BSA 12M1

FINAC II
LIABILITIES
DEFINITION OF LIABILITIES

 “LIABILITIES ARE PRESENT OBLIGATIONS OF

AN ENTITY ARISING FROM PAST
TRANSACTIONS OR EVENTS, THE
SETTLEMENT OF WHICH IS EXPECTED TO
RESULT IN AN OUTFLOW FROM THE ENTITY
OF RESOURCES EMBODYING ECONOMIC
BENEFITS”. Conceptual Framework For
Financial Reporting (CFFR)
ESSENTIAL CHARACTERISTICS OF AN ACCOUNTING
LIABILITY

 The liability is the present obligation of a

particular entity.
 The liability arises from past event.
 The settlement of the liability requires an
outflow of resources embodying economic
benefits.
PRESENT OBLIGATION

 The present obligation may be legal or

constructive obligation.
 Legal obligation as a consequence of binding
contract or statutory requirements.
 Constructive obligations also give rise to
liabilities by reason of normal business
practice, custom and a desire to maintain
good business relations or at in an equitable
manner.
PAST EVENT

 Obligating Event- creates a present obligation

because the entity has no realistic alternative but
to settle the obligation created by the event.
 For example, the acquisition of goods gives rise
to accounts payable. The obligating event is the
acquisition of goods.
 Another example is the receipt of a bank loan
results in an obligation to repay the loan. The
obligating event is the cash received from the
bank as a consequence of the bank loan.
OUTFLOW OF FUTURE ECONOMIC BENEFITS

 Without payment of money, without transfer of

noncash assets, without performance of service,
there is no accounting liability.
 A classical example is when an entity declares cash
dividend. There is an obligation to pay cash, hence
accounting liability exists.
 But when an entity declares stock dividend, there is
no accounting liability. The obligation is to issue the
entity’s own shares of stock. The stock dividend
payable is classified as part of equity rather than an
accounting liability.
EXAMPLES OF LIABILITIES

 Accounts payable
 Amounts withheld from salaries of employees
(Tax, SSS, Pag-ibig, and Philhealth)
 Accruals for wages,interests, royalties, taxes
 Dividends declared but not paid
 Debt obligations for borrowed funds
 Income tax payable
 Unearned revenue
INITIAL MEASUREMENT

 Financial liability not designated at fair value through Profit or

Loss- Fair value minus transaction costs
 Financial liability designated at fair value through Profit or Loss-
Fair value (transaction costs are expensed.
 Transaction costs are incremental costs that are directly
attributable to the issue of a financial liability which include the
following:
 Fees and commissions paid to agents, advisers, brokers and dealers
 Levies by regulatory agencies and securities exchanges
 Transfer taxes and duties
 Transaction costs do not include: 1. debt premiums or discounts,
financing costs and internal administrative or holding costs.
FAIR VALUE OF FINANCIAL LIABILITY

 Fair value is the amount for which a liability is

settled between knowledgeable and willing
parties in arm’s length transactions.
 In other words, the “fair value” of the liability is
the present value of the future cash payments
to settle the obligations.
 The term “ present value” is the discounted
amount of the future cash outflow in settling
an obligation using the market rate of interest.
SUBSEQUENT MEASUREMENT

 PFRS 9, PAR. 5.3.1provides that after initial recognition, an

entity shall measure a financial liability:
 A. At amortized cost, using the effective interest method.
 B. At fair value through profit or loss.
The amortized cost of financial liability is the amount at which the
financial liability is measured at initial recognition minus principal
repayments, plus or minus the cumulative amortization using the
effective interest method of any difference between the initial amount
and the maturity amount.
Simply stated the difference between the face amount and present value
of the financial liability is amortized through interest expense using the
effective interest method.
Actually the difference between the face amount and present value is
either the discount or premium on the issue of financial liabiliity.
MEASUREMENT OF NONCURRENT LIABILITIES

 Initially measured at fair value and

subsequently at amortized cost - for bonds
payable and noninterest bearing note
payable
 At face amount-for interest bearing note
payable. The face amount is equal to the
present value of the note payable.
MEASUREMENT OF CURRENT LIABILITIES

 Conceptually measured at fair value initially

and amortized cost subsequently.
 In practice, measured at face amount because
the discount between the face amount and
the present value is immaterial and therefore
ignored.
FAIR VALUE OPTIONS OF MEASURING LIABILITY

 PFRS9,PAR. 4.2.2provides that at initial recognition and

entity may irrevocably designate financial liability at fair
value through Profit or Loss when doing so results in
more relevant information.
 Under the fair value option, the financial liability, for
example, bonds payable, is measured at fair value at every
year end and any change in fair value is recognized in profit
or loss.
 The amortization rules for discount or premium no longer
apply. Accordingly, under the fair value option, the
interest expense is recognized using the stated or nominal
rate..
CLASSIFICATION OF LIABILITIES

 PAS 1- Liabilities are classified as current and

noncurrent liabilities
 Liabilities are current when:
 The entity expects to settle the liability within the
entity’s operating cycle.
 The entity holds the liability for the purpose of trading
 The liability is due to be settled within twelve months
after the reporting period
 The entity does not have an unconditional right to
defer settlement of the liability for at least twelve
months after the reporting period.
CURRENT LIABILITIES
 Trade payables and accruals for employee and other operating costs are
part of the working capital used in the entity’s normal operating cycle.
 Such operating items are classified as current liabilities even if they are
settled more than twelve months after the reporting period.
 When the normal operating cycle is not clearly identifiable, its duration
is assumed to be twelve months.
 Examples of current liabilities are: financial liabilities held for trading,
bank overdraft, dividends payable, income taxes, other nontrade
payables, and current portion of noncurrent financial liabilities.
 Financial liabilities held for trading are financial liabilities that are
incurred with an intention to repurchase them in the near term.
Example, is quoted debt instrument.
NON-CURRENT LIABILITIES

 RESIDUAL DEFINITION- NOT CURRENT ARE

NONCURRENT WHICH INCLUDE:
 Noncurrent portion of long-term debt
 Finance lease liability
 Deferred tax liability
 Long-term obligation to entity officers
 Long-term deferred revenue
LONG-TERM DEBT DUE IN ONE YEAR

 A liability which is due to be settled within twelve months after the

reporting period is classified as current, even if:
 the original term was for a period longer than twelve months
 An agreement to refinance or to reschedule payment on a long term basis is
completed after the reporting and before the financial statements are authorized
for issue.
 However if the refinancing on a long-term basis is completed on or
before the end of the reporting period, the refinancing is an adjusting
event and therefore the obligation is classified as noncurrent.
 If the entity has the discretion to refinance or roll over an obligation for
at least twelve months after the reporting period under an existing loan
facility, the obligation is classified as noncurrent even if it would
otherwise be due within a shorter period of time. Note that the
refinancing is at the discretion of the entity; otherwise, it should be
classified as current liability.
COVENANTS

 Covenants or restrictions are often attached to

borrowing agreements which represent
undertakings by the borrower.
 Breach of covenants results in a liability that
becomes payable on demand.
 PAS 1, par. 74, provides that such liability is
classified as current even if the lender has agreed
after the reporting period and before the
statements are authorized for issue, not to
demand payment as a consequence of the breach.
PRESENTATION OF CURRENT LIABILITIES

 PAS 1, PAR. 54 , as a minimum, the face of the

Statement of Financial Position shall include
the following items for current liabilities:
 Trade and other payables
 Current provisions
 Short-term borrowings
 Current portion of long-term debt
ESTIMATED LIABILITY

 Estimated liabilities are obligations which exist at the end of

the reporting period although their amount is not definite.
 In many cases, the date due is not also definite and in some
cases, the payee cannot be identified.
 Nevertheless, the existence of estimated liability is valid and
unquestioned.
 Estimated liabilities are either current or noncurrent in nature.
 Examples are estimated liabilities for premium, award points,
warranties, gift certificates and bonus.
 Under PAS 37, an estimated liability is considered as a
“provision” which is both probable and measurable.
PREMIUMS

 Premiums are articles of values such as toys,

dishes, silverware and other goods and in some
cases cash payments given to customers as a
result of past sales or sales promo activities.
 The entity offers premiums in exchange for
product labels, box tops, wrappers, coupons,
etc.
 An accounting liability for future distribution
of premiums when the merchandise are sold.
PREMIUMS

 Accounting Procedures
1. When the premiums are purchased
 Premiums xxx
 Cash xxx
2. When the premiums are distributed to customers.
• Premiums Expense xxx
• Premiums xxx
3. At the end of the year, when the premiums are
outstanding.
1. Premiums Expense xxx
1. Estimated Premiums Liability xxx
PREMIUMS-ILLUSTRATED

 An entity produces a certain product and sells it at

P 300 each. A soup bowl is offered to customers in
return of five wrappers plus a remittance of P10.
The bowl costs P 50 and it is estimated that sixty
percent of the wrappers will be redeemed. The
data for the first year concerning the premium
plan are as follows:
 Sales 10,000 units at P 300 P 3,000,000
 Soup bowl purchased, 2,000 units at P50 each 100,000
 Wrappers redeemed 4,000
PREMIUMS ILLUSTRATED

 Journal Entries-First Year

1. To record the sale
• Cash 3,000,000
• Sales 3,000,000
2. To record the purchase of premiums
 Premiums-soup bowls 100,000
 Cash 100,000
3. To record the redemption of wrappers.
 Cash (800 x 10) 8,000
Premiums Expense( 800 x 40) 32,000
Premiums-soup bowls (800 x 50) 40,000
Note: 4,000 wrappers/5=800 soup bowls given
PREMIUMS ILLUSTRATED

4. To record the liability for the premiums at the

end of the first year
 Premium expense 16,000
 Estimated Premium Liability 16,000
Wrappers to be redeemed(60%x10,000 wrappers) 6,000
Less: Wrappers redeemed 4,000
Balance 2,000
Premiums to be distributed(2,000/5) 400
Estimated Premiums Liability( 400 x 40) 16,000
PREMIUMS ILLUSTRATED

 Financial Statement Classification and

Presentation
 Current Assets:
 Premiums-Soup Bowls P 60,000
 Current Liability
 Estimated Premiums Liability P 16,000
 Distribution Expense:
 Premiums Expense P 48,000
CUSTOMER LOYALTY PROGRAM(CLP)

 Build brand loyalty

 Retain valued customers
 Increase sales/profit
 Reward past purchases
 Incentive for further purchases
 Customer award credits (CAC)/”Points”
 Redemption of points
 Free goods/services
 Discounted goods/services
 The entity or a third party operates the CLP
RECOGNITION AND MEASUREMENT

 Customer awards credits/points are recognized as

separate component of the initial sale.
 An accounting liability is recognized for future delivery
of goods or services.
 The fair value of the consideration received is allocated
between sale and award credits/points.
 CAC/points are measured at fair value , the amount for
which the award credits are sold separately.
 Subsequent recognition and measurement depends on
whether the entity or a third party operates the CLP.
CUSTOMER LOYALTY PROGRAM

 If the entity operates the CLP, the award

credits are recognized as “deferred
revenues”.
 The award credits shall be recognized as
“revenue” when redeemed on a “ cumulative
basis”
CUSTOMER LOYALTY PROGRAM-ILLUSTRATED

 A convenient store operates a CLP granting its customers /members

loyalty points when they buy specified amount of merchandise. The
points can be redeemed for merchandise and have no expiry. In
2015, the entity granted 10,000 points and expected that 80% or
8,000 points will be redeemed. The fair value of the points is P 100
each. The sales in 2015 was P 8 million including the points. On
December 31, 2015, 4,000 points have been redeemed for
merchandise. In 2016, the entity revised its expectation that 90% or
9,000 points instead of 80% or 8,000 points will be redeemed. In
2016, 4,100 points were redeemed by the entity. In 2017, further 900
points were redeemed. Management continue to expect that only
9,000 points will ever be redeemed, meaning no more points will be
redeemed after 2017.
 REQUIRED. Journalize the above transactions of the entity.
CUSTOMER LOYALTY PROGRAM
 JOURNAL ENTRIES
1. Initial sale in 2015
 Cash 8,000,000
 Sales 7,000,000
 Unearned Revenue-Points 1,000,000

Total consideration P 8,000,000

Fair value of points ( 10,000 x 100) 1,000,000
Fair value of initial sale P 7,000,000

2. Redemption of 4,000 points in 2015

 Unearned Revenue-points 500,000
 Sales 500,000

Revenue to be recognized in 2015: 4,000/8000xP1,000,000=P 500,000

CUSTOMER LOYALTY PROGRAM
3. Redemption of 4,100 in 2016
Unearned Revenue 400,000
Sales 400,000
Points redeemed in 2015 4,000
Points redeemed in 2016 4,100
Total points redeemed, 2016 8,100

Cumulative Revenue, 12/31/16

(8,100/9,000xP1,000,000) P 900,000
Revenue Recognized in 2015 500,000
Revenue to be recognized, 2016 P 400,000
4. Redemption of 900 points in 2017
Unearned Revenue Points100,000
Sales 100,000
Cumulative Revenue, 12/31/17 (9,000/9,000 x P 1 million) 1,000,000
Cumulative Revenue, 12/31/16 900,000
Revenue to be Recognized in 2017 100,000
WARRANTY

 Home appliances
 Guarantee to provide free repair service or
replacement at a specified period
 Involve significant costs
 An accounting liability is incurred at the point of
sale
 Two approaches in accounting for warrant costs
 Accrual
 Expense as incurred
ACCRUAL APPROACH
 Soundest- matches cost with revenue
 Warranty Expense xxx
 Estimated Warranty Liability xxx
 To record estimated warranty cost
 Estimated Warranty Liability xxx
 Cash xxx
 To record payment of actual warranty cost.
 Change in estimate, i.e., actual >estimate
 Warranty Expense xxx
 Estimated Warranty Liability xxx
 To record change in estimate .
 Change in estimate, i.e., actual < estimate
 Estimated Warranty Liability xxx
 Warranty Expense xxx
INCOME AS EXPENSED APPROACH

 Expense warranty cost only when actually

incurred
 Popular in practice, recognized for tax purposes
 Based on expediency- applicable for non-
substantial warranty or warranty with short
period
 Journal Entry
 Warranty Expense xxx
 Cash xxx
WARRANTY-SEAT WORK

 An entity sells 1,000 units of TV sets at P 9,000

each for cash with a warranty of one year. The
entity has estimated based on experience that
warranty cost average P 500/unit and 60% of the
units sold will be returned for repair. The entity
incurs P180,000 for repair during the year.
 REQUIRED: Prepare journal entries for the above
transactions for both “ accrual approach “ and
“expense as incurred approach.”
REVIEW QUESTIONS
 Define liabilities
 What are the essential characteristics of an accounting liability?
 Explain a present obligation.
 Explain a past event that lead to present obligation.
 Explain outflow of future economic benefits to settle an obligation.
 Give specific examples of liabilities.
 Explain the initial measurement of liabilities.
 What is the fair value of a financial liability?
 Explain the subsequent measurement of a liability.
 What is the meaning of amortized cost of a financial liability?
 Explain the measurement of noncurrent liabilities.
 Explain the measurement of current liabilities.
 What is the fair value option of measuring a financial liability?
 What are the classifications of liabilities?
REVIEW QUESTIONS

 Define current liabilities.

 Define noncurrent liabilities.
 Explain the treatment of a long-term debt falling due within one
year.
 What are covenants attached to borrowing agreements?
 Explain the treatment of a liability if the covenants are breached
or violated.
 How are current liabilities presented in the statement of
financial position?
 What are estimated liabilities?
 Explain the classification of estimated liabilities in the
statement of financial position
REVIEW QUESTIONS
 What is a premium?
 What is a customer loyalty program?
 Explain the measurement of award credits or points granted in a customer loyalty
program.
 Explain the recognition of award credits if the entity supplies the awards itself and if
a third party supplies the awards.
 Explain a warranty liability.
 Explain the two approaches of accounting for warranty costs.
 Explain the sale of extended warranty.
 Explain payroll taxes.
 Explain value-added taxes.
 Explain gift certificates payable.
 What are refundable deposits?
 What are the four variations in the computation of bonus?
 What is a deferred revenue? Is it current or noncurrent?
PROVISION AND CONTINGENT
LIABILITY
 A provision is an existing liability of uncertain timing
or uncertain amount.
 A provision may be the equivalent of an estimated
liability or a loss contingency that is accrued because
it is both probable and measurable.
 Recognition of a provision
 The entity has a present obligation, legal or constructive,
as a result of a past event.
 It is probable that an outflow of future economic benefits
would be required to settle the obligation.
 The amount of the obligation can be measured reliably.
PROVISION-ILLUSTRATED

 Oil spill. The entity has published as a matter of policy that it

would make good and pay for any losses from oil spill.
 Recognize for the best estimate of the costs to clean up oil spill
 A present obligation exists as a result of a past obligating event (oil
spill)
 There is no legal obligation , but there is constructive obligation.
 Measurement of a provision
 Best estimate of the expenditure required
 Single obligation
 Range of possible outcomes
 Large population of items –expected value
ILLUSTRATION-EXPECTED VALUE
METHOD
 An entity sells goods with a warranty under which the customers are
covered for the cost of repairs of any manufacturing defects that become
apparent within 6 months after purchase.
 If minor defects are detected in all products sold, repair costs would be
about P 1 million. If major defects are detected, repair costs of P 5 million
would result.
 The entity’s past experience and future expectations indicate that 75% of
the goods sold have no defects, 20% will have minor defects and 5% will
have major defects.
 The expected value of the cost of repairs is measured as follows:
 75% sales none
 20% sales ( 20% x P 1 million) 200,000
 5% sales (5%x P 5 million) 250,000
 Total expected value of the cost of repairs 450,000
 ================
ANOTHER ILLUSTRATION
 Patent infringement suit
 60% chance the court will not dismiss the case
 30% chance the entity will pay damages of P 4 million
 70% chance that the entity will pay damages of P 2 million
 10% risk adjustment factor to the probabilities of the expected cash flows
is considered proper to reflect the uncertainties in the cash flow estimate.
 The provision is measured as follows:
 30%xP4 mx60% P 720,000
 70%xP2 mx60% 840,000
 Expected cash outflow P 1,560,000
 Risk adjustment factor( 10%xP1.56m) 156,000
 Estimated amount of the provision P 1,716,000
 Note: The amount of the provision shall be discounted if the effect of the time
value of money is material.
OTHER MEASUREMENT
CONSIDERATIONS
 Risks and uncertainties- increase the amount of a provision
 Present value of obligation-where the effect of time value of money is material
 Future events-new legislation or changes in technology where there is sufficient
evidence that they will occur.
 Expected disposal of assets-any cash inflows treated separately from provision
 Reimbursements-treated as a separate asset and not netted against the provision
 Changes in provision-reviewed at every end of the accounting period
 Use of provision-for the expenditures for which provision is originally recognized
 Future operating losses-no recognition of provision
 Onerous contract- a contract in which the unavoidable costs of meeting the
obligation under the contract exceed the economic benefit expected to be
received under it. The present obligation is recognized and measured as a
provision .
 Example : Transfer of an entity to a new office, but it had to pay the remaining rentals for
the remaining periods of two years. There is no more benefits , yet it has to pay the rentals.
EXAMPLES OF PROVISION

 Warranties
 Environmental contamination
 Decommissioning or abandoned costs
 Court case
 Guarantee
 Restructuring
 Detailed formal plan
 Valid expectation in the minds of those affected
 Direct expenditures
CONTINGENT LIABILITY

 A contingent liability is a present obligation that

arises from past event but is not recognized
because it is not probable that an outflow of
resources embodying economic benefits will be
required to settle the obligation or the amount of
the obligation cannot be measured separately.
 Not recognized, but disclosed only the brief
description, estimate of financial effects,
indication of uncertainties and possibility of any
reimbursements.
CONTINGENT ASSET-PAS 37

 Contingent asset as a possible asset that

arises from past event and whose existence
will be confirmed only by the occurrence of
non-occurence of one or more uncertain
future events not wholly within the control of
the entity.
 Recognized when probable and not if only
possible or remote
EVENTS AFTER REPORTING
PERIOD
 PAS 10, par. 3” events after the reporting period”
are those events both favorable and unfavorable
that occur between the end of the reporting period
and the date when the financial statements are
authorized for issue.
 Two types of events after the reporting period:
 Adjusting events are those that provide evidence of
conditions that exist at the end of the reporting period..
 Non-adjusting events are those that are indicative of the
conditions that arise after the end of the accounting
period.
BONDS PAYABLE

 Bond is a formal unconditional promise, made under

seal, to pay a specified sum of money at a determinable
future date, and to make periodic interest payment at a
stated rate until the principal sum is paid.
 A contract of indebtedness.
 Evidenced by a bond certificate
 Features of bond issue
 Bond indenture or deed of trust
 Bond certificates
 Trustee
 Registrar/disbursing agent.
CONTENTS OF BOND INDENTURE

 Characteristics of bonds
 Maturity date and provision for repayments
 Grace period
 Sinking fund
 Deposit to cover interest payment
 Mortgage provisions
 Access to corporate records
 Certification of bonds by the trustee
 Required debt to equity ratio
 Minimum working capital to be maintained
TYPES OF BONDS

 Term and serial bonds

 Secured and unsecured bonds
 Registered and bearer bonds
 Convertible bonds
 Callable bonds
 Guaranteed bonds
 Junk bonds
SALE OF BONDS

 Various denominations, e.g., P100, P1,000, P 10,000-

enabling more investors/buyers
 Equal denomination, say, P 1,000 called “face value”
 Bond certificate as evidence of indebtedness
 Thus, if P 50 million face value bonds are sold, divided
into P 1,000 denominations, there shall be 50,000
bond certificates containing a face amount of P 1,000.
 Sale may by directly by the entity or through an
underwriter.
 Interests on bonds are usually semi-annually.
INITIAL MEASUREMENT OF BONDS
PAYABLE
 PFRS#9, par. 5.1.1-Bonds payable not designated at fair
value through profit or loss shall be measured initially at fair
value minus transaction costs that are directly attributable
to the issue of bonds payable.
 The fair value is equal to the present value of the future cash
payments to settle the bond liability.
 Bond issue costs shall be deducted from the fair value or
issue price of the bonds payable in measuring initially bonds
payable.
 However, if the bonds are designated and accounted for “ at
fair value through profit or loss” the bond issue costs are
treated as outright expense.
SUBSEQUENT MEASUREMENT OF
BONDS PAYABLE
 PFRS 9,par.5.3.1, after initial recognition, bonds
payable shall be measured either:
 At amortized cost, using the effective interest method
 At fair value through profit or loss.
 Amortized cost of bonds payable
 The amount at which the bond liability is measured
initially minus principal repayment, plus or minus the
cumulative amortization using the effective interest
method of any difference between the initial amount
and the maturity amount.
ACCOUNTING FOR THE ISSUANCE
OF BONDS
 TWO APPROACHES ARE
 Memorandum Approach
 Journal Entry Approach
 ILLUSTRATION
 An entity is authorized on January 1, 2018 to issue P 5 million, 10-year,
12% face value bonds, interest payable January 1 and July 1, consisting of
5,000 units, P 1,000 face value. The bonds are sold at face value to the
underwriter.
 Memorandum Approach
 “ The entity is authorized on January 1, 2018 to issue P 5 million, 10-year, 12%
bonds, interest payable on Jan. 1 and July 1, consisting of 5,000 units at P 1,000
face value.”
 The subsequent sale of bonds is recorded as follows:
 Cash 5,000,000
 Bonds Payable 5,000,000
ACCOUNTING FOR ISSUANCE OF
BONDS
 Journal Entry Method
 The authorization of the bonds is recorded as
follows:
 Unissued Bonds Payable 5,000,000
 Authorized Bonds Payable 5,000,000
 The subsequent sale of the bonds is recorded as
follows:
 Cash 5,000,000
 Unissued Bonds Payable 5,000,000
ISSUANCE OF BONDS AT A
PREMIUM
 Sales price is more than face value
 The bond premium is in effect a gain
 The obligation of the issuer is limited to the face value of the bonds.
 The premium is not reported as outright gain. It is amortized over
the life of the bonds and credited to interest expense.
 The investor agrees to receive interest that is less than the stated or
nominal rate of interest.
 Thus, the effective rate is less than the nominal rate of interest.
 The nominal rate is the one stated on the face of the bond
certificate.
 When bonds are sold at face value, the effective rate and the
nominal rate are the same.
EXAMPLE OF BOND ISSUE AT A
PREMIUM
 An entity sell P 5 million face value bonds at 105. The
quoted price of 105 means “ 105% of the face value of the
bonds”. Thus, the sales price is P 5.25 million ( P 5 million
x 105).
 The entry to record the sale of bonds at a premium is:
 Cash 5,250,000
 Bonds payable 5,000,000
 Premium on bonds payable 250,000
 Using the straight line method, the entry to record the
amortization of the bond premium is:
 Premium on bonds payable 25,000
 Interest Expense (250,000/10 yrs) 25,000
ISSUANCE OF BONDS AT A
DISCOUNT
 If the sales price of the bonds is less than the
face value, the bonds are said to be sold at a
discount.
 For example, an entity sells P 5 million face
value bonds at 95. The sale of the bonds is
recorded as follows:
 Cash(5,000,000x95%) 4,750,000
 Discount on bonds payable 250,000
 Bonds Payable 5,000,000
ISSUANCE OF BONDS AT A
DISCOUNT
 The bond discount is in effect a loss to the issuing
entity.
 The buyer or investor does is not willing to accept
simply the nominal rate.
 The effective rate is higher than the nominal rate.
 Bond discount is amortized as loss over the life of the
bonds and charged to interest expense.
 The entry to record the amortization of bond discount
in the above example is:
 Interest expense( 250,000/10 yrs.) 25,000
 Discount on bonds payable 25,000
PRESENTATION OF
DISCOUNT/PREMIUM IN THE FSs
 The discount is deducted from bonds payable
while the premium is added.
 Non-current Liabilities
 Bonds payable P 5,000,000
 Discount on bonds payable (250,000) P 4,750,000
 Non-current liabilities
 Bonds payable P 5,000,000
 Premium on bonds payable 250,000 P 5,250,000
RECORDING INTEREST ON BONDS
 Requires recognition of two items:
 Payment of interest during the year
 Accrual of interest at the end of the year
 These items are in addition to the proper amortization of premium on bonds payable or
discount on bonds payable.
 Example: On March 1,2018, an entity sells P 5 million face value bonds with 12%
interest payable semiannually on March 1 and September 1.
 Journal entries for 2018 and 2019
 2018
 Sept. 1, 2019
 Interest expense 300,000
 Cash 300,000
 Semi-annual interest payment (5,000,000 x 12%x1/2=P300,000)
 Dec. 31
 Interest expense 200,000
 Accrued interest payable 200,000
 Interest accrued for 4 months from Sept. 1 to Dec. 31, 2018 ( 5,000,000 x 12 % x 4/12=200,000)
RECORDING INTEREST ON BONDS
 Jan. 1
 Accrued interest payable 200,000
 Interest expense 200,000
 Reversing entry
 Mar 1
 Interest expense 300,000
 Cash 300,000
 Semiannual payment
 Sept 1
 Interest expense 300,000
 Cash 300,000
 Semiannual payment
 Dec 31
 Interest expense 200,000
 Accrued interest payable 200,000
 Interest accrued for 4 mos. From Sept 1 to Dec 31,2019
BOND ISSUE COSTS

 Bond issue costs or transaction costs are incremental costs

directly attributable to the issue of bonds payable.
 Examples are printing and engraving cost, legal and accounting
fee, registration fee, commission and other similar charges.
 Bond issue costs are not treated as outright expense but
amortized over the life of bond issue like discount on bonds
payable.
 Bond issue costs are deemed part of borrowing costs that
increases interest expense.
 Thus, the amortization of bond issue cost is recorded as follows:
 Interest expense xxx
 Bond issue cost xxx
BOND ISSUE COSTS

 Bond issue costs shall be presented as a

deduction from bonds payable (PFRS 9)
 Under the effective interest method of
amortization, the bond issue cost must be
“lumped” with the discount on bonds payable
and “ netted” against the premiums on bonds
payable.
ISSUANCE OF BONDS ON
INTEREST DATE
 On June 1, 2018 and entity sells P 5 million face value
bonds at 97. The bonds mature in 5 years and pay 12%
interest semiannually on June 1 and December 1. The
straight line method is used in amortizing the discount on
bonds payable. The pertinent entries in 2018 and 2019 are:
 2018
 June 1
 Cash (5,000,000 x 97) 4,850,000
 Discount on bonds payable 150,000
 Bonds payable 5,000,000
 Sale of bonds
ISSUANCE OF BONDS ON
INTEREST DATE
 Dec. 1
 Interest expense 300,000
 Cash 300,000
 Semiannual interest payment.
 Dec. 31
 Interest expense 50,000
 Accrued interest payable 50,000
 Interest accrued for one-month from Dec. 1 to Dec. 31,
2018( 5,000,000x12%x1/12=50,000)
 Dec. 31
 Interest expense 17,500
 Discount on bonds payable 17,500
 Amortization of bond discount from June 1 to December 31, 2018
(150,000/5yrs=30,000/year x7/12=17,500)
ISSUANCE OF BONDS ON
INTEREST DATE
 The amortization of the bond discount or premium on every interest
date or at the end of every year. In the example, it is at the end of every
year.
 If the amortization is on every interest date, the entries are:
 2018
 Dec. 1
 Interest expense 15,000
 Discount on bonds payable 15,000
 Amortization for 6 months from June 1 to Dec. 31 , 2018 (30,000x6/12=15,000)
 Dec. 31
 Interest expense 2,500
 Discount on bonds payable 2,500
 Amortization for one month from Dec. 1-31, 2018 (30,000x1/12=2,500)
 It is preferable to amortize only once at the end of the year.
ISSUANCE OF BONDS ON
INTEREST DATE
 2019
 Jan. 1
 Accrued interest payable 50,000
 Interest expense 50,000
 Reversing entry
 June 1
 Interest expense 300,000
 Cash 300,000
 Semiannual interest payment
ISSUANCE OF BONDS ON
INTEREST DATE
 Dec 1
 Interest expense 300,000
 Cash 300,000
 Semiannual interest payment
 Dec. 31
 Interest expense 50,000
 Accrued interest payable 50,000
 Interest accrued for one month
 Dec. 31
 Interest expense 30,000
 Discount on notes payable 30,000
 Amortization of discount for one year, 2019
ISSUANCE OF BONDS ON
INTEREST DATE
 Financial Statement presentation on
December 31, 2019
 Current liability
 Accrued interest payable 50,000
 Noncurrent liability
 Bonds payable 5,000,000
 Discount on bonds payable (102,500)
 Carrying amount 4,897,500
 ============
ISSUANCE OF BONDS BETWEEN
INTEREST DATES
 Bonds can be sold anytime after they are dated.
 Since interest payments of fixed amounts must be
paid on specified dates, some adjustments must
be made at the time of sale for interest that has
accrued from the last payment date.
 If the bonds are sold between interest dates, an
accrued interest is involved.
 Normally, when bonds are sold between interest
dates, the accrued interest is paid by the buyer or
investor.
ISSUANCE OF BONDS BETWEEN
INTEREST DATES
 EXAMPLE
 On April 1, 2018, an entity sells P 5 million face value bonds at P
5,228,000 plus accrued interest. The bonds are dated January 1,
2018, mature in 5 years and pay 12% interest on January 1 and July
1. The sale of bonds on April 1, 2018 is recorded as follows:
 Cash 5, 378,,000
 Bonds payable 5,000,000
 Premium on bonds payable 228,000
 Interest expense 150,000

 Issue price 5,228,000

 Add: Accrued interest from
 January 1 to April 1, 2018 ( 5 Mn x12%x3/12) 150,000
 Total cash received 5,378,000
ISSUANCE OF BONDS BETWEEN
INTEREST DATES
 In the example, the accrued interest on the date of
sale for 3 months from Jan. 1 to Apr. 1, 2018 is paid
by the investor because on July 1, 2018, three
months after the sale, the investor is going to
receive interest for 6 mos from Jan. 1 to July 1, 2018.
In the foregoing entry, the accrued interest “sold” is
credited to interest expense.
 On July 1, 2018, the entry to record the payment of
semiannual interest is:
 Interest expense ( 5,000,000 x 12%x1/2) 300,000
 Cash 300,000
ISSUANCE OF BONDS BETWEEN
INTEREST DATES
 Note that if at this point the interest expense amount is
posted, it has a debit balance of P 150,000 which
represents the correct amount of interest expense from
April 1 to July 1, 2018.
 Another approach is to credit the accrued interest on
the date of sale to accrued interest payable account.
Following this approach, the sale of bonds is recorded
as follows:
 Cash 5,378,000
 Bonds payable 5,000,000
 Premium on bonds payable 228,000
 Accrued interest payable 150,000
ISSUANCE OF BONDS BETWEEN
INTEREST DATES
 If the accrued interest payable account is credited for the
accrued interest sold at the time of the sale of the bonds, then
the payment of the first semiannual interest is recorded as
follows:
 Accrued interest payable 150,000
 Interest expense 150,000
 Cash 300,000
 In either case, the debit balance of the interest expense account
must be P 150,000.
 The approach of crediting interest expense instead of accrued
interest payable is preferable.
 For simplicity, straight line method is used in amortizing bond
premium.
BOND RETIREMENT ON MATURITY
DATE
 Establishment of sinking fund to make the bond issue
more attractive
 The periodic cash deposits plus the interest earned on
sinking fund approximate the amount of bond issue on
maturity date.
 On maturity date, the trustee sells the securities and uses
the sinking fund cash to pay the bondholders.
 Any excess cash will be returned to the bond issuer.
 Sinking fund is classified as non-current asset.
 The sinking fund is reclassified to current assets when the
bonds payable is also reclassified to current liabilities.
ILLUSTRATIVE CASE-BONDS PAID
ON MATURITY
 No accounting issue/problem
 Simply require the cancellation of bonds payable and
payments of accrued expenses.
 For example, an entity sells P 5 million face value bonds on
April 1, 2018 with 12% interest payable April 1 and October
1 and the bonds mature on April 1, 2023.
 On April 1, 2017, the entry to retire the bonds together with
the payment of last semiannual interest out of a sinking
fund is
 Bonds Payable 5,000,000
Interest Expense 300,000
Sinking Fund 5,300,000
BOND RETIREMENT PRIOR TO
MATURITY DATE
 Cancelled and permanently retired,or
 Held in treasury for future reissue
 If cancelled and permanently retired the
following procedures are applied:
 Bond premium/discount amortized up to date of
retirement
 The balance of the bond premium, bond discount
and bond issue cost determined.
 The accrued interest to date of retirement is also
determined.
BOND RETIREMENT PRIOR TO
MATURITY DATE
 If cancelled and permanently retired the
following procedures are applied (Cont’d)
 The total cash payment is computed equal to
retirement price plus accrued interest.
 The carrying amount of the bond is determined.
 The gain or loss on retirement is computed.
 The retirement of the bond is then recorded by
cancelling the bond liability together with the
unamortized premium/discount and bond issue cost.
The accrued interest is debited to interest expense.
ILLUSTRATION

 On March 1, 2012, P 5 mn face value bonds are sold for P

4,730,000. The bonds are dated March 1, 2018 and mature in 5
years. The bonds pay interest semi-annually on March 1 and
September 1. For simplicity, straight line method of
amortization will be used.
 All of the bonds are retired on July 1, 2015 at 97. The
procedures for the retirement of bonds are as follows:
 Amortization of discount up to July 1, 2015.The last amortization was
on December 31,2014. Thus the amortization of discount from Jan. 1
to July 1, 2015 is
 Interest Expense 27,000
 Discount on Bonds Payable 27,000
 (270,000/5yrs= 54,000/year)
 (54,000 x 1/2=27,000)
ILLUSTRATION

 The balance of the discount on bonds payable is

computed as follows:
 Discount on bonds payable-Mar. 1, 2012 P 270,000
 Less: Amortization (3/1/12 to 7/1/15
 ;40 mos. (P 270,000 x 40/60) 180,000
 Balance, July 1, 2015 P 90,000
 The accrued interest on the date of retirement, July
1, 2015 is computed as follows: [P 5,000,000 x
12%x4/12=P 200,000].The last payment of interest
was March 1, 2015. Thus the accrued interest is for 4
months, from March 1 to July 1, 2015.
ILLUSTRATION

 The total cash payment is computed as follows:

 Retirement price ( P 5 million x 97) P 4,850,000
 Add: Accrued interest 200,000
 Total cash payment P 5,050,000
 The carrying amount of the bond is computed
as follows:
 Bonds payable P 5,000,000
 Discount on bonds payable 90,000
 Carrying amount, 7/1/15 P 4,910,000
ILLUSTRATION

 Gain or loss on the early retirement is computed as

follows:
 Carrying amount of bonds payable P 4,910,000
 Less: Retirement price 4,850,000
 Gain on early retirement P 60,000
 The entry to record the early retirement on July 1, 2015 is
 Bonds payable 5,000,000
 Interest expense 200,000
 Cash 5,050,000
 Discount on bonds payable 90,000
 Gain on early retirement of bonds 60,000
TREASURY BONDS

 Treasury bonds are an entity’s own bonds originally

issued and reacquired but not cancelled.
 The accounting is the same as the retirement of bonds
before maturity date.
 The treasury bonds should be debited at its face value
and any related unamortized premium/discount or bond
issue cost should be cancelled.
 Any accrued interest paid is charged to interest expense.
 The difference between the acquisition cost and the
carrying amount of the treasury bonds is treated as gain
or loss on the acquisition of treasury bonds.
ILLUSTRATION

 An entity originally issued P 5 million face value bonds at 105

or a premium of P 250,000. Subsequently, the entity
reacquired P 1 million face value bonds to be placed in the
treasury at 103. At the time of the reacquisition, the
unamortized premium balance is P 200,000, and accrued
interest on the treasury bonds is P 30,000 which is paid in
cash.
 The entry to record the reacquisition of treasury bonds is:
 Treasury bonds 1,000,000
 Premium on bonds payable 40,000
 Interest expense 30,000
 Cash 1,060,000
 Gain on acquisition of treasury bonds 10,000