SOL. MAN.

Chapter 3 Bonds Payable & Other Concepts 2021

Intermediate Accounting 2 (IA2)

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Chapter 3
Bonds Payable & Other Concepts
PROBLEM 1: TRUE OR FALSE
1. TRUE
2. FALSE - A debenture is an unsecured bond.
3. FALSE - Monitoring for compliance with the indenture
is the responsibility of the trustee of the bond issue.
4. FALSE – the conversion option belongs to the
bondholder, not the issuer
5. TRUE – The increased rate is intended to entice
investors to buy bonds during periods when the
demand is low.
6. FALSE - lower (*par value of bonds is another term
for face amount of bonds)
7. FALSE
8. FALSE
9. FALSE
10. TRUE

PROBLEM 2: MULTIPLE CHOICE – THEORY

1. C
2. C
3. A
4. D
5. C
6. D
7. C
8. C
Sample assumptions:
F Face amount: 1M
F Nominal int. rate: 10%
F n=3
F Effective int. rate: 12%

Initial carrying amount: (1M x PV of 1 @12%, n=3) +

(100K x PV ord. annuity @12%, n=3) = 951,963

Using effective interest method:

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Interest Paymen Amortizati Present

Date expense ts on Value
1/1/x1 951,963
12/31/
x1 100,000 114,236 14,236 966,199

Using straight-line method:

Discount on bonds (1M – 951,963) 48,037
Divide by: Term 3
Annual amortization of discount 16,012

Carrying amount - 1/1/x1 951,963

Discount amortization - 20x1 16,012
Carrying amount - 12/31/x1 967,975

I. Effect on Bond carrying amount

967,975 SLM vs. 966,199 EIM = Overstated

II. Effect on Retained earnings

F 100K interest + 16,012 amort. = 116,012 int. expense

under SLM
F 116,012 SLM vs. 114,236 EIM: overstated
F Effect on Retained earnings: Understated

9. B
Solution:
EFFECT ON DECEMBER 31, 20X1:
Using straight line method:
Discount on bonds - 1/2/x1 150,000
Divide by: Term 6
Annual amortization of discount 25,000

Discount on bonds - 1/2/x1 150,000

Amortization - 20x1 (25,000)
Discount on bonds - 12/31/x1 125,000

Face amount 1,000,000

Discount on bonds - 12/31/x1 (125,000)

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Carrying amount - 12/31/x1 875,000

Using effective interest method:

Interest Paymen Amortizati Present
Date expense ts on Value
1/2/x1 850,000
12/31/
x1 102,000 80,000 22,000 872,000

Carrying amounts - 12/31/x1:

Straight line (erroneous) 875,000

Effective interest method 872,000

Difference - overstatement (3,000)

EFFECT ON JANUARY 2, 20X7:

On January 2, 20x7, maturity date, there will be NO
EFFECT of the error on the carrying amount of the
bonds because on this date, the discount would have
been fully amortized under both the straight line
method and the effective interest method.

10. C

PROBLEM 3: EXERCISES
1. Solution:
Jan. Cash 1,903,9
1, Discount on bonds payable 27
20x1 Bonds payable 96,073 2,000,0
00

Date Interes Intere Amortizat Present

t st ion value

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payme expen
nts se
Jan. 1, 1,903,92
20x1 7
Dec. 31, 228,47 1,932,39
20x1 200,000 1 28,471 8
Dec. 31, 231,88 1,964,28
20x2 200,000 8 31,888 6
Dec. 31, 235,71 2,000,00
20x3 200,000 4 35,714 0

Dec. 31, Interest expense 228,47

20x1 Cash 1 200,00
Discount on bonds 0
payable 28,471
Dec. 31, Interest expense 231,88
20x2 Cash 8 200,00
Discount on bonds 0
payable 31,888
Dec. 31, Interest expense 235,71
20x3 Cash 4 200,00
Discount on bonds 0
payable 35,714

Bonds payable 2,000,

Cash 000 2,000,
000

2. Solution:
Jan. 1, Cash (2,206,168 – 106,694) 2,099,
20x1 Bonds payable 474 2,000,
Premium on B/P (squeeze) 000
99,474

Interes Intere
t st
paymen expen Amortizat Present
Date ts se ion value
Jan. 1,
20x1 2,099,474
Dec. 31, 209,94
20x1 240,000 7 30,053 2,069,421
Dec. 31, 240,000 206,94 33,058 2,036,363

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20x2 2
Dec. 31, 203,63
20x3 240,000 7 36,363 2,000,000

Dec. Interest expense 209,94

31, Premium on bonds payable 7
20x1 Cash 30,053 240,00
0
Dec. Interest expense 206,94
31, Premium on bonds payable 2
20x2 Cash 33,058 240,00
0
Dec. Interest expense 203,63
31, Premium on bonds payable 6
20x1 Cash 36,364 240,00
0

3. Solution:
Interes
t
payme Interest Amortizat Present
Date nts expense ion value
Jan. 1,
20x1 2,151,632
Dec. 31,
20x1 240,000 215,163 24,837 2,126,795
Dec. 31,
20x2 240,000 212,680 27,320 2,099,475
July 1,
20x3 120,000 104,974 15,026 2,084,449

July Interest expense 104,97

31, Premium on bonds payable 4
20x3 Interest payable 15,026 120,00
0
July Bonds payable 2,000,0
31, Premium on bonds payable 00
20x3 Interest payable 84,449
Cash (2M x 102%) 120,00 2,040,0
Gain on retirement of 0 00
bonds 164,44
9

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4. Solution:

Initial recognition:
Issue price (2M x 105%)
2,100,000
(a)
Fair value of bonds without conversion feature
( 1,903,926)
Equity component
196,074

(a)
Future cash PV factors @12%, Present
flows n=3 value
Princip 2,000,00
al 0 0.711780 1,423,560
Interes
t 200,000 2.401831 480,366
Fair value of bonds without
conversion feature 1,903,926

Jan. Cash (2M x 105%) 2,100,0

1, Discount on bonds payable 00
20x (2M – 1,903,926) 96,074
1 Bonds payable 2,000,0
Share premium – 00
conversion 196,07
feature 4

Subsequent measurement:
Interes Intere
t st
paymen expen Amortizati Present
Date ts se on value
Jan. 1, 1,903,92
20x1 6
Dec. 31, 228,47 1,932,39
20x1 200,000 1 28,471 7
Dec. 31, 231,88 1,964,28
20x2 200,000 8 31,888 5
Dec. 31, 235,71 2,000,00
20x3 200,000 5 35,715 0

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Dec. Interest expense 228,47

31, Discount on bonds payable 1 28,471
20x1 Cash 200,00
0
Dec. Interest expense 231,88
31, Discount on bonds payable 8 31,888
20x2 Cash 200,00
0
Dec. Bonds payable 2,000,0
31, Discount on bonds payable 00
20x2 (2M – 1,964,285) 35,715
Share capital [(2M ÷ 1,000) 1,600,
x8 000
shares x 100 par value)]
Share premium 364,28
to record the conversion 5
Dec. Share premium 20,000
31, Cash 20,000
20x2 to record the stock issuance
costs
Dec. Share premium – conversion 196,07
31, feature 4 196,07
20x2 Share premium 4
to transfer within equity the
equity component of the compound
instrument

5. Solution:
 Initial measurement:
Issue price
2,200,000
(a)
Fair value of bonds without conversion feature
( 1,903,926)
Equity component
296,074

PV factors @12%, Present

(a)
Future cash flows n=3 value
Principal 2,000,000 0.711780 1,423,560
Interest 200,000 2.401831 480,366
Fair value of bonds without conversion 1,903,926

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feature

 Subsequent measurement:
Interes Intere
t st
payme expen Amortizat Present
Date nts se ion value
Jan. 1, 1,903,92
20x1 6
Dec. 31, 228,47 1,932,39
20x1 200,000 1 28,471 7
Dec. 31, 231,88 1,964,28
20x2 200,000 8 31,888 5
Dec. 31, 235,71 2,000,00
20x3 200,000 5 35,715 0

 Retirement:
Retirement price 2,000,000
Fair value of bonds w/o conversion feature – 12.31.20x2
(1,981,982)(b)
Retirement price allocated to equity component
18,018
(b)
Future cash PV factors @11%, Present
flows n=1 value
Principal 2,000,000 0.900901 1,802,802
Interest 200,000 0.900901 180,180
Fair value of bonds without conversion
feature – 12.31.x2 1,981,982

 Journal entries:
Jan. Cash 2,200,0
1, Discount on bonds payable (2M – 00
20x 1,903,926) 96,074 2,000,0
1 Bonds payable 00
Sh. premium – conversion 296,07
feature 4
Dec Interest expense 228,47
. Discount on bonds payable 1 28,471
31, Cash 200,00
20x

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1 0
Dec Interest expense 231,88
. Discount on bonds payable 8 31,888
31, Cash 200,00
20x 0
2
Dec Bonds payable 2,000,0
. Loss on extinguishment of 00
31, bonds 17,697 35,715
20x Discount on B/P (2M – 1,981,9
2 1,964,285) 82
Cash
to record retirement of
convertible bonds
Dec Share premium – conversion 18,018
. feature 18,018
31, Cash
20x to record the allocation of
2 retirement price to the equity
component
Dec Share premium – conversion 278,05
. feature (296,074 –18,018) 6
31, Share premium 278,05
20x to record forfeiture of the 6
2 conversion feature of retired
convertible bonds

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PROBLEM 4: MULTIPLE CHOICE – COMPUTATIONAL

1. D
9¾% registered debentures, callable in 2002, 700,00
due in 2007 0
9½% collateral trust bonds, convertible into
600,00
common stock
beginning in 2000, due in 2010 0
1,300,
Total term bonds
000

2. B
Interes
t
Payment expens Amortizat Present
Date s e ion value
1/2/0
1 469,500
6/30/
01 22,500 23,475 975 470,475

3. B
Interes
t
payme Interest Amortizati Present
Date nts expense on value
Jan. 1, 3,807,85
20x1 2
Dec. 31, 3,864,79
20x1 400,000 456,942 56,942 4

4,000,000 face amount – 3,864,794 = 135,206

4. D
Interes
t
payme Interest Amortizati Present
Date nts expense on value
Jan. 1, 20x1 3,628,536
Dec. 31, 400,00 3,736,53
20x1 0 507,995 107,995 1

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5. D
Issue price of bonds (200 x 1,000 x 202,0
101%) 00
Accrued interest (200 x 1,000 x 9% x 7,50
5/12) 0
209,5
Total proceeds 00

6. A
Future cash PV @ 10%, PV Present
flows n=3 factors value

Principa 2,000, 0.75131 1,502,63

l 000 PV of 1 5 0

240,00 PV of ord. annuity 2.48685

Interest 0 of 1 2 596,844
2,099,4
74

7. B
Solution:

Redemption price (5M x 4,900,00

98%) 0
Less: Carrying amount of
bonds:

Face amount 5,000,000

Unamortized premium 30,000

Unamortized issue 4,980,00

costs (50,000) 0

Gain on retirement 80,000

8. D

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The periodic cash flows are computed as follows:

Due date Amounts due Periodic
Principal Interest Cash flows
12/31/x1 40,000 16,000 56,000
12/31/x2 40,000 12,800 52,800
12/31/x3 40,000 9,600 49,600
12/31/x4 40,000 6,400 46,400
12/31/x5 40,000 3,200 43,200

The amortization table is prepared as follows:

Interes
t Payme Amortizat Present
Date expense nts ion value
12/31/
x0 190,280
12/31/
x1 19,028 56,000 36,972 153,308
12/31/
x2 15,331 52,800 37,469 115,839
12/31/
x3 11,584 49,600 38,016 77,823
12/31/
x4 7,782 46,400 38,618 39,205
12/31/
x5 3,920 43,200 39,280 (75)

9. A
 Total cash flow due at maturity date: (6M x 110% x
110% x 110%) = 7,986,000
 Initial measurement of bonds: 7,986,000 x PV of 1
@18%, n=3 = 4,860,526
 Subsequent measurement:
i. Bonds: 4,860,526 x 118% - 600,000 interest
payable = 5,135,421
ii. Interest payable: (6M x 10%) = 600,000

Alternative solution:
Intere Inter
PV of
st est Amortizat PV of
Date cash
expens paya ion bonds
flows
e ble
Jan. 1, 4,860,5 4,860,52
20x1 26 6

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Dec. 31, 874,89 5,735,4 600,0 5,135,4

20x1 5 21 00 274,895 21
Dec. 31, 1,032,3 6,767,7 660,0 5,507,79
20x2 76 96 00 372,376 6
Dec. 31, 1,218,2 7,986,0 726,0 6,000,00
20x3 03 00 00 492,203 0

10. C
Fair value of bonds without the
warrants 196,000

Face amount of bonds 200,000

Discount on bonds (4,000)

11. B
Carrying amount of bonds converted 1,300,000
Par value of shares issued (50,000 x 1) (50,000)
Share premium 1,250,000

12. C
 Initial measurement:
Issue price
2,200,000
(a)
Fair value of bonds without conversion feature
( 1,903,926)
Equity component
296,074
(a)
Future cash PV factors @12%, Present
flows n=3 value
Principal 2,000,000 0.711780 1,423,560
Interest 200,000 2.401831 480,366
Fair value of bonds without conversion
feature 1,903,926

 Subsequent measurement:
Interes Intere
t st
paymen expen Amortizati Present
Date ts se on value

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1,903,92
Jan. 1, 20x1 6
Dec. 31, 228,47 1,932,39
20x1 200,000 1 28,471 7
Dec. 31, 231,88 1,964,28
20x2 200,000 8 31,888 5

 Retirement:
Retirement price
1,000,000
Fair value of bonds w/o conversion feature
(1,981,982 (b) x ½)
( 990,991)
Allocation of retirement price to equity component
9,009
(b)
Future cash PV factors @11%, Present
flows n=1 value
Principa 2,000,00
l 0 0.900901 1,802,802
200,0
Interest 00 0.900901 180,180
Fair value of bonds w/o conversion feature
- 12/31/20x2 1,981,982

Carrying amount of bonds retired

(1,964,285 x ½) 982,143
Retirement price allocated to bonds 990,991
Loss on retirement
(8,849)

Equity component from issuance (296,074 x

148,037
1/2)
Retirement price allocated to equity
(9,009)
component
Net amount reclassified within equity 139,028

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Supporting journal entries:

De Bonds payable (2M x ½) 1,000,
c.
31,
Loss on extinguishment of 000
20 bonds 8,849 17,85
x2 Discount on bonds payable 8
[(2M – 1,964,285) x ½ ] 990,9
Cash 91
to record the retirement of bonds
De Share premium – conversion 148,03
c.
31, feature (296,074 x ½) 7
20 Cash 9,009
x2 Share premium 139,0
to transfer within equity the 28
amount allocated to the equity component
of the compound instrument

13. D
Payment for the liability:
50,00
Cash 0
Carrying amount of investment 375,0
securities 00 425,000
Carrying amount of liability
settled:
500,0
Principal 00
75,00
Accrued interest 0 575,000
Gain on settlement 150,000

14. B (28,000 – 25,000) = 3,000

15.D
The modification is analyzed as follows:
Old terms New terms
Principal 1,000,000 950,000
Accrued interest 40,000 30,000
Remaining term ('n') 1 year

The present value of the modified liability is computed as

follows:
Future cash flows PV of 1 Present

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@10%, n=1 value

Principal 950,000 0.90909 863,636
Interest 30,000 0.90909 27,273
Present value of the modified liability 890,908

The difference between the old liability and the new liability
is tested for substantiality.
Carrying amount of old liability
(1M principal + 40,000 accrued 1,040,000
interest)
Present value of modified liability 890,908
Difference 149,092

Difference 149,092
Divide by: Carrying amount of old
1,040,000
liability
14.34%

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
(carrying amount) of old obligation. Therefore, the old
liability is extinguished and the difference of ₱149,092 is
recognized as gain on extinguishment.

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PROBLEM 5: CLASSROOM ACTIVITY

Solutions:
Requirement (a): Effective interest rate
Trial & Error
PV = CF x PVF

There is discount. Therefore, the EIR must be higher

than 8%.

First trial: @10% per annum (5% semi-annual)

 922,782 = (1,000,000 x PV of 1 @ 5%, n=10) +
(40,000 x PV ordinary annuity @5%, n=10)
 922,782 = 613,913 + 308,869
 922,782 equals 922,782

 The EIR is 10% (per annum).

Requirement (b): Amortization table

Interest Interest Amortizat Present
Date payments expense ion value
7/1/x
1 922,782
1/1/x
2 40,000 46,139 6,139 928,921
7/1/x 40,000
2 46,446 6,446 935,367
1/1/x 40,000
3 46,768 6,768 942,135
7/1/x 40,000
3 47,107 7,107 949,242
1/1/x 40,000
4 47,462 7,462 956,704
7/1/x 40,000
4 47,835 7,835 964,539
1/1/x 40,000
5 48,227 8,227 972,766
7/1/x 40,000
5 48,638 8,638 981,404
1/1/x 40,000
6 49,070 9,070 990,474
7/1/x 40,000
6 49,526* 9,526* 1,000,000*

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* The last figures are ‘squeezed’ to eliminate the difference due to

rounding-offs and make the amortized cost at maturity date exactly
equal to 1M.

Requirement (c): Journal entries

7/1/x1
Cash 922,782
Discount on bonds payable 77,218
Bonds payable
1,000,000

12/31/x1
Interest expense 46,139
Interest payable 40,000
Discount on bonds payable
6,139

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PROBLEM 6: FOR CLASSROOM DISCUSSION

1. Solutions:

Requirement (a):
Issue price 4,800,000
Transaction costs (473,767)
Carrying amount - 1/1/x1 4,326,233

Requirement (b):
Face amount 5,000,000
Initial carrying amount (4,326,233)
Net discount on bonds payable 673,767

Requirement (c):

Interest Interest Amortizat Present

Date paid expense ion value
1/1/x1 4,326,233
12/31/x
1 500,000 692,197 192,197 4,518,430
12/31/x
2 500,000 722,949 222,949 4,741,379
12/31/x
3 500,000 758,621 258,621 5,000,000

 Answer: Periodic interest payments are less than

periodic interest expenses.

Requirement (d):
1/1/x1
Cash 4,800,000
Discount on bonds payable 200,000
Bonds payable
5,000,000

1/1/x1
Discount on bonds payable (Bond issue costs) 473,767
Cash 473,767

12/31/x1
Interest expense 692,197

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Cash 500,000
Discount on bonds payable 192,197

12/31/x2
Interest expense 722,949
Cash 500,000
Discount on bonds payable 222,949

12/31/x3
Interest expense 758,621
Cash 500,000
Discount on bonds payable 258,621

Bonds payable 5,000,000

Cash 5,000,000

2. Solution:

Requirement (a):
Issue price
5,415,183
Accrued interest (5M x 14% x 3/12)
(175,000)

Carrying amount - 4/1/x1 5,240,183

Requirement (b):
4/1/x1
Cash 5,415,183
Bonds payable 5,000,000
Premium on bonds payable 240,183
Interest expense (or Interest payable)
175,000

Requirement (c):
(5,240,183 x 12% x 9/12) = 471,616

3. Solution:
Issue
Cash flows
PV factors price
5,000,000

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PROBLEM 5: CLASSROOM ACTIVITY

Solutions:
Requirement (a): Effective interest rate
Trial & Error
PV = CF x PVF

There is discount. Therefore, the EIR must be higher

than 8%.
1 0
First trial: @10% per annum (5% semi-annual)
 922,782 = (1,000,000 x PV of 1 @ 5%, n=10) +
 (40,000 x PV ordinary annuity @5%, n=10)
 922,782 = 613,913 + 308,869
 922,782 equals 922,782

 The EIR is 10% (per annum).

Requirement (b): Amortization table

Interest Interest Amortizat Present
Date payments expense ion value
7/1/x
1 922,782
1/1/x
2 40,000 46,139 6,139 928,921
7/1/x 40,000
2 46,446 6,446 935,367
1/1/x 40,000
3 46,768 6,768 942,135
7/1/x 40,000
3 47,107 7,107 949,242
1/1/x 40,000
4 47,462 7,462 956,704
7/1/x 40,000
4 47,835 7,835 964,539
1/1/x 40,000
5 48,227 8,227 972,766
7/1/x 40,000
5 48,638 8,638 981,404
1/1/x 40,000
6 49,070 9,070 990,474
7/1/x 40,000
6 49,526* 9,526* 1,000,000*

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* The last figures are ‘squeezed’ to eliminate the difference due to

rounding-offs and make the amortized cost at maturity date exactly
equal to 1M. 1 0
Requirement (c): Journal entries
7/1/x1
Cash 922,782
Discount on bonds payable 77,218
Bonds payable
1,000,000

12/31/x1
Interest expense 46,139
Interest payable 40,000
Discount on bonds payable
6,139

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PROBLEM 6: FOR CLASSROOM DISCUSSION

1. Solutions:

Requirement (a):
Issue price 4,800,000
Transaction costs (473,767)
Carrying amount - 1/1/x1 4,326,233

Requirement (b):
Face amount 5,000,000
Initial carrying amount (4,326,233)
Net discount on bonds payable 673,767

Requirement (c):

Interest Interest Amortizat Present

Date paid expense ion value
1/1/x1 4,326,233
12/31/x
1 500,000 692,197 192,197 4,518,430
12/31/x
2 500,000 722,949 222,949 4,741,379
12/31/x
3 500,000 758,621 258,621 5,000,000

 Answer: Periodic interest payments are less than

periodic interest expenses.
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Requirement (d):