiannually on January 1, and July 1 What is the carrying amount of the bonds payable on December $1, 2021? ‘A. 4,580,000 C. 4,631,088 B. 4,604,800 D. 5,000,000 (On January 1, 2017, Bontoc Company issued 5,000,000, 8% serial bonds to be repaid in the amount ‘of P1,000,000 each year. Interest is payable annually on December 31. The bonds were issued to yield 10% a year. The bond proceeds were P4,757,000 based on the present value at January 1, 2017 of five annual payments. The entity amortized the bond discount by the interest method, ‘On December 31, 2017, what is the carrying amount of the bonds payable? A. 3,832,700 C. 4,805,600 B. 4,832,700 D. 3,805,600 ‘On January 1, 2019, Rossana Company issued 10-year bonds with face value of P5,000,000 for 5,775,000. The entity paid bond issue cost of P100,000 on same date. The stated interest rate on the bonds is 10% payable annually every December 31. The bonds have an 8% yield per annum after considering the bond issue cost. The entity used the effective interest method of amortizing bond premium. What is the interest expense for 20197 ‘A. 454,000 C. 400,000 B. 500,000 D. 867,500 ‘On January 1, 2021, Mom Company received P 1,032,880 for P1,000,000 face amount, 12% bonds, a price that yields 10% interest is payable semi-annually every June 30 and December 31. Interest ‘expense for the year ended December 31, 2021 is A. 123,946 C. 103,288 B. 124,155 D. 102,870 Page 8 of 114. On December 31, 2019, the liability section of Phillies Company's statement of financial position included bonds payable of P10 million and unamortized premium on bonds payable of P180,000. Further verification revealed that these bonds were issued on December 31, 2017 and will become due on December 31, 2027. Interest at 12% is payable every June 30 and December 31. On April 1, 2020, Phillies retired P4,000,000 of these bonds at 97 plus accrued interest. How much was the total amount of cash paid for the retirement of bonds on April 1, 20207 ‘A. 3,950,000 ©. 4,040,000 B. 4,000,000 D. 4,180,000 415. The 12% bonds payable of Nyman Company had a carrying amount of P832,000 on December 31, 2021. The bonds, which had a face value of P800,000, were issued at a premium to yield 109. Nyman uses the effective-interest method of amortization, Interest is paid on June 30 and December 31. On June 30, 2022, several years before their maturity, Nyman retired the bonds at 104 plus accrued interest. The loss on retirement is: ‘A. 32,000 c. 9,920 B. 6,400 D. o 16. On December 31, 2018, Affenpinscher Corporation issued 20-year, noncovertible bonds of 5,000,000 for P5,851,160 to yield 10%. Interest is payable annually on December 31 at 12%. On June 1, 2021, Affenpinscher retires 3,000 of its own P1,000 bonds, Total cash paid by Affenpinscher Js P3,120,000. The accounting period of Affenpinscher is the calendar year. What is the amount of gain or loss on early retirement of bond that will be reported in 2021 income statement? A. 617,440 ©. 514,740 B. 517,440 D. 367,440 17. On January 1, 2022, Marimar Company issued 10,000 of its 12%, P1,000 face value 5-year bonds at 105. Interest on the bonds is payable annually every December 31. In connection with the sale of these bonds, Marimar paid the following expenses: Promotion costs 100,000, Engraving and printing 400,000 Underwriter’s commissions 500,000 Using the straight-line method, what amount should Marimar report as bond interest expense for the year 20227 A. 1,100,000 ©. 1,200,000 B. 1,300,000 D. 1,600,000 18. Sanji, Inc. issued P100,000 of its 8%, five-year bonds on January 1, 2015, at 98. Interest is paid on January 1 and July 1. The bonds are callable at 103 and straight-line amortization is used, The bonds are recallable on April 1, 2017. ‘The journal entry to record the reacquisition of the bonds will include a: Debit Bonds payable P100,000 Credit Gain on retirement 5,000 Credit Discount on bonds payable P1,100 Debit Loss on retirement P4,200 poe> Page 9 of 11§3 SCRIBD ( Search Q MODULE 08: 1) The following information pertains to Braves Company issuance of bonds on July 1, 2016. Face amount = P'10,000,000; Term — 10 years; Stated interest rate ~8%; interest payment dates — July 1 and January 1; Effective yield — 12%, At 4% AL 6% Present value of an ordinary annuity of P1 for 10 periods att 7.38 Present value of an ordinary annuity of P1 for 20 periods: 13.59 11.47 Present value of P1 for 10 periods 0.68 0.56 Present value of Pt for 20 periods 0.46 ost AL 8% AL 12% Present value of an ordinary annuity of P1 for 10 periods 671 6.14 Present value of an ordinary annuity of P1 for 20 periods 9.82 851 Present value of P1 for 10 periods 0.46 0.56 Present value of P1 for 20 periods 0.2 ost ‘What should be the total issue price of the bonds? ‘A. 659,600 B. 768,800 c. 1,229,400 D. 1,340,400 2) ‘At the beginning of current year, Glocie issued ten-year bonds with a face amount of P5,000,000 and stated interest rate of 8% payable annually at every year-end. The bonds were price to yield 10% PV of 1 for 10 periods at 10% 0.9855 PV of an ordinary annuity of 1 for 10 periods at 10% 6.1450 ‘What is the issue price of the bonds? ‘A. 5,000,000 B. 1,927,500 ©. 5,614,500 D. 4,385,500 3) On March 1, 2022, Erik Company issued 10,000 of its P1,000 face value bonds at 95 plus accrued interest. Erik Company paid bond issue cost of P1,000,000. The bonds were dated November 1 2021, mature on November 1, 2031, and bear interest at 12% payable semiannually on November 1 and May 1 ‘The net amount that Erik receive from the bond issuance is ‘A. 8,900,000 B. 9,000,000 c.8,500,000 D. 8,500,000 4) On January 1, 2020, AAA Co. issued 10%, P12,000,000 bonds at 105. Transaction costs incurred amounted to P177,086. Principal on the bonds mature in three equal annual installments. Interest payments are also made annually at each year-end, How much is the carrying amount of the bonds on December $1, 20207 A 8,844,635 B. 8,793,368 ©. 8,312,841 D. 8,216,735 5) On January 1, 2018, Cardinals Company issued its 9% P2 milion bonds, which mature on January 1, 2026. The bonds wore issued for P1,878,000 to yield 10% resulting in a bond discount of 122,000. Interest is payable annually on December 31 What is the carrying amount of the bonds at December 31, 2016? ‘A. 1,885,800 B. 1,896,000 C. 1,898,780 D. 1,898,000 6) On January 1, 2019, Pikipek Company issued 1,000 P4,000, 10% 8 year bonds for P3,807,852. Principal is due on December 31, 2021 but interests are due annually every year-end. The effective interest rate is 12%, Pekipek Co. incorrectly used the straight line method instead of the effective interest method to ‘amortize the discount. ‘What is the effect of the error on the carrying amount of the bonds on December 31, 20197 A. 7,107 over B. 7,107 under C. 6,341 over D. 6,341 under 7) On January 1, 2018, Kimber Company issued 9% bonds in face amount of P8,000,000, which mature ‘on January 1, 2028. The bonds were issued for P7,512,000 to yield 10%, The entity used the interest method of amortizing bond discount. Interest is payable annually on December 31 ‘On December 31, 2018, what is the carrying amount of bonds payable? A 7,543,000 B. 7,584,000 c. 7,587,120 D. 7,892,000 Page 10 of8) On December 31, 2017, Dome Company issued P4,000,000, 8% serial bonds, to be repaid in the amount ‘of PB00,000 each year. Interest is payable annually on December 31. The bonds were issued to yield 10% a year. The bond proceeds totaled P3,805,600 based on the present value on December 31, 2017 of five annual payments. ‘Due date Principal Joterest Present value on 12/31/17, 12/31/18 ‘800,000 320,000 1,018,000 42/81/19 800,000 256,000 872,200 12/31/20 800,000 192,000 745,000 12/31/21 800,000 128,000 633,800 12/31/22 800,000 64,000 536,600. 3,805,600 ‘What is the carrying amount of the bonds payable on December 31, 2018 using the interest method of amortizing the bond discount? A. 3,066,160 B. 3,866,160 C. 3,386,160 D. 2,854,775 9) Prescott Corporation issued ten thousand P1,000 bonds on January 1, 2018. They have a ten-year term and pay interest semiannually. This is the partial bond amortization schedule for the bonds. Payment Cash Effective interest Decrease in balance 11,487,747 1 400,000 344,632 55,368 11,432,379 2 400,000 342,971 57,029 11,975,350 3 400,000 341,261 58,739 11,316,611 4 400,000 ‘What is the effective annual rate of interest on the bonds? A 3% B. 4% C. 6% D. 8% 10) On December 31, 2015, Ariana Grande Corporation issued 20-year, nonconvertible bonds of P5,000,000 {for P5,851,160 to yield 10%. Interest is payable annually on December 31 at 12%. On April 1, 2017, Ariana Grande retires 2,000 of its own P1,000 bonds at 102 plus accrued interest. The accounting period of Ariana Grande Corporation is the calendar year. What is the amount of gain or loss on early retirement of bond that will be reported in 2017 income statement? A. 292,873 gain B. 292,873 loss C. 232,878 loss D. 282,873 gain Page 11 of 11