Illustrative Examples - Bonds Payable 4y3e4o
This document was ed by and they confirmed that they have the permission to share it. If you are author or own the copyright of this book, please report to us by using this report form. Report 3i3n4
Overview 26281t
& View Illustrative Examples - Bonds Payable as PDF for free.
More details 6y5l6z
- Words: 8,441
- Pages: 26
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE ILLUSTRATION: BONDS ISSUED AT FACE AMOUNT - NO TRANSACTION COSTS On January 1, 20x1, ABC Co., issued 1,000, P1,000, 12%, 3-year bonds at face amount. Transaction costs are negligible. Principal is due on December 31, 20x3 but interest are due annually every year end.
JOURNAL ENTRIES: Jan. 1, 20x1
Cash
1,000,000 Bonds Payable
Dec. 31, 20x1
Interest Expense (1M x 12%)
1,000,000 120,000
Cash Dec. 31, 20x2
120,000
Interest Expense (1M x 12%)
120,000
Cash Dec. 31, 20x3
120,000
Interest Expense (1M x 12%) Bonds Payable
120,000 1,000,000
Cash
1,120,000
ILLUSTRATION: BONDS ISSUED AT DISCOUNT On January 1, 20x1, ABC Co., issued 1,000, P1,000, 10%, 3-year bonds for P951,963. Principal is due on December 31, 20x3 but interest are due annually every year end. The effective interest rate is 12%.
SOLUTION: Face Amount of Bonds
P 1,000,000
Cash Proceeds (Issue price)
(
951,963)
Discount on Bonds Payable
P
48,037
Interest Payments = Face Amount x Nominal Interest Rate = 1,000,000 x 10% = 100,000
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
951,963
Dec. 31, 20x1
100,000
114,236
14,236
966,199
Dec. 31, 20x1
100,000
115,944
15,944
982,142
Dec. 31, 20x1
100,000
117,857
17,857
1,000,000
Unamortized Discount of Bonds Payable - Dec. 31, 20x1 = Face Amount - Carrying Amount = 1,000,000 - 966,199 = 33,801 JOURNAL ENTREIS Jan. 1, 20x1
Cash
951,963
Discount on Bonds Payable
48,963
Bonds Payable Dec. 31, 20x1
Interest Expense
1,000,000 114,236
Cash
100,000
Discount on Bonds Payable Dec. 31, 20x2
Interest Expense Cash
14,236 115,944 100,000
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Discount on Bonds Payable Dec. 31, 20x3
15,944
Interest Expense
117,857
Bonds Payable
1,000,000
Cash
1,100,000
Discount on Bonds Payable
17,857
ILLUSTRATION: BONDS ISSUED AT A On January 1, 20x1, ABC Co., issued 1,000, P1,000, 12%, 3-year bonds for P1,049,737. Principal is due on December 31, 20x3 but interest are due annually every year end. The effective interest rate is 10%.
SOLUTION: Cash Proceeds (Issue price)
P 1,049,737
Face Amount of Bonds
( 1,000,000)
on Bonds Payable
P
49,737
Interest Payments = Face Amount x Nominal Interest Rate = 1,000,000 x 10% = 120,000
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. -c)
Jan. 1, 20x1
1,049,737
Dec. 31, 20x1
120,000
104,974
15,026
1,034,711
Dec. 31, 20x1
120,000
103,471
16,529
1,018,182
Dec. 31, 20x1
120,000
101,818
18,182`
1,000,000
JOURNAL ENTREIS Jan. 1, 20x1
Cash
1,049,737 Bonds Payable
1,000,000
on Bonds Payable Dec. 31, 20x1
Interest Expense
49,737 104,974
on Bonds Payable
15,026
Cash Dec. 31, 20x2
120,000
Interest Expense
103,471
on Bonds Payable
16,529
Cash Dec. 31, 20x3
120,000
Interest Expense
101,818
on Bonds Payable Bonds Payable
18,182 1,000,000
Cash
1,120,000
ILLUSTRATION: BONDS ISSUED AT FACE AMOUNT - WITH TRANSACTION COSTS On January 1, 20x1, ABC Co., issued 10%, P1,000,000 bonds at face amount. Commission paid to underwriters amounted to P48,037. Principal is due on December 31, 20x3 but interest are due annually every year end.
SOLUTION: Bonds Payable
P 1,000.000
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Bond Issue Costs
(
48,037)
Carrying amount of Bonds Payable
P
951,963
Although the bonds are issued at face amount, it is as if there is a discount because the cash proceeds is less than the face amount of the bonds due to the transaction costs incurred.
We use trial and error to determine the EIR
FIRST TRIAL @ 11% Future Cash Flows
PV Factors @11%,
Present Value
Principal
0.73119
731,190
Annual Interest (1M x 3%)
2.44371
244,371
Totals
975,561
SECOND TRIAL @ 11% Future Cash Flows
PV Factors @12%,
Present Value
Principal
0.71178
711,780
Annual Interest (1M x 3%)
2.40183
240,183
Totals
951,963
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
951,963
Dec. 31, 20x1
100,000
114,236
14,236
966,199
Dec. 31, 20x1
100,000
115,944
15,944
982,142
Dec. 31, 20x1
100,000
117,857
17,857
1,000,000
JOURNAL ENTRIES: Jan. 1, 20x1
Cash
951,963
Bond Issue Cost
48,037
Bonds Payable Dec. 31, 20x1
Interest Expense
1,000,000 114,236
Bond Issue Cost
14,236
Cash Dec. 31, 20x2
Interest Expense
100,000 115,944
Bond Issue Cost
15,944
Cash Dec. 31, 20x3
Interest Expense Bonds Payable Bond Issue Cost Cash
100,000 117,857 1,000,000 17,857 1,100,000
ILLUSTRATION: BONDS ISSUED AT DISCOUNT - WITH TRANSACTION COSTS On January 1, 20x1, ABC Co., issued 10%, P1,000,000, 3-year bonds for P951,963 amount. Principal is due on December 31, 20x3 but interest are due annually every year end. In addition, ABC incurred bond issue costs of P44,829. The effective interest rate is 12% before adjustment for bond issue costs and 14% after adjustment for bond issue costs.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Solution: Issue Price before Bond issue cost
P 951,963
Bond Issue Costs
(
Carrying amount of Bonds Payable
P 907,134
44,829)
Discount on Notes Payable = (Face Amount - Issue Price) + Bond Issue Costs = 1,000,000 - (951,963 + 44,829) = 92,866
The bond issue costs are added to the discount on bonds payable because the bond issue costs are amortized together with the discount. - this simplifies the subsequent recording of amortization in that there is no need to allocate the amortization between the discount and the bond issue costs.
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
907,134
Dec. 31, 20x1
100,000
126,999
26,999
934,133
Dec. 31, 20x1
100,000
130,779
30,779
964,912
Dec. 31, 20x1
100,000
135,088
35,088
1,000,000
The EIR to be used is 14% -
If the bond issue costs are NOT added to the bond discount, the amortization shall be allocated to the bond issue costs and the discount based on their outstanding balances.
the rate adjusted for the bond issue costs.
Outstanding Balances
Fraction
Discount on Bonds Payable
48,037
48,037/92,866
Bond Issue Costs
44,829
44,829/92,866
Allocation of Amortization 13,966 13,033
92,866
26,999
JOURNAL ENTRIES: Jan. 1, 20x1
Cash
907,134
Discount on Bonds Payable
92,866
Bonds Payable If
1,000,000
bond issue costs are not added to the bond discount
Jan. 1, 20x1
Cash
907,134
Discount on Bonds Payable
48,037
Bond Issue Cost
44,829
Bonds Payable Dec. 31, 20x1
Interest Expense Cash
1,000,000 126,999 100,000
Discount on Bonds Payable
13,966
Bonds Issue Cost
13,033
ILLUSTRATION: BONDS ISSUED AT - WITH TRANSACTION COSTS On January 1, 20x1, ABC Co., issued 12%, P1,000,000, 3-year bonds for P1,103,084 amount. Principal is due on December 31, 20x3 but interest are due annually every year end. In addition, ABC incurred bond issue costs of P53,347. The effective interest rate before adjustment for transaction costs is 8%.
Solution:
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Issue Price before Bond issue cost
P 1,103,084
Bond Issue Costs
(
Carrying amount of Bonds Payable
P 1,049,737
55,347)
on Notes Payable = (Issue Price - Face Amount) - Bond Issue Costs = 1,103,084 - 1,000,000 - 55,347 = 49,737
The bond issue costs are deducted from the on bonds payable in order to simplify the subsequent recording of amortization.
The effective interest rate given in problem is before adjustment for transaction costs. We CANNOT use that rate. We will use trial and error to find the after adjustment EIR.
FIRST TRIAL @
10% Future Cash Flows
PV Factors @11%,
Present Value
Principal
0.751315
751,315
Annual Interest (1M x 3%)
2.48685
298,422
Totals
1,049,737
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
1,049,737
Dec. 31, 20x1
120,000
104,974
15,026
1,034,711
Dec. 31, 20x1
120,000
103,471
16,529
1,018,182
Dec. 31, 20x1
120,000
101.818
18,182
1,000,000
JOURNAL ENTREIS Jan. 1, 20x1
Cash
1,049,737 Bonds Payable
1,000,000
on Bonds Payable Dec. 31, 20x1
Interest Expense on Bonds Payable Cash
49,737 104,974 15,026 120,000
ILLUSTRATION: STRAIGHT-LINE METHOD OF AMORTIZATION On January 1, 20x1, ABC Co., issued 1,000, P1,000, 10%, 3-year bonds for P951,963. Principal is due on December 31, 20x3 but interest are due annually every year end. The effective interest rate is 12%. ABC Co., incorrectly used the straight-line method instead of the effective interest method to amortized the discount.
Erroneous amortization of discount using straight line: Face Amount of Bonds
P 1,000,000
Cash Proceeds
(
951,963)
Discount on Bonds Payable
P
44,037
Divide by: Term of bonds (in years) Annual Amortization
3 years P
16,012
Interest Expense for 20x1 recognized under straight-line method: Interest Expense = Interest Paid + Annual Amortization of Discount = (1,000,000 x 10%) + 16,012
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE = 116,012
Carrying Amount for 20x1 recognized under straight-line method: Carrying Amount -
Dec. 31, 20x1 =
Carrying Amount - Jan. 1, 20x1 + Amortization of Discount
= 951,963 + 16,012 = 967,975
AMORTIZATION TABLE UNDER EIR DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
951,963
Dec. 31, 20x1
100,000
114,236
14,236
966,199
Dec. 31, 20x1
100,000
115,944
15,944
982,142
Dec. 31, 20x1
100,000
117,857
17,857
1,000,000
Effect on Carrying Amount of Bonds as of Dec. 31, 20x1: Carrying Amounts on Dec. 31,20x1 Straight-line
967,975
Effective Interest Rate
966,199
Difference - overstatement under straight-line
1,776
Effect on 20x1 Profit: Interest Expense 20x1 Straight-line
116,012
Effective Interest Rate
114,236
Difference - overstatement under straight-line
1,776
ILLUSTRATION: PRE-ISSUANCE INTEREST On April 1, 20x1, ABC Co., issued 12%, P1,000,000 bonds dated January 1, 20x1 at 97 including accrued interest. The bonds mature in ten years and pay interest annually every year-end.
Solution: Cash proceeds including accrued interest (1M x 97%)
970,000
Accrued interest sold (1M x 12% x 3/12)
(30,000)
Carrying amount of the bonds, April 1, 20x1
940,000
The initial carrying amount of the bonds is equal to the cash proceeds EXCLUDING the accrued interest.
Alternative: the initial carrying amount of the bonds may be computed by preparing the pro-forma entry to record the issuance of the bonds payable. April 1, 20x1
Cash (1M x 97%)
970,000
Discount on bonds payable (1M - 940K)
60,000
Bonds Payable
1,000,0000
Interest Expense
30,000
Interest payable may be credited in lieu of interest expense.
Either way, total interest expense (disregard amortization of discount) in 20x1 should be limited to the post-issuance interest expense of P90,000 (1M x 12% x 9/12) Interest Expense was initially credited
Interest payable was initially credited
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE The entry to record interest expense on Dec. 31, 20x1 is:
Interest Expense
120,000
Cash
The entry to record interest expense on Dec. 31, 20x1 is:
Interest Expense
90,000
Interest Payable
30,000
120,000
Interest expense for 20x1 = 120,000 debit minus 30,000 credit on April 1, 20x1 = 90,000
Cash
120,000
Interest expense = 90,000 debit on Dec. 31, 20x1
ILLUSTRATION: PRE-ISSUANCE INTEREST On April 1, 20x1, ABC Co., issued 12%, P1,000,000 bonds dated January 1, 20x1 at 97 excluding accrued interest. The bonds mature in ten years and pay interest annually every year-end.
Solution: Cash Proceeds = Cash Proceeds excluding interest + Accrued Interest = (1M x 97%) + (1M x 12% x 3/12) = 1,000,000
Discount on Bonds Payable = Face Amount - Cash Proceeds excluding interest = 1,000,000 - 970,000 = 30,000
JOURNAL ENTREIS Jan. 1, 20x1
Cash
1,000,000
Discount of Bonds
30,000
Bonds Payable
1,000,000
Interest Expense
30,0000
Accrued interest sold increases the proceeds from issuance BUT should NOT affect the initial carrying amount of the bonds.
The initial carrying amount of the bonds is equal to the issue price excluding the accrued interest sold.
ILLUSTRATION: ISSUE PRICE OF BONDS - ISSUANCE ON INTEREST DATE ABC Co., is contemplating on issuing 12%, 3-year, P1,000,000 bonds. Principal is due at maturity but interest is due annually at each year-end. ABC determines that the current market rate on January 1, 20x1 is 10%.
Solution: Issue Price of Bonds = Present value of cash flows or (Future Cash Flows x PV Factor) Future Cash Flows Principal Annual Interest
PV Factors @11%,
Present Value
1,000,0000
0.751315
751,315
120,000
2.486852
298,422
Totals
1,049,737
ILLUSTRATION: ISSUE PRICE OF BONDS - ISSUANCE IN BETWEEN INTEREST DATES ABC Co., is contemplating on issuing 12%, 3-year, P1,000,000 bonds on April 1, 20x1. Principal is due at maturity but interest is due annually at each year-end. ABC determines that the current market rate on January 1, 20x1 is 10%.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE
The issue price on April 1, 20x1 is computed simply by amortizing the issue price on January 1, 20x1 up to April 1, 20x1.
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR x 3/12)
(b-a)
(Prev. Bal. -c)
Jan. 1, 20x1
1,049,737
Apr. 1, 20x1
30,000
26,243
3,757
1,045,980
The estimated issue price pertaining only to the bonds on April 1, 20x1 is P1,045,980.
However, since the bonds are issued in between interest dates, the total cash proceeds from the issuance of the bonds will necessarily include the accrued interest sold. The total issue price is computed by adding the accrued interest sold to the computed issue price of the bonds only. Issue Price pertaining to bonds only
1,045,980
Accrued interest sold
30,000
Total Issue Price or Cash Proceeds
1,075,980
ALTERNATIVE: computing first the full amortization for the period of issue. The full amortization is then allocated to the period prior to the expected date of issuance. AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
1,049,737
Dec. 31, 20x1
120,000
104,974
15,026
Carrying Amount as of January 1, 20x1
1,034,711
1,049,737
amortization up to April 1, 20x1 (15,206 x 3/12) Issue price pertaining to bonds only, April 1, 20x1 Accrued interest sold
(3,802) 1,045,936 30,000
Total issue price or cash proceeds
1,075,936
ILLUSTRATION: RETIREMENT OF BONDS - BOND REFUNDING On January 1, 20x1, ABC Co., issued new bonds with face amount of P10M for P10,800,000. ABC used the proceeds to retire an existing 10-year, 12%, P8,000,000 bond issued five years earlier. The bonds have an unamortized discounts of P340,000 on January 1, 20x1. ABC retired the entire outstanding bonds at a call of P400,000. Costs incurred that are directly attributable to the retirement amounted to P50,000. ABC has an income tax rate of 30%.
Solution: Face Amount of bonds retired
8,000,000
Unamortized discount, January 1, 20x1
( 340,000)
Carrying amount of bonds retired Face amount of bonds retired
7,660,000 8,000,000
Call
400,000
Expense of reacquisition
50,000
Retirement Price (Call Price)
8,450,000
Loss on Extinguishment of Bonds
( 790,000)
JOURNAL ENTREIS Issuance of the new bonds
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Jan. 1, 20x1
Cash
10,8000,000 Bonds Payable
10,000,000
on Bonds Payable
800,000
The gain or loss on extinguishment may be squeezed by preparing the extinguishment entry: Jan. 1, 20x1
Bonds Payable
8,000,000
Loss on Extinguishment of bonds (squeezed)
790,000
Discount of Bonds Payable
340,000
Cash
8,450,000
Notice that the loss is recognized at gross of tax. Netting of tax is normally permitted only for results of discounted operations, items of OCI, and retrospective adjustments to the beginning balance of retained earnings.
ILLUSTRATION: RETIREMENT OF BONDS On January 1, 20x1, ABC Co., issued 5-year, 12%, P1,000,000 bonds for P1,075,816. Principal is due at maturity but interest are die annually. The effective interest rate is 10%. On July 1, 20x3, ABC called in the entire bonds and retired them at 102. The retirement price includes payments for accrued interest. AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
1,075,816
Dec. 31, 20x1
120,000
107,,582
12,418
1,063,398
Dec. 31, 20x2
120,000
106,340
13,660
1,049,737
July 1, 20x3
60,000
52,487
7,513
1,042,224
Solution: Carrying amount of bonds retired
1,042,224
Retirement price including payment for Accrued Interest (1M x 102%)
1,020,000
Accrued Interest
( 60,000)
Retirement Price (Call Price)
960,000
Gain on Extinguishment of Bonds
82,224
JOURNAL ENTREIS The entry to update the carrying amount of the bonds payable July. 1, 20x1
Interest Expense on Bonds Payable
52,587 7,513
Interest Payable
60,000
The entry to record the extinguishment July. 1, 20x1
Bonds Payable
1,000,000
Interest Payable
60,000
on Bonds Payable
42,224
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Cash
1,020,000
Gain on Extinguishment of bonds
82,224
on Bonds Payable = 1,042,224 - 1,000,000 = 42,224
Since the bonds are retired in between interest payment sates, the retirement price necessarily includes payments for accrued interest.
The portion pertaining to the payment for the accrued interest must be excluded so that the gain or loss may be properly computed.
ILLUSTRATION: SERIAL BONDS - ISSUED AT DISCOUNT On January 1, 20x1, ABC Co., issued 10%, P3,000,000 bonds for P2,900,305. Principal on the bonds matures in three equal annual installments. Interest is also due annually at each year-end. The effective interest rate on the bonds is 12%.
Solution: Annual Cash Flows Date
Principal Payments
+
Interest Payments
=
Total Payments/Cash Flows
(Outstanding Bal. X Nominal Rate)
Dec. 31, 2ox1
1,000,000
3M x 10% = 300,000
1,300,000
Dec. 31, 2ox2
1,000,000
2M x 10% = 200,000
1,200,000
Dec. 31, 2ox3
1,000,000
1M x 10% = 100,000
1,100,000
AMORTIZATION TABLE DATE
ANNUALT PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
2,900,305
Dec. 31, 20x1
1,300,000
348,037
951,963
1,948,342
Dec. 31, 20x2
1,200,000
233,801
966,199
982,143
Dec. 31, 20x3
1,100,000
117,857
982,143
0
JOURNAL ENTREIS Jan. 1, 20x1
Cash
2,900,305
Discount on Bonds Payable
99,695
Bonds Payable Dec. 31, 20x1
Interest Expense Bonds Payable
3,000,000 348,037 1,000,000
Cash
1,300,000
Discount on Bonds Payable (squeezed) Dec. 31, 20x1
Interest Expense Bonds Payable
233,801 1,000,000
Cash
1,200,000
Discount on Bonds Payable (squeezed) Dec. 31, 20x1
Interest Expense Bonds Payable
48,037
33,801
117,857 1,000,000
Cash Discount on Bonds Payable (squeezed)
1,100,00 17,857
ILLUSTRATION: ADJUSTMENT TO EFFECTIVE INTEREST RATE - SERIAL BONDS On January 1, 20x1, ABC Co., issued 10%, P3,000,000 bonds at 105. Transaction costs incurred amounted to P44,274. Principal on the bonds matures in three equal annual installments. Interest is also due annually at each year-end.
Carrying amount of Bonds = (Face Amount x Issued %) - Transaction costs
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE = (P3,000,000 x 105%) - P44,274 = 3,105,726
on Bonds Payable = (Face Amount x Issued %) - Face Amount - Transaction costs = (P3,000,000 x 105%) - P3,000,000 - P44,274 = 105,726
Annual Cash Flows Date
Principal Payments
+
Interest Payments
=
Total Payments/Cash Flows
(Outstanding Bal. X Nominal Rate)
Dec. 31, 2ox1
1,000,000
3M x 10% = 300,000
1,300,000
Dec. 31, 2ox2
1,000,000
2M x 10% = 200,000
1,200,000
Dec. 31, 2ox3
1,000,000
1M x 10% = 100,000
1,100,000
The bond issue costs are deducted from the in order to simplify the subsequent recording of amortization.
To amortized we need to use EIR, since EIR is not given we need to do trial and error to determine EIR.
First Trial @ 9%
Date
Future Cash Flows
x
PV of 1 @ 9%, n= 1-3
=
Present Value
Dec. 31, 2ox1
1,300,000
0.91743
1,192,659
Dec. 31, 2ox2
1,200,000
0.84168
1,010,016
Dec. 31, 2ox3
1,100,000
0.77218
849,398
Total
3,052,073
Second Trial @ 8% Date
Future Cash Flows
x
PV of 1 @ 8%, n= 1-3
=
Present Value
Dec. 31, 2ox1
1,300,000
0.925926
1,203,704
Dec. 31, 2ox2
1,200,000
0.857339
1,028,807
Dec. 31, 2ox3
1,100,000
0.793832
873,215
Total
3,105,726
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
3,105,726
Dec. 31, 20x1
1,300,000
248,458
1,051,542
2,054,184
Dec. 31, 20x2
1,200,000
164,335
1,035,665
1,018,518
Dec. 31, 20x3
1,100,000
82,482
1,018,518
0
JOURNAL ENTREIS Jan. 1, 20x1
Cash
3,105,726 Bonds Payable
3,000,000
on Bonds Payable Dec. 31, 20x1
Interest Expense on Bonds Payable Bonds Payable
105,726 248,458 51,542 1,000,000
Cash Dec. 31, 20x2
Interest Expense on Bonds Payable Bonds Payable
1,300,000 164,335 35,665 1,000,000
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Cash Dec. 31, 20x3
1,200,000
Interest Expense
82,482
on Bonds Payable
18,518
Bonds Payable
1,000,000
Cash
1,100,000
amortization = Interest Payment - Interest Expense = 300,000 - 248,458 = 51,542
ILLUSTRATION: ISSUE PRICE OF SERIAL BONDS On January 1, 20x1, ABC Co., contemplates on issuing 10%, P3,000,000 bonds. Principal on the bonds matures in three equal annual installments. Interest on the outstanding principal balance is also payable annually at each year-end. The effective interest rate on the bonds is 12%.
Annual Cash Flows Date
Principal Payments
+
Interest Payments
=
Total Payments/Cash Flows
(Outstanding Bal. X Nominal Rate)
Dec. 31, 2ox1
1,000,000
3M x 10% = 300,000
1,300,000
Dec. 31, 2ox2
1,000,000
2M x 10% = 200,000
1,200,000
Dec. 31, 2ox3
1,000,000
1M x 10% = 100,000
1,100,000
Present Value Date
Future Cash Flows
x
PV of 1 @ 12%, n= 1-3
Dec. 31, 2ox1
1,300,000
0.892857
1,160,714
Dec. 31, 2ox2
1,200,000
0.797194
956,633
Dec. 31, 2ox3
1,100,000
0.711780
782,958
Total
=
Present Value
2,900,305
The estimated issue price of the bonds on January 1, 20x1 is P 2,900,305.
ILLUSTRATION: ZERO-COUPON BONDS On January 1, 20x1, ABC Co., issued 10%, P3,000,000 bonds at a yield to maturity interest of 18%. Principal and interest are due on December 31, 20x3.
First compute for the Future Cash Flows/ Future Payments of Bonds using ordinary annuity and nominal rate Face Amount
P 3,000,000
FV of OA of P1 @ 10%, n=3
1.331
Maturity Value of the Bonds (Future Cash Flows)
P 3,993,000
Then compute for the Present Value of the Bonds using the yield rate of 18% and PV of P1 Future Cash Flows
P 3,993,000
PV of P1 @ 18%, n=3
0.6086309
Present Value of Bonds
P 2,430,263
AMORTIZATION TABLE DATE
Jan. 1, 20x1
INTEREST EXPENSE (a)
PV of Cash Flows (b)
Interest Payable ©
AMORTIZATION (d)
PRESENT VALUE (e)
(b x EIR)
(Prev. Bal. + a)
[NR x (Principal + Accrued interest)
(a-c)
(Prev. Bal. + d)
2,430,263
2,430,263
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Dec. 31, 20x1
437,447
2,867,710
300,000
137,447
2,567,710
Dec. 31, 20x2
516,188
3,383,898
330,000
186,188
2,753,898
Dec. 31, 20x3
609,102
3,993,000
363,000
246,102
3,000,000
JOURNAL ENTREIS Jan. 1, 20x1
Cash
2,430,263
Discount on Bonds Payable
569,736
Bonds Payable Dec. 31, 20x1
Dec. 31, 20x2
Dec. 31, 20x3
3,000,000
Interest Expense
437,447
Discount on Bonds Payable
137,447
Interest Payable
300,000
Interest Expense
516,188
Discount on Bonds Payable
186,188
Interest Payable
330,000
Interest Expense
609,102
Discount on Bonds Payable
246,102
Interest Payable
363,000
Bonds Payable
3,000,000
Interest Payable (300 + 330 + 363)
993,000
Cash
3,993,000
ILLUSTRATION: AMORTIZATION OF CALLABLE BONDS On January 1, 20x1, ABC Co., issued 5-year, 10%, P1,000,000 callable bonds at a discount of P33,801. Principal is due on December 31, 2x5 but interest are due annually at each year-end. The bond indenture restricts the issuer to call the bonds during the first 2 years. On issuance date, ABC expects to call the bonds on January 1, 20x3, upon the lapse of 2 year restriction. The effective interest rate is 12%.
Carrying Amount of Bond = Face Amount - Discount = P1,000,000 - P33,801 = 966,199 AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
966,199
Dec. 31, 20x1
100,000
115,944
15,944
982,143
Dec. 31, 20x2
100,000
117,857
17,857
1,000,000
JOURNAL ENTREIS Jan. 1, 20x1
Cash
966,199
Discount on Bonds Payable
33,801
Bonds Payable Dec. 31, 20x1
1,000,000
Interest Expense
115,944
Discount on Bonds Payable
15,944
Interest Payable Dec. 31, 20x2
100,000
Interest Expense
117,857
Discount on Bonds Payable Interest Payable Assume that the bonds were in fact called-in
17,857 100,000
for redemption on Jan. 1,20x3 @ 101
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Jan. 1, 20x3
Bonds Payable
1,000,000
Loss on redemption of Bonds
10,000
Cash
1,010,000
Assume that the bonds were not called-in for redemption on Jan. 1,20x3. Dec. 31, 20x3
Interest Expense
100,000
Cash
100,000
ILLUSTRATION: REDEEMABLE PREFERENCE SHARES On January 1, 20x1, ABC Co., issued redeemable 6% preference shares with aggregate par value of P1,000,000 for P880,000. transaction costs incurred amounted to P17,391. Bondholders can present the preference shares to ABC for redemption at any time beginning January 1, 20x3. Based on ABC’s past experience, most redeemable preference shares are presented for redemption after 5 years. The effective interest rate is 3%.
Cash Proceeds/Carrying Amount = RPS issued price - transaction costs = P880,000 - P17,391 = 862,609 Or Carrying Amount = Face Amount of RPS - Discount on RPS = P1,000,000 - 137,391 = 862,609
Discount on RPS = Face amount of RPS - Cash Proceeds = P1,000,000 - 862,609 = 137,391
The transaction costs are treated as valuation item (included in discount) because RPS are considered as liability.
AMORTIZATION TABLE DATE
INTEREST EXPENSE (a) (c x EIR)
DISCOUNT AMORTIZATION (b)
PRESENT VALUE (c) (Prev. Bal. + a)
(prev. Bal. - a)
Jan. 1, 20x1
137,391
862,609
Dec. 31, 20x1
25,878
111,513
888,487
Dec. 31, 20x2
26,655
84,858
915,142
Dec. 31, 20x3
27,454
57,404
942,596
Dec. 31, 20x4
28,278
29,126
970,874
Dec. 31, 20x5
29,126
-
1,000,000
JOURNAL ENTRIES Jan. 1, 20x1
Cash
862,609
Discount on Bonds Payable
137,391
Redeemable Preference Shares Dec. 31, 20x1
1,000,000
Interest Expense
25,878
Discount on RPS
25,878
Assume that ABC Co., declares dividends on March 31, 20x2 March 31, 20x2
Interest Expense (P1M x 6%) Cash
60,000 60,000
Dividends are recognized as interest expense and charged to profit or loss
Assume that the preference shares are redeemed at a of P100,000 on Dec. 31, 20x5
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Dec. 31, 20x5
Redeemable Preference Shares
1,000,000
Loss on Redemption of PS
100,000
Cash
1,100,000
Assume that the RPS are presented for redemption on Dec. 31, 20x3 at a of P200K. Dec. 31, 20x3
Redeemable Preference Shares
1,000,000
Loss on Redemption of PS
257,404
Discount on RPS
57,504
Cash
1,200,000
ILLUSTRATION: ISSUE OF CONVERTIBLE BONDS On January 1, 20x1, ABC Co., issued its 10%, 3-year, P1,000,000 convertible bonds for the face amount of P1,000,000. Each P1,000 bond is convertible into 8 shares with par value of P100 per share. When the bonds were issued, they were selling at 98 without the conversion option. ABC incurred P50,000 transaction costs on the issue of the bonds.
Equity Component = Issue Price - Fair Value of Debt Instrument without equity feature = P1,000,000 - (1,000,000 x 98%) = 20,000
Transaction Costs Allocations Component
Allocated Amount from Issue Price
Debt Component
980,000
Equity Component
20,000
Fraction
x
Transaction Costs
980K/1M
Allocation of Transaction Costs
50,000
20K/1M
1,000,000
=
49,000
50,000
1,000
1M/1M
50,000
Carrying amount of the Debt and Equity Components Debt Components
Equity Components
Totals
Allocation of Issue Price
980,000
20,000
1,000,000
Allocation of Transaction Costs
( 49,000)
(1,000)
(50,000)
Net Carrying Amounts
931,000
19,000
950,000
JOURNAL ENTRIES SIMPE ENTRIES Jan. 1, 20x1
Cash
1,000,000
Discount on Bonds Payable
20,000
Bonds Payable
1,000,000
Share - conversion feature Jan. 1, 20x1
Discount on Bonds Payable Share - conversion Feature
20,000 49,000 1,000
Cash
50,000
COMPOUND ENTRY Jan. 1, 20x1
Cash Discount on Bonds Payable (1M - 931K) Bonds Payable Share - conversion feature
950,000 69,000 1,000,000 19,000
ILLUSTRATION: CONVERSION OF CONVERTIBLE BONDS On January 1, 20x1, ABC Co., issued its 10%, 3-year, P1,000,000 convertible bonds at 105. Each P1,000 bond is convertible into 8 shares with par value of P100 per share. Principal is due on December 31, 20x3 but interest are due annually at each year-end. When bonds were issued, they were selling at a yield to maturity market ate of 12% without the conversion option.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE On December 31, 20x2, all of the bonds were converted into equity. Conversion costs incurred amounted to P20,000.
Fair Value of the Bond without the conversion option Future Cash Flows Principal
1,000,000
Interest
100,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
711,780
2.401831
240,183
PV of OA of P1
Fair value of debt instrument w/o conversion feature
951,963
Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument without equity feature = (P1,000,000 x 105%) - 951,963 = 98,037 AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
951,963
Dec. 31, 20x1
100,000
114,236
14,236
966,199
Dec. 31, 20x2
100,000
115,944
15,944
982,143
Dec. 31, 20x3
100,000
117,857
17,857
1,000,000
JOURNAL ENTRIES Jan. 1, 20x1
Cash
1,050,000
Discount on Bonds Payable
48,037
Bonds Payable
1,000,000
Share - conversion feature Dec. 31, 20x1
Interest Expense
98,037
114,236
Discount on Bonds Payable
14,236
Cash Dec. 31, 20x2
100,000
Interest Expense
115,944
Discount on Bonds Payable
15,944
Cash
100,000
Entries to record conversion Dec. 31, 20x2
Bonds Payable
1,000,000
Discount on Bonds Payable
17,857
Share Capital [(8 shares x 1,000) x 100]
800,000
Share (squeezed)
182,143
Share
20,000
Cash
Share - conversion feature Share Discount on Bonds Payable - Jan.1, 20x1= 1,000,000 - 951,963 = 48,037 Discount on Bonds Payable - Dec. 31, 20x2= 1,000,000 - 982,143 = 17,857 Share = Bonds Payable - Unamortized Discount - Share Capital
20,000
98,037 98,037
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE = 1,000,000 - 17,857 - 800,000 = 182,143
The conversion of the bonds is ed for as equity set-off meaning, the carrying amount of the bonds is simply derecognized, the aggregate par value of the shares issued is credited to “share capital” and the difference is credited to “Share ”. NO gain or loss is recognized on the conversion.
The share issuance costs are treated as a reduction to share .
The “share -conversion feature” is closed to the “Share ” general because all of the conversion privilege has been exercised.
Prior to the conversion of the bonds, the “share -conversion feature” is part of the share but described as pertaining to the conversion feature. When the conversion feature is exercised, such amount is just reclassified within share .
The conversion increased equity by the carrying amount of bonds on conversion date less the transaction costs incurred on the conversion. Carrying amount of bonds on date of conversion
982,143
Conversion costs
( 20,000)
Net Increase in Equity
962,143
Increase in share capital
800,000
Net increase in share (280,180 - 20,000)
260,180
Decrease in share - conversion feature
(98,037)
Net Increase in Equity
962,143
ILLUSTRATION: PARTIAL CONVERSION OF CONVERTIBLE BONDS On January 1, 20x1, ABC Co., issued its 12%, 3-year, P1,000,000 convertible bonds at 110. Each P1,000 bond is convertible into 8 shares with par value of P100 per share. Principal is due on December 31, 20x3 but interest are due annually at each year-end. When bonds were issued, they were selling at a yield to maturity market ate of 10% without the conversion option. On December 31, 20x2, half of the bonds were converted into equity. Conversion costs incurred amounted to P20,000.
Fair Value of the Bond without the conversion option Future Cash Flows Principal
1,000,000
Interest
100,000
PV @ 10%, n=3
PV Factors
Present Value
PV of P1
0.751315
751,315
2.486852
298,422
PV of OA of P1
Fair value of debt instrument w/o conversion feature
1,049,737
Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument without equity feature = (P1,000,000 x 110%) - 1,049,737 = 50,263
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1 Dec. 31, 20x1
1,049,737 120,000
104,974
15,026
1,034,711
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Dec. 31, 20x2
120,000
103,471
16,529
1,018,182
Dec. 31, 20x3
120,000
101,818
18,182
1,000,000
JOURNAL ENTRIES Jan. 1, 20x1
Cash
1,100,000
Bonds Payable
Dec. 31, 20x1
1,000,000
on Bonds Payable
49,737
Share - conversion feature
50,263
Interest Expense
104,974
on Bonds Payable
15,026
Cash Dec. 31, 20x2
120,000
Interest Expense
103,471
on Bonds Payable
16,529
Cash
120,000
Entries to record conversion Dec. 31, 20x2
Bonds Payable
500,000
on Bonds Payable (18,182 x 1/2)
9,091
Share Capital [(8 shares x 500) x 100]
400,000
Share (squeezed)
109,091
Share
20,000
Cash
Share - conversion feature Share
20,000
25,132 25,132
on Bonds Payable - Jan.1, 20x1= 1,049,737 - 1,000,000 = 49,737 Share = Bonds Payable + Unamortized - Share Capital = 500,000 + 9,091 - 400,000 = 109,091
Credit to share capital
400,000
Credit to share (109,091+ 25,132)
134,223
Debit to share for the stock issuance costs
(20,000)
Debit to share - conversion feature
(25,132)
Net Increase in Equity
489,091
Credit to share (109,091- 25,132)
134,223
Debit to share for the stock issuance costs
(20,000)
Net Increase in Share General
114,223
ILLUSTRATION: CONVERSION IN BETWEEN INTEREST PAYMENT DATES On January 1, 20x1, ABC Co., issued its 12%, 3-year, P1,000,000 convertible bonds at 110. Each P1,000 bond is convertible into 8,000 shares with par value of P100 per share. Principal is due on December 31, 20x3 but interest are due annually at each year-end. At issuance date, the bonds are selling at P1,049,737 without the conversion privilege. The effective interest rate is 10%. On July 1, 20x2, all of the bonds were converted into equity. Conversion costs incurred amounted to P20,000. The accrued interest is settled separately in cash.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument without equity feature = (P1,000,000 x 110%) - 1,049,737 = 50,263 AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
1,049,737
Dec. 31, 20x1
120,000
104,974
15,026
1,034,711
July 1, 20x2
60,000
51,736
8,264
1,026,446
JOURNAL ENTRIES Jan. 1, 20x1
Cash
1,100,000
Bonds Payable
Dec. 31, 20x1
1,000,000
on Bonds Payable
49,737
Share - conversion feature
50,263
Interest Expense
104,974
on Bonds Payable
15,026
Cash July 1, 20x2
120,000
Interest Expense
51,736
on Bonds Payable
8,264
Cash
60,000
COMPOUND ENTRY to record conversion July 1, 20x2
Bonds Payable
1,000,000
on Bonds Payable (1,026,446 - 1M)
24,446
Share -conversion feature
50,263
Share Capital [(8000 x 100]
800,000
Cash
20,000
Share (squeezed)
256,709
ILLUSTRATION: RETIREMENT OF CONVERTIBLE BONDS On January 1, 20x1, ABC Co., issued its 10%, 3-year, P1,000,000 convertible bonds for P1,100,000. Principal is due at maturity but interest is payable every year-end. The bonds are convertible into 6,000 ordinary shares with par value of P100 per share. At the issuance date, the prevailing market rate of interest for similar debt without conversion feature is 12%. On December 31, 20x2, all of the convertible bonds were retired for P1,000,000. The prevailing rate of interest on a similar instrument as of December 31, 20x2 is 11% without the conversion feature.
Fair Value of the Bond without the conversion option Future Cash Flows Principal
1,000,000
Interest
100,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
711,780
2.401831
240,183
PV of OA of P1
Fair value of debt instrument w/o conversion feature
Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument without equity feature = P1,100,000 - 951,963 = 148,037
951,963
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
951,963
Dec. 31, 20x1
100,000
114,236
14,236
966,199
Dec. 31, 20x2
100,000
115,944
15,944
982,143
Dec. 31, 20x3
100,000
117,857
17,857
1,000,000
JOURNAL ENTRIES Jan. 1, 20x1
Cash
1,100,000
Discount on Bonds Payable
48,037
Bonds Payable
1,000,000
Share - conversion feature Dec. 31, 20x1
Interest Expense
114,236
Discount on Bonds Payable
14,236
Cash
148,037
100,000
On retirement date, the retirement price is allocated to the liability and equity components for purposes of determining gain or loss on extinguishment of debt. The allocation procedure is similar to the allocation of issue price. Fair Value of the Bond without the conversion option on retirement date Future Cash Flows Principal
PV @ 11%, n=1
1,000,000
Interest
PV Factors
PV of P1
100,000
PV of OA of P1
0.900901
900,901
0.900901
90,090
Fair value of debt instrument w/o conversion feature
Equity component = Total Retirement Price = 1,000,000
Present Value
990,991
- Fair value of the bonds without conversion feature
- 990,991 = 9,009
Gain (loss) on Extinguishment = Carrying amount of bonds on Retirement date - Retirement price allocated to bonds = 982,143 - 990,991 = (8,848) Dec. 31, 20x2
Bonds Payable
1,000,000
Share -conversion feature Loss on Extinguishment of Bonds Discount on BP (1M - 982,143) Cash
Equity component allocated from issue price
Amount permanently closed to share
8,848 17,857 1,000,000
Share (squeezed)
Equity component allocated from the retirement price
148,037
139,082
148,037 (
9,009) 139,028
The equity component is closed to the share general because the conversion feature is forfeited by the extinguishment of the convertible bonds.
The equity component remains in equity regardless of whether the conversion feature is exercised or not. However, the equity component is reduced by the amount of retirement price allocated to the equity component.]
ILLUSTRATION: PARTIAL RETIREMENT OF CONVERTIBLE BONDS
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE On January 1, 20x1, ABC Co., issued its 10%, 3-year, P1,000,000 convertible bonds for P1,100,000. Principal is due at maturity but interest is payable every year-end. The bonds are convertible into 6,000 ordinary shares with par value of P100 per share. At the issuance date, the prevailing market rate of interest for similar debt without conversion feature is 12%. On December 31, 20x2, half of the convertible bonds were retired for P500,000. The prevailing rate of interest on a similar instrument as of December 31, 20x2 is 11% without the conversion feature.
Fair Value of the Bond without the conversion option on retirement date Future Cash Flows Principal
1,000,000
Interest
100,000
PV @ 11%, n=1 PV of P1 PV of OA of P1
PV Factors
Present Value
0.900901
900,901
0.900901
90,090
Fair value of debt instrument w/o conversion feature
Equity component = Total Retirement Price = 500,000
-
990,991
- Fair value of the bonds without conversion feature
495,496 = 4,504
Gain (loss) on Extinguishment = Carrying amount of bonds on Retirement date - Retirement price allocated to bonds = 491,072 - 495,496 = (4,425) Dec. 31, 20x2
Bonds Payable
500,000
Share -conversion feature
74,019
Loss on Extinguishment of Bonds
4,425
Discount on BP (500K - 491,072)
8,929
Cash
500,000
Share (squeezed)
69,515
ILLUSTRATION: BONDS WITH DETACHABLE SHARE WARRANTS On January 1,20x1, ABC Co., issued a 3-year, 10%, 1,000, P1,000 bonds at 97. Each bond has one detachable share warrant entitling the holder to buy 10 shares of ABC with par value of P100 at P120 per share. Shortly after issuance, the bonds are selling at 95 ex-warrants.
Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument ex-warrants = (1,000 x P1,000 x 97%) - (1,000 x P1,000 x 95%) = 20,000 JOURNAL ENTRIES Jan. 1, 20x1
Cash
970,000
Discount on Bonds Payable (1M - 950K) Bonds Payable
50,000 1,000,000
Share - warrant outstanding
20,000
Assuming half of the warrants exercised on September 21, 20x1 Sep. 21, 20x1
Cash (1,000 x 10 x 1/2 x P120) Share - warrants outs. (20k x 1/1)
600,000 10,000
Share Capital (1K x 10 x 1/2 x P100)
500,000
Share
110,000
Assume half of the warrants expired on December 31, 20x2 Dec. 31, 20x2
Share - warrants outs. (20k x 1/1) Share
10,000 10,000
Regardless of whether the warrants are exercised or not, the amount allocated to the equity component remains in equity.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE
When the warrants are exercised or when they expire, the value assigned to the warrants is transferred to the general share because by then, the warrant are not outstanding anymore.
ILLUSTRATION: BONDS WITH DETACHABLE SHARE WARRANTS On January 1,20x1, ABC Co., issued a 3-year, 12%, P1,000,000 bonds for P1,100,000. Each 1,000 bond has two detachable warrant entitling the holder to purchase one share of ABC with par value of P500 at P520 per share. Without the warrants, the bonds are selling at a yield to maturity rate of 10%. On September 21, 20x1, all of the share warrant were exercised.
Fair Value of the Bond without the conversion option Future Cash Flows Principal
1,000,000
Interest
120,000
PV @ 10%, n=3
PV Factors
Present Value
PV of P1
0.751315
751,315
2.486852
298,422
PV of OA of P1
Fair value of debt instrument w/o share warrants
1,049,737
Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument without the warrants = P1,100,000 - P1,049,737 = 50,263 JOURNAL ENTRIES Jan. 1, 20x1
Cash
1,100,000
Bonds Payable
1,000,000
on Bonds Payable
49,737
Share - conversion feature
50,263
Entry to record the exercise of all of the share warrants Dec. 31, 20x1
Cash (1M/1K x 2 x P520)
1,040,000
Share - Warrant Outs.
50,263
Share Capital (1M/1K x 2 x 500)
1,000,000
Share
90,263
ILLUSTRATION: TRANSFER OF NONCASH ASSET ABC Co., owes XYZ Bank P1,000,000 plus accrued interest of P90,000. The unamortized discount on the loan is P20,000. The debt is a 10-year, 12% loan. During 20x1, ABC’s business deteriorated due to loss of demand for its services. On December 31, 20x1, XYZ Bank agrees to accept old equipment and cancel the entire debt. The equipment has a cost of P3,000,000, accumulated depreciation of P2,200,00 and fair value of P900,000.
JOURNAL ENTRIES Jan. 1, 20x1
Loan Payable
1,000,000
Interest Payable
90,000
Accumulated Depreciation
2,200,000
Discount on loan payable
20,000
Equipment
3,000,000
Gain on Extinguishment of debt (squeezed)
Fair value of non cash asset transferred is ignored. Carrying amount of liability (1M - 20K + 90K)
P 1,070,000
Carrying amount of noncash asset transferred (3M - 2.2M) Gain (loss) on extinguishment of debt
(800,000) P
270,000
270,000
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE
ILLUSTRATION: EQUITY SWAP - WITH FAIR VALUE OF SECURITIES On December 31, 20x1, ABC Co., issued 10,000 shares with par value of P100 per share in settlement of a P1,000,000 loan payable with a related unamortized discount of P20,000, and accrued interest of P90,000. On December 31, 20x1, the shares are selling at P120 per share.
Carrying amount of liability (1M - 20K + 90K)
P 1,070,000
Fair value of securities issued (10,000 x P120)
( 1,200,000)
Gain (Loss) on extinguishment of debt
(P 130,000)
JOURNAL ENTRIES Jan. 1, 20x1
Loan Payable
1,000,000
Interest Payable
90,000
Loss on extinguishment
130,000
Discount on loan payable
20,000
Share Capital (10,000 x P100)
1,000,000
Share [(120-100) x 10,000]
200,000
ILLUSTRATION: EQUITY SWAP - FAIR VALUE OF SECURITIES NOT DETERMINABLE On December 31, 20x1, ABC Co., issued 10,000 shares with par value of P100 per share in settlement of a 12%, P1,000,000 loan payable with a related unamortized discount of P20,000, and accrued interest of P90,000. The remaining term of the loan is 3-years. The fair value of the shares is not reliably determinable. The prevailing market rate for similar dept on December 31, 20x1 is 8%.
Fair Value of the Financial liability extinguished Future Cash Flows Principal
1,000,000
Interest
120,000
PV @ 8%, n=3 PV of P1 PV of OA of P1
PV Factors
Present Value
0.793832
793,832
2.577097
309,252
Fair value of debt instrument w/o share warrants
1,103,084
JOURNAL ENTRIES Jan. 1, 20x1
Loan Payable
1,000,000
Interest Payable
90,000
Loss on extinguishment
33,084
Discount on loan payable Share Capital (10,000 x P100) Share
20,000 1,000,000 103,084
Carrying amount of liability (1M - 20K + 90K)
P 1,070,000
Fair value of securities issued (10,000 x P120)
( 1,103,084)
Gain (Loss) on extinguishment of debt
(P
33,084)
ILLUSTRATION: MODIFICATION OF - SUBSTANTIAL On December 31, 20x1, ABC Co. Agreed to the following modification of its existing liability:
Reduced the principal on the loan of P5,000,000 to P4,000,000
Forgave the accrued interest of P600,000
Extended the maturity date from December 31, 20x2 to December 31, 20x4.
Reduced the loan’s nominal interest rate of 12% to 10%.
Interest is payable annually at each year-end. The original effective interest rate of the debt instrument for Both ABC and its creditor, the Bank, is 12%. The prevailing market rate of interest as of December 31, 20x1 is 11%.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE
Future Cash Flows Principal
4,000,000
Interest
400,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
2,847,121
2.401831
960,733
PV of OA of P1
Present Value of Modified Liability
3,807,853
The difference between the old liability and the new liability is tested for substantiality. Carrying Amount of Old Liability (5M principal + 600K)
5,600,000
Present value of modified liability
(3,807,853)
Difference
1,792,147
Divide by: Carrying amount of Old Liability
5,6000,000 32%
The modification is considered substantial because the modification resulted to a present value of the new obligation different by at least 10% of the present value of old obligation. Therefore, the old liability is extinguished and the difference of P1,792,147 is recognized as gain on extinguishment. The new liability is recognized also.
JOURNAL ENTRIES Jan. 1, 20x1
Loan Payable-old
5,000,000
Interest Payable
600,000
Discount on Loan Payable -new
192,147
Loan payable
4,000,000
Gain on Extinguishment of debt
1,792,147
Discount on Loan Payable - New = 4,000,000 - 3,807,853 = 192,147
The future cash flows on the modified liability are discounted using the original EIR on the old liability. The prevailing interest rate on date of modification is ignored. This is because the liability is measured at amortized cost. Using the current rate would change the measurement to fair value measurement.
There is gain on extinguishment of debt because the modification is substantial and the old liability is extinguished by the replacement of a new obligation with a lower amount.
Computation in of the creditor: Future Cash Flows Principal
4,000,000
Interest
400,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
2,847,121
2.401831
960,733
PV of OA of P1
Fair value of debt instrument w/o share warrants Present value of future cash flows (recoverable amount)
3,807,853 3,807,853
Carrying amount of loan before impairment (5M + 600K) Impairment Loss
(5,600,000) (1,792,147)
JOURNAL ENTRIES Jan. 1, 20x1
Impairment Loss
1,792,147
Interest Payable Allowance for Impairment Loss(loan Rec.
ILLUSTRATION: MODIFICATION OF - SUBSTANTIAL WITH DIRECT COSTS On December 31, 20x1, ABC Co. Agreed to the following modification of its existing liability:
Reduced the principal on the loan of P5,000,000 to P4,000,000
Extended the maturity date from December 31, 20x2 to December 31, 20x4.
60,000 1,192,147
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE
Reduced the loan’s nominal interest rate of 12% to 10%.
Fees incurred directly attributable to the restructuring totaled P50,000
Interest is payable annually at each year-end. The original effective interest rate of the debt instrument is 12%.
Future Cash Flows Principal
4,000,000
Interest
400,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
2,847,121
2.401831
960,733
PV of OA of P1
Fair value of debt instrument w/o share warrants
3,807,853
The difference between the old liability and the new liability is tested for substantiality. Carrying Amount of Old Liability (5M principal + 600K)
5,000,000
Present value of modified liability
(3,807,853)
Difference
1,192,147
Divide by: Carrying amount of Old Liability
5,6000,000 23.84%
The modification is considered substantial because the modification resulted to a present value of the new obligation different by at least 10% of the present value of old obligation. Therefore, the old liability is extinguished and the gain on extinguishment is recognized after deducting the direct costs incurred on the restructuring. The new liability is also recognized.
JOURNAL ENTRIES Jan. 1, 20x1
Loan Payable-old
5,000,000
Discount on Loan Payable -new
192,147
Loan payable
4,000,000
Cash
50,000
Gain on Extinguishment of debt
1,142,147
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Dec. 31, 20x1
3,807,853
Dec. 31, 20x2
400,000
456,942
56,942
3,864,796
Dec. 31, 20x3
400,000
463,775
63,775
3,928,571
Dec. 31, 20x4
400,000
471,429
71,429
4,000,000
ILLUSTRATION: MODIFICATION OF - NOT SUBSTANTIAL, WITH DIRECT COSTS On December 31, 20x1, ABC Co. Agreed to the following modification of its existing liability:
The principal remained unchanged at P5,000,000.
Forgave the balance in accrued interest of P150,000.
Extended the maturity date from December 31, 20x2 to December 31, 20x4.
Reduced the loan’s nominal interest rate of 12% to 10%.
Fees incurred directly attributable to the restructuring totaled P50,000
Interest is payable annually at each year-end. The original effective interest rate of the debt instrument is 12%.
Future Cash Flows Principal
5,000,000
Interest
500,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
3,588,901
2.401831
1,200,916
PV of OA of P1
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Fair value of debt instrument w/o share warrants
4,759,817
The difference between the old liability and the new liability is tested for substantiality. Carrying Amount of Old Liability (5M principal + 600K)
5,150,000
Present value of modified liability
(4,759,817)
Difference
390,183
Divide by: Carrying amount of Old Liability
5,150,000 7.58%
The modification is considered not substantial because the did not result to a present value of the new obligation different by at least 10% of the present value of old obligation. Therefore, the old liability is NOT extinguished and NO gain or loss on extinguishment is recognized. The new liability is also NOT recognized. However, the direct cost incurred on the restructuring is included in carrying the amount of the old liability.
JOURNAL ENTRIES Dec. 31, 20x1
Interest Payable
150,000
Cash
50,000
on Loan Payable
100,000
The adjusted carrying amount of the old liability Face amount on loan payable on Loan Payable (150K - 50K) Carrying amount of loan - Dec. 31, 20x1
5,000,000 100,000 5,100,000
The new EIR is computed to be used in recognizing interest expense after the modification. Such rate is the rate that would exactly discount the future cash flows equal to the carrying amount of the loan as of date of modification.
The trial and error approach combined with interpolation, if needed, may be used to compute for the imputed rate of interest.
JOURNAL ENTRIES: Jan. 1, 20x1
Cash
1,000,000 Bonds Payable
Dec. 31, 20x1
Interest Expense (1M x 12%)
1,000,000 120,000
Cash Dec. 31, 20x2
120,000
Interest Expense (1M x 12%)
120,000
Cash Dec. 31, 20x3
120,000
Interest Expense (1M x 12%) Bonds Payable
120,000 1,000,000
Cash
1,120,000
ILLUSTRATION: BONDS ISSUED AT DISCOUNT On January 1, 20x1, ABC Co., issued 1,000, P1,000, 10%, 3-year bonds for P951,963. Principal is due on December 31, 20x3 but interest are due annually every year end. The effective interest rate is 12%.
SOLUTION: Face Amount of Bonds
P 1,000,000
Cash Proceeds (Issue price)
(
951,963)
Discount on Bonds Payable
P
48,037
Interest Payments = Face Amount x Nominal Interest Rate = 1,000,000 x 10% = 100,000
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
951,963
Dec. 31, 20x1
100,000
114,236
14,236
966,199
Dec. 31, 20x1
100,000
115,944
15,944
982,142
Dec. 31, 20x1
100,000
117,857
17,857
1,000,000
Unamortized Discount of Bonds Payable - Dec. 31, 20x1 = Face Amount - Carrying Amount = 1,000,000 - 966,199 = 33,801 JOURNAL ENTREIS Jan. 1, 20x1
Cash
951,963
Discount on Bonds Payable
48,963
Bonds Payable Dec. 31, 20x1
Interest Expense
1,000,000 114,236
Cash
100,000
Discount on Bonds Payable Dec. 31, 20x2
Interest Expense Cash
14,236 115,944 100,000
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Discount on Bonds Payable Dec. 31, 20x3
15,944
Interest Expense
117,857
Bonds Payable
1,000,000
Cash
1,100,000
Discount on Bonds Payable
17,857
ILLUSTRATION: BONDS ISSUED AT A On January 1, 20x1, ABC Co., issued 1,000, P1,000, 12%, 3-year bonds for P1,049,737. Principal is due on December 31, 20x3 but interest are due annually every year end. The effective interest rate is 10%.
SOLUTION: Cash Proceeds (Issue price)
P 1,049,737
Face Amount of Bonds
( 1,000,000)
on Bonds Payable
P
49,737
Interest Payments = Face Amount x Nominal Interest Rate = 1,000,000 x 10% = 120,000
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. -c)
Jan. 1, 20x1
1,049,737
Dec. 31, 20x1
120,000
104,974
15,026
1,034,711
Dec. 31, 20x1
120,000
103,471
16,529
1,018,182
Dec. 31, 20x1
120,000
101,818
18,182`
1,000,000
JOURNAL ENTREIS Jan. 1, 20x1
Cash
1,049,737 Bonds Payable
1,000,000
on Bonds Payable Dec. 31, 20x1
Interest Expense
49,737 104,974
on Bonds Payable
15,026
Cash Dec. 31, 20x2
120,000
Interest Expense
103,471
on Bonds Payable
16,529
Cash Dec. 31, 20x3
120,000
Interest Expense
101,818
on Bonds Payable Bonds Payable
18,182 1,000,000
Cash
1,120,000
ILLUSTRATION: BONDS ISSUED AT FACE AMOUNT - WITH TRANSACTION COSTS On January 1, 20x1, ABC Co., issued 10%, P1,000,000 bonds at face amount. Commission paid to underwriters amounted to P48,037. Principal is due on December 31, 20x3 but interest are due annually every year end.
SOLUTION: Bonds Payable
P 1,000.000
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Bond Issue Costs
(
48,037)
Carrying amount of Bonds Payable
P
951,963
Although the bonds are issued at face amount, it is as if there is a discount because the cash proceeds is less than the face amount of the bonds due to the transaction costs incurred.
We use trial and error to determine the EIR
FIRST TRIAL @ 11% Future Cash Flows
PV Factors @11%,
Present Value
Principal
0.73119
731,190
Annual Interest (1M x 3%)
2.44371
244,371
Totals
975,561
SECOND TRIAL @ 11% Future Cash Flows
PV Factors @12%,
Present Value
Principal
0.71178
711,780
Annual Interest (1M x 3%)
2.40183
240,183
Totals
951,963
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
951,963
Dec. 31, 20x1
100,000
114,236
14,236
966,199
Dec. 31, 20x1
100,000
115,944
15,944
982,142
Dec. 31, 20x1
100,000
117,857
17,857
1,000,000
JOURNAL ENTRIES: Jan. 1, 20x1
Cash
951,963
Bond Issue Cost
48,037
Bonds Payable Dec. 31, 20x1
Interest Expense
1,000,000 114,236
Bond Issue Cost
14,236
Cash Dec. 31, 20x2
Interest Expense
100,000 115,944
Bond Issue Cost
15,944
Cash Dec. 31, 20x3
Interest Expense Bonds Payable Bond Issue Cost Cash
100,000 117,857 1,000,000 17,857 1,100,000
ILLUSTRATION: BONDS ISSUED AT DISCOUNT - WITH TRANSACTION COSTS On January 1, 20x1, ABC Co., issued 10%, P1,000,000, 3-year bonds for P951,963 amount. Principal is due on December 31, 20x3 but interest are due annually every year end. In addition, ABC incurred bond issue costs of P44,829. The effective interest rate is 12% before adjustment for bond issue costs and 14% after adjustment for bond issue costs.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Solution: Issue Price before Bond issue cost
P 951,963
Bond Issue Costs
(
Carrying amount of Bonds Payable
P 907,134
44,829)
Discount on Notes Payable = (Face Amount - Issue Price) + Bond Issue Costs = 1,000,000 - (951,963 + 44,829) = 92,866
The bond issue costs are added to the discount on bonds payable because the bond issue costs are amortized together with the discount. - this simplifies the subsequent recording of amortization in that there is no need to allocate the amortization between the discount and the bond issue costs.
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
907,134
Dec. 31, 20x1
100,000
126,999
26,999
934,133
Dec. 31, 20x1
100,000
130,779
30,779
964,912
Dec. 31, 20x1
100,000
135,088
35,088
1,000,000
The EIR to be used is 14% -
If the bond issue costs are NOT added to the bond discount, the amortization shall be allocated to the bond issue costs and the discount based on their outstanding balances.
the rate adjusted for the bond issue costs.
Outstanding Balances
Fraction
Discount on Bonds Payable
48,037
48,037/92,866
Bond Issue Costs
44,829
44,829/92,866
Allocation of Amortization 13,966 13,033
92,866
26,999
JOURNAL ENTRIES: Jan. 1, 20x1
Cash
907,134
Discount on Bonds Payable
92,866
Bonds Payable If
1,000,000
bond issue costs are not added to the bond discount
Jan. 1, 20x1
Cash
907,134
Discount on Bonds Payable
48,037
Bond Issue Cost
44,829
Bonds Payable Dec. 31, 20x1
Interest Expense Cash
1,000,000 126,999 100,000
Discount on Bonds Payable
13,966
Bonds Issue Cost
13,033
ILLUSTRATION: BONDS ISSUED AT - WITH TRANSACTION COSTS On January 1, 20x1, ABC Co., issued 12%, P1,000,000, 3-year bonds for P1,103,084 amount. Principal is due on December 31, 20x3 but interest are due annually every year end. In addition, ABC incurred bond issue costs of P53,347. The effective interest rate before adjustment for transaction costs is 8%.
Solution:
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Issue Price before Bond issue cost
P 1,103,084
Bond Issue Costs
(
Carrying amount of Bonds Payable
P 1,049,737
55,347)
on Notes Payable = (Issue Price - Face Amount) - Bond Issue Costs = 1,103,084 - 1,000,000 - 55,347 = 49,737
The bond issue costs are deducted from the on bonds payable in order to simplify the subsequent recording of amortization.
The effective interest rate given in problem is before adjustment for transaction costs. We CANNOT use that rate. We will use trial and error to find the after adjustment EIR.
FIRST TRIAL @
10% Future Cash Flows
PV Factors @11%,
Present Value
Principal
0.751315
751,315
Annual Interest (1M x 3%)
2.48685
298,422
Totals
1,049,737
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
1,049,737
Dec. 31, 20x1
120,000
104,974
15,026
1,034,711
Dec. 31, 20x1
120,000
103,471
16,529
1,018,182
Dec. 31, 20x1
120,000
101.818
18,182
1,000,000
JOURNAL ENTREIS Jan. 1, 20x1
Cash
1,049,737 Bonds Payable
1,000,000
on Bonds Payable Dec. 31, 20x1
Interest Expense on Bonds Payable Cash
49,737 104,974 15,026 120,000
ILLUSTRATION: STRAIGHT-LINE METHOD OF AMORTIZATION On January 1, 20x1, ABC Co., issued 1,000, P1,000, 10%, 3-year bonds for P951,963. Principal is due on December 31, 20x3 but interest are due annually every year end. The effective interest rate is 12%. ABC Co., incorrectly used the straight-line method instead of the effective interest method to amortized the discount.
Erroneous amortization of discount using straight line: Face Amount of Bonds
P 1,000,000
Cash Proceeds
(
951,963)
Discount on Bonds Payable
P
44,037
Divide by: Term of bonds (in years) Annual Amortization
3 years P
16,012
Interest Expense for 20x1 recognized under straight-line method: Interest Expense = Interest Paid + Annual Amortization of Discount = (1,000,000 x 10%) + 16,012
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE = 116,012
Carrying Amount for 20x1 recognized under straight-line method: Carrying Amount -
Dec. 31, 20x1 =
Carrying Amount - Jan. 1, 20x1 + Amortization of Discount
= 951,963 + 16,012 = 967,975
AMORTIZATION TABLE UNDER EIR DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
951,963
Dec. 31, 20x1
100,000
114,236
14,236
966,199
Dec. 31, 20x1
100,000
115,944
15,944
982,142
Dec. 31, 20x1
100,000
117,857
17,857
1,000,000
Effect on Carrying Amount of Bonds as of Dec. 31, 20x1: Carrying Amounts on Dec. 31,20x1 Straight-line
967,975
Effective Interest Rate
966,199
Difference - overstatement under straight-line
1,776
Effect on 20x1 Profit: Interest Expense 20x1 Straight-line
116,012
Effective Interest Rate
114,236
Difference - overstatement under straight-line
1,776
ILLUSTRATION: PRE-ISSUANCE INTEREST On April 1, 20x1, ABC Co., issued 12%, P1,000,000 bonds dated January 1, 20x1 at 97 including accrued interest. The bonds mature in ten years and pay interest annually every year-end.
Solution: Cash proceeds including accrued interest (1M x 97%)
970,000
Accrued interest sold (1M x 12% x 3/12)
(30,000)
Carrying amount of the bonds, April 1, 20x1
940,000
The initial carrying amount of the bonds is equal to the cash proceeds EXCLUDING the accrued interest.
Alternative: the initial carrying amount of the bonds may be computed by preparing the pro-forma entry to record the issuance of the bonds payable. April 1, 20x1
Cash (1M x 97%)
970,000
Discount on bonds payable (1M - 940K)
60,000
Bonds Payable
1,000,0000
Interest Expense
30,000
Interest payable may be credited in lieu of interest expense.
Either way, total interest expense (disregard amortization of discount) in 20x1 should be limited to the post-issuance interest expense of P90,000 (1M x 12% x 9/12) Interest Expense was initially credited
Interest payable was initially credited
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE The entry to record interest expense on Dec. 31, 20x1 is:
Interest Expense
120,000
Cash
The entry to record interest expense on Dec. 31, 20x1 is:
Interest Expense
90,000
Interest Payable
30,000
120,000
Interest expense for 20x1 = 120,000 debit minus 30,000 credit on April 1, 20x1 = 90,000
Cash
120,000
Interest expense = 90,000 debit on Dec. 31, 20x1
ILLUSTRATION: PRE-ISSUANCE INTEREST On April 1, 20x1, ABC Co., issued 12%, P1,000,000 bonds dated January 1, 20x1 at 97 excluding accrued interest. The bonds mature in ten years and pay interest annually every year-end.
Solution: Cash Proceeds = Cash Proceeds excluding interest + Accrued Interest = (1M x 97%) + (1M x 12% x 3/12) = 1,000,000
Discount on Bonds Payable = Face Amount - Cash Proceeds excluding interest = 1,000,000 - 970,000 = 30,000
JOURNAL ENTREIS Jan. 1, 20x1
Cash
1,000,000
Discount of Bonds
30,000
Bonds Payable
1,000,000
Interest Expense
30,0000
Accrued interest sold increases the proceeds from issuance BUT should NOT affect the initial carrying amount of the bonds.
The initial carrying amount of the bonds is equal to the issue price excluding the accrued interest sold.
ILLUSTRATION: ISSUE PRICE OF BONDS - ISSUANCE ON INTEREST DATE ABC Co., is contemplating on issuing 12%, 3-year, P1,000,000 bonds. Principal is due at maturity but interest is due annually at each year-end. ABC determines that the current market rate on January 1, 20x1 is 10%.
Solution: Issue Price of Bonds = Present value of cash flows or (Future Cash Flows x PV Factor) Future Cash Flows Principal Annual Interest
PV Factors @11%,
Present Value
1,000,0000
0.751315
751,315
120,000
2.486852
298,422
Totals
1,049,737
ILLUSTRATION: ISSUE PRICE OF BONDS - ISSUANCE IN BETWEEN INTEREST DATES ABC Co., is contemplating on issuing 12%, 3-year, P1,000,000 bonds on April 1, 20x1. Principal is due at maturity but interest is due annually at each year-end. ABC determines that the current market rate on January 1, 20x1 is 10%.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE
The issue price on April 1, 20x1 is computed simply by amortizing the issue price on January 1, 20x1 up to April 1, 20x1.
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR x 3/12)
(b-a)
(Prev. Bal. -c)
Jan. 1, 20x1
1,049,737
Apr. 1, 20x1
30,000
26,243
3,757
1,045,980
The estimated issue price pertaining only to the bonds on April 1, 20x1 is P1,045,980.
However, since the bonds are issued in between interest dates, the total cash proceeds from the issuance of the bonds will necessarily include the accrued interest sold. The total issue price is computed by adding the accrued interest sold to the computed issue price of the bonds only. Issue Price pertaining to bonds only
1,045,980
Accrued interest sold
30,000
Total Issue Price or Cash Proceeds
1,075,980
ALTERNATIVE: computing first the full amortization for the period of issue. The full amortization is then allocated to the period prior to the expected date of issuance. AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
1,049,737
Dec. 31, 20x1
120,000
104,974
15,026
Carrying Amount as of January 1, 20x1
1,034,711
1,049,737
amortization up to April 1, 20x1 (15,206 x 3/12) Issue price pertaining to bonds only, April 1, 20x1 Accrued interest sold
(3,802) 1,045,936 30,000
Total issue price or cash proceeds
1,075,936
ILLUSTRATION: RETIREMENT OF BONDS - BOND REFUNDING On January 1, 20x1, ABC Co., issued new bonds with face amount of P10M for P10,800,000. ABC used the proceeds to retire an existing 10-year, 12%, P8,000,000 bond issued five years earlier. The bonds have an unamortized discounts of P340,000 on January 1, 20x1. ABC retired the entire outstanding bonds at a call of P400,000. Costs incurred that are directly attributable to the retirement amounted to P50,000. ABC has an income tax rate of 30%.
Solution: Face Amount of bonds retired
8,000,000
Unamortized discount, January 1, 20x1
( 340,000)
Carrying amount of bonds retired Face amount of bonds retired
7,660,000 8,000,000
Call
400,000
Expense of reacquisition
50,000
Retirement Price (Call Price)
8,450,000
Loss on Extinguishment of Bonds
( 790,000)
JOURNAL ENTREIS Issuance of the new bonds
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Jan. 1, 20x1
Cash
10,8000,000 Bonds Payable
10,000,000
on Bonds Payable
800,000
The gain or loss on extinguishment may be squeezed by preparing the extinguishment entry: Jan. 1, 20x1
Bonds Payable
8,000,000
Loss on Extinguishment of bonds (squeezed)
790,000
Discount of Bonds Payable
340,000
Cash
8,450,000
Notice that the loss is recognized at gross of tax. Netting of tax is normally permitted only for results of discounted operations, items of OCI, and retrospective adjustments to the beginning balance of retained earnings.
ILLUSTRATION: RETIREMENT OF BONDS On January 1, 20x1, ABC Co., issued 5-year, 12%, P1,000,000 bonds for P1,075,816. Principal is due at maturity but interest are die annually. The effective interest rate is 10%. On July 1, 20x3, ABC called in the entire bonds and retired them at 102. The retirement price includes payments for accrued interest. AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
1,075,816
Dec. 31, 20x1
120,000
107,,582
12,418
1,063,398
Dec. 31, 20x2
120,000
106,340
13,660
1,049,737
July 1, 20x3
60,000
52,487
7,513
1,042,224
Solution: Carrying amount of bonds retired
1,042,224
Retirement price including payment for Accrued Interest (1M x 102%)
1,020,000
Accrued Interest
( 60,000)
Retirement Price (Call Price)
960,000
Gain on Extinguishment of Bonds
82,224
JOURNAL ENTREIS The entry to update the carrying amount of the bonds payable July. 1, 20x1
Interest Expense on Bonds Payable
52,587 7,513
Interest Payable
60,000
The entry to record the extinguishment July. 1, 20x1
Bonds Payable
1,000,000
Interest Payable
60,000
on Bonds Payable
42,224
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Cash
1,020,000
Gain on Extinguishment of bonds
82,224
on Bonds Payable = 1,042,224 - 1,000,000 = 42,224
Since the bonds are retired in between interest payment sates, the retirement price necessarily includes payments for accrued interest.
The portion pertaining to the payment for the accrued interest must be excluded so that the gain or loss may be properly computed.
ILLUSTRATION: SERIAL BONDS - ISSUED AT DISCOUNT On January 1, 20x1, ABC Co., issued 10%, P3,000,000 bonds for P2,900,305. Principal on the bonds matures in three equal annual installments. Interest is also due annually at each year-end. The effective interest rate on the bonds is 12%.
Solution: Annual Cash Flows Date
Principal Payments
+
Interest Payments
=
Total Payments/Cash Flows
(Outstanding Bal. X Nominal Rate)
Dec. 31, 2ox1
1,000,000
3M x 10% = 300,000
1,300,000
Dec. 31, 2ox2
1,000,000
2M x 10% = 200,000
1,200,000
Dec. 31, 2ox3
1,000,000
1M x 10% = 100,000
1,100,000
AMORTIZATION TABLE DATE
ANNUALT PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
2,900,305
Dec. 31, 20x1
1,300,000
348,037
951,963
1,948,342
Dec. 31, 20x2
1,200,000
233,801
966,199
982,143
Dec. 31, 20x3
1,100,000
117,857
982,143
0
JOURNAL ENTREIS Jan. 1, 20x1
Cash
2,900,305
Discount on Bonds Payable
99,695
Bonds Payable Dec. 31, 20x1
Interest Expense Bonds Payable
3,000,000 348,037 1,000,000
Cash
1,300,000
Discount on Bonds Payable (squeezed) Dec. 31, 20x1
Interest Expense Bonds Payable
233,801 1,000,000
Cash
1,200,000
Discount on Bonds Payable (squeezed) Dec. 31, 20x1
Interest Expense Bonds Payable
48,037
33,801
117,857 1,000,000
Cash Discount on Bonds Payable (squeezed)
1,100,00 17,857
ILLUSTRATION: ADJUSTMENT TO EFFECTIVE INTEREST RATE - SERIAL BONDS On January 1, 20x1, ABC Co., issued 10%, P3,000,000 bonds at 105. Transaction costs incurred amounted to P44,274. Principal on the bonds matures in three equal annual installments. Interest is also due annually at each year-end.
Carrying amount of Bonds = (Face Amount x Issued %) - Transaction costs
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE = (P3,000,000 x 105%) - P44,274 = 3,105,726
on Bonds Payable = (Face Amount x Issued %) - Face Amount - Transaction costs = (P3,000,000 x 105%) - P3,000,000 - P44,274 = 105,726
Annual Cash Flows Date
Principal Payments
+
Interest Payments
=
Total Payments/Cash Flows
(Outstanding Bal. X Nominal Rate)
Dec. 31, 2ox1
1,000,000
3M x 10% = 300,000
1,300,000
Dec. 31, 2ox2
1,000,000
2M x 10% = 200,000
1,200,000
Dec. 31, 2ox3
1,000,000
1M x 10% = 100,000
1,100,000
The bond issue costs are deducted from the in order to simplify the subsequent recording of amortization.
To amortized we need to use EIR, since EIR is not given we need to do trial and error to determine EIR.
First Trial @ 9%
Date
Future Cash Flows
x
PV of 1 @ 9%, n= 1-3
=
Present Value
Dec. 31, 2ox1
1,300,000
0.91743
1,192,659
Dec. 31, 2ox2
1,200,000
0.84168
1,010,016
Dec. 31, 2ox3
1,100,000
0.77218
849,398
Total
3,052,073
Second Trial @ 8% Date
Future Cash Flows
x
PV of 1 @ 8%, n= 1-3
=
Present Value
Dec. 31, 2ox1
1,300,000
0.925926
1,203,704
Dec. 31, 2ox2
1,200,000
0.857339
1,028,807
Dec. 31, 2ox3
1,100,000
0.793832
873,215
Total
3,105,726
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
3,105,726
Dec. 31, 20x1
1,300,000
248,458
1,051,542
2,054,184
Dec. 31, 20x2
1,200,000
164,335
1,035,665
1,018,518
Dec. 31, 20x3
1,100,000
82,482
1,018,518
0
JOURNAL ENTREIS Jan. 1, 20x1
Cash
3,105,726 Bonds Payable
3,000,000
on Bonds Payable Dec. 31, 20x1
Interest Expense on Bonds Payable Bonds Payable
105,726 248,458 51,542 1,000,000
Cash Dec. 31, 20x2
Interest Expense on Bonds Payable Bonds Payable
1,300,000 164,335 35,665 1,000,000
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Cash Dec. 31, 20x3
1,200,000
Interest Expense
82,482
on Bonds Payable
18,518
Bonds Payable
1,000,000
Cash
1,100,000
amortization = Interest Payment - Interest Expense = 300,000 - 248,458 = 51,542
ILLUSTRATION: ISSUE PRICE OF SERIAL BONDS On January 1, 20x1, ABC Co., contemplates on issuing 10%, P3,000,000 bonds. Principal on the bonds matures in three equal annual installments. Interest on the outstanding principal balance is also payable annually at each year-end. The effective interest rate on the bonds is 12%.
Annual Cash Flows Date
Principal Payments
+
Interest Payments
=
Total Payments/Cash Flows
(Outstanding Bal. X Nominal Rate)
Dec. 31, 2ox1
1,000,000
3M x 10% = 300,000
1,300,000
Dec. 31, 2ox2
1,000,000
2M x 10% = 200,000
1,200,000
Dec. 31, 2ox3
1,000,000
1M x 10% = 100,000
1,100,000
Present Value Date
Future Cash Flows
x
PV of 1 @ 12%, n= 1-3
Dec. 31, 2ox1
1,300,000
0.892857
1,160,714
Dec. 31, 2ox2
1,200,000
0.797194
956,633
Dec. 31, 2ox3
1,100,000
0.711780
782,958
Total
=
Present Value
2,900,305
The estimated issue price of the bonds on January 1, 20x1 is P 2,900,305.
ILLUSTRATION: ZERO-COUPON BONDS On January 1, 20x1, ABC Co., issued 10%, P3,000,000 bonds at a yield to maturity interest of 18%. Principal and interest are due on December 31, 20x3.
First compute for the Future Cash Flows/ Future Payments of Bonds using ordinary annuity and nominal rate Face Amount
P 3,000,000
FV of OA of P1 @ 10%, n=3
1.331
Maturity Value of the Bonds (Future Cash Flows)
P 3,993,000
Then compute for the Present Value of the Bonds using the yield rate of 18% and PV of P1 Future Cash Flows
P 3,993,000
PV of P1 @ 18%, n=3
0.6086309
Present Value of Bonds
P 2,430,263
AMORTIZATION TABLE DATE
Jan. 1, 20x1
INTEREST EXPENSE (a)
PV of Cash Flows (b)
Interest Payable ©
AMORTIZATION (d)
PRESENT VALUE (e)
(b x EIR)
(Prev. Bal. + a)
[NR x (Principal + Accrued interest)
(a-c)
(Prev. Bal. + d)
2,430,263
2,430,263
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Dec. 31, 20x1
437,447
2,867,710
300,000
137,447
2,567,710
Dec. 31, 20x2
516,188
3,383,898
330,000
186,188
2,753,898
Dec. 31, 20x3
609,102
3,993,000
363,000
246,102
3,000,000
JOURNAL ENTREIS Jan. 1, 20x1
Cash
2,430,263
Discount on Bonds Payable
569,736
Bonds Payable Dec. 31, 20x1
Dec. 31, 20x2
Dec. 31, 20x3
3,000,000
Interest Expense
437,447
Discount on Bonds Payable
137,447
Interest Payable
300,000
Interest Expense
516,188
Discount on Bonds Payable
186,188
Interest Payable
330,000
Interest Expense
609,102
Discount on Bonds Payable
246,102
Interest Payable
363,000
Bonds Payable
3,000,000
Interest Payable (300 + 330 + 363)
993,000
Cash
3,993,000
ILLUSTRATION: AMORTIZATION OF CALLABLE BONDS On January 1, 20x1, ABC Co., issued 5-year, 10%, P1,000,000 callable bonds at a discount of P33,801. Principal is due on December 31, 2x5 but interest are due annually at each year-end. The bond indenture restricts the issuer to call the bonds during the first 2 years. On issuance date, ABC expects to call the bonds on January 1, 20x3, upon the lapse of 2 year restriction. The effective interest rate is 12%.
Carrying Amount of Bond = Face Amount - Discount = P1,000,000 - P33,801 = 966,199 AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
966,199
Dec. 31, 20x1
100,000
115,944
15,944
982,143
Dec. 31, 20x2
100,000
117,857
17,857
1,000,000
JOURNAL ENTREIS Jan. 1, 20x1
Cash
966,199
Discount on Bonds Payable
33,801
Bonds Payable Dec. 31, 20x1
1,000,000
Interest Expense
115,944
Discount on Bonds Payable
15,944
Interest Payable Dec. 31, 20x2
100,000
Interest Expense
117,857
Discount on Bonds Payable Interest Payable Assume that the bonds were in fact called-in
17,857 100,000
for redemption on Jan. 1,20x3 @ 101
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Jan. 1, 20x3
Bonds Payable
1,000,000
Loss on redemption of Bonds
10,000
Cash
1,010,000
Assume that the bonds were not called-in for redemption on Jan. 1,20x3. Dec. 31, 20x3
Interest Expense
100,000
Cash
100,000
ILLUSTRATION: REDEEMABLE PREFERENCE SHARES On January 1, 20x1, ABC Co., issued redeemable 6% preference shares with aggregate par value of P1,000,000 for P880,000. transaction costs incurred amounted to P17,391. Bondholders can present the preference shares to ABC for redemption at any time beginning January 1, 20x3. Based on ABC’s past experience, most redeemable preference shares are presented for redemption after 5 years. The effective interest rate is 3%.
Cash Proceeds/Carrying Amount = RPS issued price - transaction costs = P880,000 - P17,391 = 862,609 Or Carrying Amount = Face Amount of RPS - Discount on RPS = P1,000,000 - 137,391 = 862,609
Discount on RPS = Face amount of RPS - Cash Proceeds = P1,000,000 - 862,609 = 137,391
The transaction costs are treated as valuation item (included in discount) because RPS are considered as liability.
AMORTIZATION TABLE DATE
INTEREST EXPENSE (a) (c x EIR)
DISCOUNT AMORTIZATION (b)
PRESENT VALUE (c) (Prev. Bal. + a)
(prev. Bal. - a)
Jan. 1, 20x1
137,391
862,609
Dec. 31, 20x1
25,878
111,513
888,487
Dec. 31, 20x2
26,655
84,858
915,142
Dec. 31, 20x3
27,454
57,404
942,596
Dec. 31, 20x4
28,278
29,126
970,874
Dec. 31, 20x5
29,126
-
1,000,000
JOURNAL ENTRIES Jan. 1, 20x1
Cash
862,609
Discount on Bonds Payable
137,391
Redeemable Preference Shares Dec. 31, 20x1
1,000,000
Interest Expense
25,878
Discount on RPS
25,878
Assume that ABC Co., declares dividends on March 31, 20x2 March 31, 20x2
Interest Expense (P1M x 6%) Cash
60,000 60,000
Dividends are recognized as interest expense and charged to profit or loss
Assume that the preference shares are redeemed at a of P100,000 on Dec. 31, 20x5
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Dec. 31, 20x5
Redeemable Preference Shares
1,000,000
Loss on Redemption of PS
100,000
Cash
1,100,000
Assume that the RPS are presented for redemption on Dec. 31, 20x3 at a of P200K. Dec. 31, 20x3
Redeemable Preference Shares
1,000,000
Loss on Redemption of PS
257,404
Discount on RPS
57,504
Cash
1,200,000
ILLUSTRATION: ISSUE OF CONVERTIBLE BONDS On January 1, 20x1, ABC Co., issued its 10%, 3-year, P1,000,000 convertible bonds for the face amount of P1,000,000. Each P1,000 bond is convertible into 8 shares with par value of P100 per share. When the bonds were issued, they were selling at 98 without the conversion option. ABC incurred P50,000 transaction costs on the issue of the bonds.
Equity Component = Issue Price - Fair Value of Debt Instrument without equity feature = P1,000,000 - (1,000,000 x 98%) = 20,000
Transaction Costs Allocations Component
Allocated Amount from Issue Price
Debt Component
980,000
Equity Component
20,000
Fraction
x
Transaction Costs
980K/1M
Allocation of Transaction Costs
50,000
20K/1M
1,000,000
=
49,000
50,000
1,000
1M/1M
50,000
Carrying amount of the Debt and Equity Components Debt Components
Equity Components
Totals
Allocation of Issue Price
980,000
20,000
1,000,000
Allocation of Transaction Costs
( 49,000)
(1,000)
(50,000)
Net Carrying Amounts
931,000
19,000
950,000
JOURNAL ENTRIES SIMPE ENTRIES Jan. 1, 20x1
Cash
1,000,000
Discount on Bonds Payable
20,000
Bonds Payable
1,000,000
Share - conversion feature Jan. 1, 20x1
Discount on Bonds Payable Share - conversion Feature
20,000 49,000 1,000
Cash
50,000
COMPOUND ENTRY Jan. 1, 20x1
Cash Discount on Bonds Payable (1M - 931K) Bonds Payable Share - conversion feature
950,000 69,000 1,000,000 19,000
ILLUSTRATION: CONVERSION OF CONVERTIBLE BONDS On January 1, 20x1, ABC Co., issued its 10%, 3-year, P1,000,000 convertible bonds at 105. Each P1,000 bond is convertible into 8 shares with par value of P100 per share. Principal is due on December 31, 20x3 but interest are due annually at each year-end. When bonds were issued, they were selling at a yield to maturity market ate of 12% without the conversion option.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE On December 31, 20x2, all of the bonds were converted into equity. Conversion costs incurred amounted to P20,000.
Fair Value of the Bond without the conversion option Future Cash Flows Principal
1,000,000
Interest
100,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
711,780
2.401831
240,183
PV of OA of P1
Fair value of debt instrument w/o conversion feature
951,963
Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument without equity feature = (P1,000,000 x 105%) - 951,963 = 98,037 AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
951,963
Dec. 31, 20x1
100,000
114,236
14,236
966,199
Dec. 31, 20x2
100,000
115,944
15,944
982,143
Dec. 31, 20x3
100,000
117,857
17,857
1,000,000
JOURNAL ENTRIES Jan. 1, 20x1
Cash
1,050,000
Discount on Bonds Payable
48,037
Bonds Payable
1,000,000
Share - conversion feature Dec. 31, 20x1
Interest Expense
98,037
114,236
Discount on Bonds Payable
14,236
Cash Dec. 31, 20x2
100,000
Interest Expense
115,944
Discount on Bonds Payable
15,944
Cash
100,000
Entries to record conversion Dec. 31, 20x2
Bonds Payable
1,000,000
Discount on Bonds Payable
17,857
Share Capital [(8 shares x 1,000) x 100]
800,000
Share (squeezed)
182,143
Share
20,000
Cash
Share - conversion feature Share Discount on Bonds Payable - Jan.1, 20x1= 1,000,000 - 951,963 = 48,037 Discount on Bonds Payable - Dec. 31, 20x2= 1,000,000 - 982,143 = 17,857 Share = Bonds Payable - Unamortized Discount - Share Capital
20,000
98,037 98,037
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE = 1,000,000 - 17,857 - 800,000 = 182,143
The conversion of the bonds is ed for as equity set-off meaning, the carrying amount of the bonds is simply derecognized, the aggregate par value of the shares issued is credited to “share capital” and the difference is credited to “Share ”. NO gain or loss is recognized on the conversion.
The share issuance costs are treated as a reduction to share .
The “share -conversion feature” is closed to the “Share ” general because all of the conversion privilege has been exercised.
Prior to the conversion of the bonds, the “share -conversion feature” is part of the share but described as pertaining to the conversion feature. When the conversion feature is exercised, such amount is just reclassified within share .
The conversion increased equity by the carrying amount of bonds on conversion date less the transaction costs incurred on the conversion. Carrying amount of bonds on date of conversion
982,143
Conversion costs
( 20,000)
Net Increase in Equity
962,143
Increase in share capital
800,000
Net increase in share (280,180 - 20,000)
260,180
Decrease in share - conversion feature
(98,037)
Net Increase in Equity
962,143
ILLUSTRATION: PARTIAL CONVERSION OF CONVERTIBLE BONDS On January 1, 20x1, ABC Co., issued its 12%, 3-year, P1,000,000 convertible bonds at 110. Each P1,000 bond is convertible into 8 shares with par value of P100 per share. Principal is due on December 31, 20x3 but interest are due annually at each year-end. When bonds were issued, they were selling at a yield to maturity market ate of 10% without the conversion option. On December 31, 20x2, half of the bonds were converted into equity. Conversion costs incurred amounted to P20,000.
Fair Value of the Bond without the conversion option Future Cash Flows Principal
1,000,000
Interest
100,000
PV @ 10%, n=3
PV Factors
Present Value
PV of P1
0.751315
751,315
2.486852
298,422
PV of OA of P1
Fair value of debt instrument w/o conversion feature
1,049,737
Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument without equity feature = (P1,000,000 x 110%) - 1,049,737 = 50,263
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1 Dec. 31, 20x1
1,049,737 120,000
104,974
15,026
1,034,711
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Dec. 31, 20x2
120,000
103,471
16,529
1,018,182
Dec. 31, 20x3
120,000
101,818
18,182
1,000,000
JOURNAL ENTRIES Jan. 1, 20x1
Cash
1,100,000
Bonds Payable
Dec. 31, 20x1
1,000,000
on Bonds Payable
49,737
Share - conversion feature
50,263
Interest Expense
104,974
on Bonds Payable
15,026
Cash Dec. 31, 20x2
120,000
Interest Expense
103,471
on Bonds Payable
16,529
Cash
120,000
Entries to record conversion Dec. 31, 20x2
Bonds Payable
500,000
on Bonds Payable (18,182 x 1/2)
9,091
Share Capital [(8 shares x 500) x 100]
400,000
Share (squeezed)
109,091
Share
20,000
Cash
Share - conversion feature Share
20,000
25,132 25,132
on Bonds Payable - Jan.1, 20x1= 1,049,737 - 1,000,000 = 49,737 Share = Bonds Payable + Unamortized - Share Capital = 500,000 + 9,091 - 400,000 = 109,091
Credit to share capital
400,000
Credit to share (109,091+ 25,132)
134,223
Debit to share for the stock issuance costs
(20,000)
Debit to share - conversion feature
(25,132)
Net Increase in Equity
489,091
Credit to share (109,091- 25,132)
134,223
Debit to share for the stock issuance costs
(20,000)
Net Increase in Share General
114,223
ILLUSTRATION: CONVERSION IN BETWEEN INTEREST PAYMENT DATES On January 1, 20x1, ABC Co., issued its 12%, 3-year, P1,000,000 convertible bonds at 110. Each P1,000 bond is convertible into 8,000 shares with par value of P100 per share. Principal is due on December 31, 20x3 but interest are due annually at each year-end. At issuance date, the bonds are selling at P1,049,737 without the conversion privilege. The effective interest rate is 10%. On July 1, 20x2, all of the bonds were converted into equity. Conversion costs incurred amounted to P20,000. The accrued interest is settled separately in cash.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument without equity feature = (P1,000,000 x 110%) - 1,049,737 = 50,263 AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. - c)
Jan. 1, 20x1
1,049,737
Dec. 31, 20x1
120,000
104,974
15,026
1,034,711
July 1, 20x2
60,000
51,736
8,264
1,026,446
JOURNAL ENTRIES Jan. 1, 20x1
Cash
1,100,000
Bonds Payable
Dec. 31, 20x1
1,000,000
on Bonds Payable
49,737
Share - conversion feature
50,263
Interest Expense
104,974
on Bonds Payable
15,026
Cash July 1, 20x2
120,000
Interest Expense
51,736
on Bonds Payable
8,264
Cash
60,000
COMPOUND ENTRY to record conversion July 1, 20x2
Bonds Payable
1,000,000
on Bonds Payable (1,026,446 - 1M)
24,446
Share -conversion feature
50,263
Share Capital [(8000 x 100]
800,000
Cash
20,000
Share (squeezed)
256,709
ILLUSTRATION: RETIREMENT OF CONVERTIBLE BONDS On January 1, 20x1, ABC Co., issued its 10%, 3-year, P1,000,000 convertible bonds for P1,100,000. Principal is due at maturity but interest is payable every year-end. The bonds are convertible into 6,000 ordinary shares with par value of P100 per share. At the issuance date, the prevailing market rate of interest for similar debt without conversion feature is 12%. On December 31, 20x2, all of the convertible bonds were retired for P1,000,000. The prevailing rate of interest on a similar instrument as of December 31, 20x2 is 11% without the conversion feature.
Fair Value of the Bond without the conversion option Future Cash Flows Principal
1,000,000
Interest
100,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
711,780
2.401831
240,183
PV of OA of P1
Fair value of debt instrument w/o conversion feature
Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument without equity feature = P1,100,000 - 951,963 = 148,037
951,963
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Jan. 1, 20x1
951,963
Dec. 31, 20x1
100,000
114,236
14,236
966,199
Dec. 31, 20x2
100,000
115,944
15,944
982,143
Dec. 31, 20x3
100,000
117,857
17,857
1,000,000
JOURNAL ENTRIES Jan. 1, 20x1
Cash
1,100,000
Discount on Bonds Payable
48,037
Bonds Payable
1,000,000
Share - conversion feature Dec. 31, 20x1
Interest Expense
114,236
Discount on Bonds Payable
14,236
Cash
148,037
100,000
On retirement date, the retirement price is allocated to the liability and equity components for purposes of determining gain or loss on extinguishment of debt. The allocation procedure is similar to the allocation of issue price. Fair Value of the Bond without the conversion option on retirement date Future Cash Flows Principal
PV @ 11%, n=1
1,000,000
Interest
PV Factors
PV of P1
100,000
PV of OA of P1
0.900901
900,901
0.900901
90,090
Fair value of debt instrument w/o conversion feature
Equity component = Total Retirement Price = 1,000,000
Present Value
990,991
- Fair value of the bonds without conversion feature
- 990,991 = 9,009
Gain (loss) on Extinguishment = Carrying amount of bonds on Retirement date - Retirement price allocated to bonds = 982,143 - 990,991 = (8,848) Dec. 31, 20x2
Bonds Payable
1,000,000
Share -conversion feature Loss on Extinguishment of Bonds Discount on BP (1M - 982,143) Cash
Equity component allocated from issue price
Amount permanently closed to share
8,848 17,857 1,000,000
Share (squeezed)
Equity component allocated from the retirement price
148,037
139,082
148,037 (
9,009) 139,028
The equity component is closed to the share general because the conversion feature is forfeited by the extinguishment of the convertible bonds.
The equity component remains in equity regardless of whether the conversion feature is exercised or not. However, the equity component is reduced by the amount of retirement price allocated to the equity component.]
ILLUSTRATION: PARTIAL RETIREMENT OF CONVERTIBLE BONDS
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE On January 1, 20x1, ABC Co., issued its 10%, 3-year, P1,000,000 convertible bonds for P1,100,000. Principal is due at maturity but interest is payable every year-end. The bonds are convertible into 6,000 ordinary shares with par value of P100 per share. At the issuance date, the prevailing market rate of interest for similar debt without conversion feature is 12%. On December 31, 20x2, half of the convertible bonds were retired for P500,000. The prevailing rate of interest on a similar instrument as of December 31, 20x2 is 11% without the conversion feature.
Fair Value of the Bond without the conversion option on retirement date Future Cash Flows Principal
1,000,000
Interest
100,000
PV @ 11%, n=1 PV of P1 PV of OA of P1
PV Factors
Present Value
0.900901
900,901
0.900901
90,090
Fair value of debt instrument w/o conversion feature
Equity component = Total Retirement Price = 500,000
-
990,991
- Fair value of the bonds without conversion feature
495,496 = 4,504
Gain (loss) on Extinguishment = Carrying amount of bonds on Retirement date - Retirement price allocated to bonds = 491,072 - 495,496 = (4,425) Dec. 31, 20x2
Bonds Payable
500,000
Share -conversion feature
74,019
Loss on Extinguishment of Bonds
4,425
Discount on BP (500K - 491,072)
8,929
Cash
500,000
Share (squeezed)
69,515
ILLUSTRATION: BONDS WITH DETACHABLE SHARE WARRANTS On January 1,20x1, ABC Co., issued a 3-year, 10%, 1,000, P1,000 bonds at 97. Each bond has one detachable share warrant entitling the holder to buy 10 shares of ABC with par value of P100 at P120 per share. Shortly after issuance, the bonds are selling at 95 ex-warrants.
Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument ex-warrants = (1,000 x P1,000 x 97%) - (1,000 x P1,000 x 95%) = 20,000 JOURNAL ENTRIES Jan. 1, 20x1
Cash
970,000
Discount on Bonds Payable (1M - 950K) Bonds Payable
50,000 1,000,000
Share - warrant outstanding
20,000
Assuming half of the warrants exercised on September 21, 20x1 Sep. 21, 20x1
Cash (1,000 x 10 x 1/2 x P120) Share - warrants outs. (20k x 1/1)
600,000 10,000
Share Capital (1K x 10 x 1/2 x P100)
500,000
Share
110,000
Assume half of the warrants expired on December 31, 20x2 Dec. 31, 20x2
Share - warrants outs. (20k x 1/1) Share
10,000 10,000
Regardless of whether the warrants are exercised or not, the amount allocated to the equity component remains in equity.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE
When the warrants are exercised or when they expire, the value assigned to the warrants is transferred to the general share because by then, the warrant are not outstanding anymore.
ILLUSTRATION: BONDS WITH DETACHABLE SHARE WARRANTS On January 1,20x1, ABC Co., issued a 3-year, 12%, P1,000,000 bonds for P1,100,000. Each 1,000 bond has two detachable warrant entitling the holder to purchase one share of ABC with par value of P500 at P520 per share. Without the warrants, the bonds are selling at a yield to maturity rate of 10%. On September 21, 20x1, all of the share warrant were exercised.
Fair Value of the Bond without the conversion option Future Cash Flows Principal
1,000,000
Interest
120,000
PV @ 10%, n=3
PV Factors
Present Value
PV of P1
0.751315
751,315
2.486852
298,422
PV of OA of P1
Fair value of debt instrument w/o share warrants
1,049,737
Issue Price allocation Equity Component = Issue Price - Fair Value of Debt Instrument without the warrants = P1,100,000 - P1,049,737 = 50,263 JOURNAL ENTRIES Jan. 1, 20x1
Cash
1,100,000
Bonds Payable
1,000,000
on Bonds Payable
49,737
Share - conversion feature
50,263
Entry to record the exercise of all of the share warrants Dec. 31, 20x1
Cash (1M/1K x 2 x P520)
1,040,000
Share - Warrant Outs.
50,263
Share Capital (1M/1K x 2 x 500)
1,000,000
Share
90,263
ILLUSTRATION: TRANSFER OF NONCASH ASSET ABC Co., owes XYZ Bank P1,000,000 plus accrued interest of P90,000. The unamortized discount on the loan is P20,000. The debt is a 10-year, 12% loan. During 20x1, ABC’s business deteriorated due to loss of demand for its services. On December 31, 20x1, XYZ Bank agrees to accept old equipment and cancel the entire debt. The equipment has a cost of P3,000,000, accumulated depreciation of P2,200,00 and fair value of P900,000.
JOURNAL ENTRIES Jan. 1, 20x1
Loan Payable
1,000,000
Interest Payable
90,000
Accumulated Depreciation
2,200,000
Discount on loan payable
20,000
Equipment
3,000,000
Gain on Extinguishment of debt (squeezed)
Fair value of non cash asset transferred is ignored. Carrying amount of liability (1M - 20K + 90K)
P 1,070,000
Carrying amount of noncash asset transferred (3M - 2.2M) Gain (loss) on extinguishment of debt
(800,000) P
270,000
270,000
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE
ILLUSTRATION: EQUITY SWAP - WITH FAIR VALUE OF SECURITIES On December 31, 20x1, ABC Co., issued 10,000 shares with par value of P100 per share in settlement of a P1,000,000 loan payable with a related unamortized discount of P20,000, and accrued interest of P90,000. On December 31, 20x1, the shares are selling at P120 per share.
Carrying amount of liability (1M - 20K + 90K)
P 1,070,000
Fair value of securities issued (10,000 x P120)
( 1,200,000)
Gain (Loss) on extinguishment of debt
(P 130,000)
JOURNAL ENTRIES Jan. 1, 20x1
Loan Payable
1,000,000
Interest Payable
90,000
Loss on extinguishment
130,000
Discount on loan payable
20,000
Share Capital (10,000 x P100)
1,000,000
Share [(120-100) x 10,000]
200,000
ILLUSTRATION: EQUITY SWAP - FAIR VALUE OF SECURITIES NOT DETERMINABLE On December 31, 20x1, ABC Co., issued 10,000 shares with par value of P100 per share in settlement of a 12%, P1,000,000 loan payable with a related unamortized discount of P20,000, and accrued interest of P90,000. The remaining term of the loan is 3-years. The fair value of the shares is not reliably determinable. The prevailing market rate for similar dept on December 31, 20x1 is 8%.
Fair Value of the Financial liability extinguished Future Cash Flows Principal
1,000,000
Interest
120,000
PV @ 8%, n=3 PV of P1 PV of OA of P1
PV Factors
Present Value
0.793832
793,832
2.577097
309,252
Fair value of debt instrument w/o share warrants
1,103,084
JOURNAL ENTRIES Jan. 1, 20x1
Loan Payable
1,000,000
Interest Payable
90,000
Loss on extinguishment
33,084
Discount on loan payable Share Capital (10,000 x P100) Share
20,000 1,000,000 103,084
Carrying amount of liability (1M - 20K + 90K)
P 1,070,000
Fair value of securities issued (10,000 x P120)
( 1,103,084)
Gain (Loss) on extinguishment of debt
(P
33,084)
ILLUSTRATION: MODIFICATION OF - SUBSTANTIAL On December 31, 20x1, ABC Co. Agreed to the following modification of its existing liability:
Reduced the principal on the loan of P5,000,000 to P4,000,000
Forgave the accrued interest of P600,000
Extended the maturity date from December 31, 20x2 to December 31, 20x4.
Reduced the loan’s nominal interest rate of 12% to 10%.
Interest is payable annually at each year-end. The original effective interest rate of the debt instrument for Both ABC and its creditor, the Bank, is 12%. The prevailing market rate of interest as of December 31, 20x1 is 11%.
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE
Future Cash Flows Principal
4,000,000
Interest
400,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
2,847,121
2.401831
960,733
PV of OA of P1
Present Value of Modified Liability
3,807,853
The difference between the old liability and the new liability is tested for substantiality. Carrying Amount of Old Liability (5M principal + 600K)
5,600,000
Present value of modified liability
(3,807,853)
Difference
1,792,147
Divide by: Carrying amount of Old Liability
5,6000,000 32%
The modification is considered substantial because the modification resulted to a present value of the new obligation different by at least 10% of the present value of old obligation. Therefore, the old liability is extinguished and the difference of P1,792,147 is recognized as gain on extinguishment. The new liability is recognized also.
JOURNAL ENTRIES Jan. 1, 20x1
Loan Payable-old
5,000,000
Interest Payable
600,000
Discount on Loan Payable -new
192,147
Loan payable
4,000,000
Gain on Extinguishment of debt
1,792,147
Discount on Loan Payable - New = 4,000,000 - 3,807,853 = 192,147
The future cash flows on the modified liability are discounted using the original EIR on the old liability. The prevailing interest rate on date of modification is ignored. This is because the liability is measured at amortized cost. Using the current rate would change the measurement to fair value measurement.
There is gain on extinguishment of debt because the modification is substantial and the old liability is extinguished by the replacement of a new obligation with a lower amount.
Computation in of the creditor: Future Cash Flows Principal
4,000,000
Interest
400,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
2,847,121
2.401831
960,733
PV of OA of P1
Fair value of debt instrument w/o share warrants Present value of future cash flows (recoverable amount)
3,807,853 3,807,853
Carrying amount of loan before impairment (5M + 600K) Impairment Loss
(5,600,000) (1,792,147)
JOURNAL ENTRIES Jan. 1, 20x1
Impairment Loss
1,792,147
Interest Payable Allowance for Impairment Loss(loan Rec.
ILLUSTRATION: MODIFICATION OF - SUBSTANTIAL WITH DIRECT COSTS On December 31, 20x1, ABC Co. Agreed to the following modification of its existing liability:
Reduced the principal on the loan of P5,000,000 to P4,000,000
Extended the maturity date from December 31, 20x2 to December 31, 20x4.
60,000 1,192,147
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE
Reduced the loan’s nominal interest rate of 12% to 10%.
Fees incurred directly attributable to the restructuring totaled P50,000
Interest is payable annually at each year-end. The original effective interest rate of the debt instrument is 12%.
Future Cash Flows Principal
4,000,000
Interest
400,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
2,847,121
2.401831
960,733
PV of OA of P1
Fair value of debt instrument w/o share warrants
3,807,853
The difference between the old liability and the new liability is tested for substantiality. Carrying Amount of Old Liability (5M principal + 600K)
5,000,000
Present value of modified liability
(3,807,853)
Difference
1,192,147
Divide by: Carrying amount of Old Liability
5,6000,000 23.84%
The modification is considered substantial because the modification resulted to a present value of the new obligation different by at least 10% of the present value of old obligation. Therefore, the old liability is extinguished and the gain on extinguishment is recognized after deducting the direct costs incurred on the restructuring. The new liability is also recognized.
JOURNAL ENTRIES Jan. 1, 20x1
Loan Payable-old
5,000,000
Discount on Loan Payable -new
192,147
Loan payable
4,000,000
Cash
50,000
Gain on Extinguishment of debt
1,142,147
AMORTIZATION TABLE DATE
INTEREST PAYMENTS(a)
INTEREST EXPENSE (b)
AMORTIZATION (c)
PRESENT VALUE (d)
(d x EIR)
(b-a)
(Prev. Bal. + c)
Dec. 31, 20x1
3,807,853
Dec. 31, 20x2
400,000
456,942
56,942
3,864,796
Dec. 31, 20x3
400,000
463,775
63,775
3,928,571
Dec. 31, 20x4
400,000
471,429
71,429
4,000,000
ILLUSTRATION: MODIFICATION OF - NOT SUBSTANTIAL, WITH DIRECT COSTS On December 31, 20x1, ABC Co. Agreed to the following modification of its existing liability:
The principal remained unchanged at P5,000,000.
Forgave the balance in accrued interest of P150,000.
Extended the maturity date from December 31, 20x2 to December 31, 20x4.
Reduced the loan’s nominal interest rate of 12% to 10%.
Fees incurred directly attributable to the restructuring totaled P50,000
Interest is payable annually at each year-end. The original effective interest rate of the debt instrument is 12%.
Future Cash Flows Principal
5,000,000
Interest
500,000
PV @ 12%, n=3
PV Factors
Present Value
PV of P1
0.711780
3,588,901
2.401831
1,200,916
PV of OA of P1
ILLUSTRATIVE PROBLEMS OF BONDS PAYABLE Fair value of debt instrument w/o share warrants
4,759,817
The difference between the old liability and the new liability is tested for substantiality. Carrying Amount of Old Liability (5M principal + 600K)
5,150,000
Present value of modified liability
(4,759,817)
Difference
390,183
Divide by: Carrying amount of Old Liability
5,150,000 7.58%
The modification is considered not substantial because the did not result to a present value of the new obligation different by at least 10% of the present value of old obligation. Therefore, the old liability is NOT extinguished and NO gain or loss on extinguishment is recognized. The new liability is also NOT recognized. However, the direct cost incurred on the restructuring is included in carrying the amount of the old liability.
JOURNAL ENTRIES Dec. 31, 20x1
Interest Payable
150,000
Cash
50,000
on Loan Payable
100,000
The adjusted carrying amount of the old liability Face amount on loan payable on Loan Payable (150K - 50K) Carrying amount of loan - Dec. 31, 20x1
5,000,000 100,000 5,100,000
The new EIR is computed to be used in recognizing interest expense after the modification. Such rate is the rate that would exactly discount the future cash flows equal to the carrying amount of the loan as of date of modification.
The trial and error approach combined with interpolation, if needed, may be used to compute for the imputed rate of interest.
Related Documents 3h463d
Illustrative Examples - Bonds Payable 4y3e4o
November 2022 0
Chapter 14 Financing Liabilities: Bonds And Long-term Notes Payable 4v3lj
November 2021 0
Oxygen Family - Theory Notes With Illustrative Examples [unlocked By Www.freemypdf.com] 4e4e5y
October 2019 18
On Bonds 1j5hx
November 2021 0
Vouchers Payable 4b2i5u
November 2019 88
Workflow Payable Process_ilt 3r384u
July 2020 0More Documents from "Emma Mariz Garcia" 2bo6h
Ifrs 8 Summary 3e1317
December 2022 0
Chapter 2: Management ing And The Business Environment 132s2k
November 2019 65
Chapter 6-receivables 2 6y4a1x
June 2020 4
ar Afar 1 Final Preboard May 2018 1ah5x
May 2020 7
Illustrative Examples - Bonds Payable 4y3e4o
November 2022 0
May 2020 22