FINANCIAL INSTRUMENT

Investment in Debt Securities

Bonds
– Bonds are long-term debt instruments similar to term loans except that they are usually offered to the public
and sold to many investors.
– Bond indenture is the contractual arrangement between the issuer and the bondholders. It contains
restrictive covenants intended to prevent the issuer from taking actions contrary to the interests of the
bondholders. A trustee, often a bank, is appointed to ensure compliance.
Types of bonds
 Term bonds – bonds that mature on a single date.
 Serial bonds – bonds that mature in a series of maturity dates.
 Registered bonds – bonds issued in the name of the holder (owner). Interest payments are sent directly to
the holder.
 Coupon (bearer) bonds – bonds that can be freely transferred and have a detachable coupon for each
interest payment.
 Zero-coupon bonds (strip bonds) – bonds that do not pay periodic interests. Principal and compounded
interest are due only at maturity date.
 Callable bonds – bonds containing call provisions giving the issuer thereof the right to redeem the bonds
prior to their maturity date.
 Convertible bonds – bonds giving the holder thereof the option of exchanging the bonds for shares of stocks
of the issuer.
Accounting for investments measured at amortized cost
 The accounting for investments in bonds that are measured at amortized cost is similar to the accounting
for notes and loans receivables, in the sense that it also involves the following:
a. Present value computations
b. Preparation of amortization table (Effective interest method)
Discount vs. Premium
– If the carrying amount is less than the face amount, the difference represents a discount.
– If the carrying amount is more than the face amount, the difference represents a premium.
– If there is a discount, the EIR is higher than the NIR.
– If there is a premium, the EIR is lower than the NIR.
– Discount or premium is amortized using the effective interest method.
Effect of discount amortization
You have acquired a bond with face amount of ₱5,000 for ₱4,000.
 Would this be favorable or an unfavorable on your part?
 Favorable. Why? --- You will be collecting ₱5,000 (excluding interest) while your cash outflow is only ₱4,000.
 On acquisition date, it seems you have earned a “gain” of ₱1,000 right?
 Yes; however, the PFRSs prohibit you from recognizing this “gain” outright. You need to amortize it over the
term of the bond.
 The “gain” represents the discount (Carrying amt. less than Face amt.).
 The effect of the amortization is an increase in interest income.
 Over the term of the bonds, total interest income will be greater than total collections of interests by
₱1,000.
Transaction costs
– Transaction costs incurred in the acquisition of bonds to be measured at amortized cost are included as part
of the cost of the investment.
Sale of bonds prior to maturity
– When bonds are sold prior to maturity, the difference between the net disposal proceeds and the carrying
amount of the bonds, adjusted for any discount or premium amortization up to date of disposal, is
recognized as gain or loss in profit or loss.
Serial bonds
– Serial bonds are bonds with series of maturity dates. Serial bonds are accounted for similar to term bonds.
However, the periodic collections on serial bonds include not only collections for interests but also
collections for principal.
Zero-coupon bonds
– Zero-coupon bonds are bonds that do not pay periodic interests. Both principal and interest are due only at
maturity date.
Financial assets measured at FVOCI (mandatory)
– Initial measurement: Fair value + Transaction costs.
– Subsequent measurement: Fair value
 Changes in fair value are recognized in OCI.
 Impairment losses and gains are recognized in profit or loss.
 Interest revenue is computed using the effective interest method and is recognized in profit or loss.
– Derecognition: When the asset is derecognized, the cumulative balance of gains and losses in equity are
transferred to profit or loss as a reclassification adjustment.
– The amounts recognized in profit or loss for a debt instrument measured at FVOCI are the same as the
amounts that would have been recognized in profit or loss if the debt instrument had been measured at
amortized cost.

FINANCIAL INSTRUMENT
Investment Corporation (SM)
Jollibee
– Financial instrument is “any contract that gives rise to a financial asset of one entity and a financial liability
or equity instrument of another entity.” (PAS 32)
– Financial instruments include both financial assets and financial liabilities.
– Financial instruments include equity instruments of another entity but exclude an entity’s own equity
instruments. An entity’s own equity instruments are neither assets nor liabilities, but rather equity.
Financial assets
A financial asset is any asset that is:
a. Cash;
b. Equity instrument of another entity; or
c. Contractual right to receive cash or another financial asset or to exchange financial instruments with
another entity under conditions that are potentially favorable.
A financial asset is any asset that is:
a. Cash
b. A contractual right to receive cash or another financial asset from another entity.
c. A contractual right to exchange financial instrument with another entity under conditions that are potentially
favorable.
d. An equity instrument of another entity.
Examples of financial asset
o Cash or deposit of cash
o Contractual right to receive cash like trade and other receivables
o Potentially favorable exchanges like share options
o Equity instruments like trading securities
Measurement:
o Financial asset is recognized initially at fair value plus transaction cost that are directly attributable to the
acquisition.
o Subsequent measurement:
a. Fair value through profit or loss (FVPL)
b. Fair value through other comprehensive income (FVOCI)
 c. Amortized cost

Financial liabilities
A financial liability is any liability that is:
a. a contractual obligation to deliver cash or another financial asset to another entity; or
b. a contractual obligation to exchange financial instruments with another entity under conditions that are
potentially unfavorable.
Examples of financial liability
a. Payables, such as accounts, notes, loans, bonds and accrued payables
b. Lease liabilities
c. Held for trading liabilities and derivatives
d. Redeemable preference shares issued
Measurement:
– Financial liability is recognized initially at fair value minus transaction cost that are directly attributable to
the acquisition.
– Subsequent measurement:
a. Fair value through profit or loss (FVPL)
b. Fair value through other comprehensive income (FVOCI)
c. Amortized cost
Initial recognition and Classification
– Financial assets are recognized only when the entity becomes a party to the contractual provisions of the
instrument.
Basis of classification
Financial assets are classified based on:
1. the entity’s business model for managing the financial assets; and
2. the contractual cash flow characteristics of the financial asset.

Equity vs. Debt instruments

– Only debt instruments can be classified under the Amortized Cost or FVOCI (mandatory) measurement
categories.
– Equity instruments are measured at FVPL, unless the entity makes an irrevocable election on initial
recognition to measure them at FVOCI.
– A debt instrument that is not measured at amortized cost or at FVOCI is measured at FVPL.
 – A debt security is any security that represents a creditor relationship with an entity.

What is an equity security

- The term “equity security” encompasses any instrument representing ownership shares and right, warrants
or options to acquire or dispose of ownership shares at a fixed ore determinable price.

Fair Value Measurement

– Fair value is “the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.” (PFRS 13)
– Fair value is based on the market price of the asset in a:
a. principal market; or
b. the most advantageous market (in the absence of a principal market)
– The market price used in measuring fair value is not adjusted for any transaction costs, but is adjusted for
any transport costs.

BONDS PAYABLE
Technical Knowledge
1. To understand the nature and purpose of a bond.
2. To understand the nature and purpose of a bond.
3. To know the measurement of bonds payable.
4. To understand the concept of bond premium and bond discount.
5. To apply the fair value option of measuring bonds payable.

WHAT IS BOND?
– A 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.
– It is a contract debt whereby one party called the issuer borrows funds from another party called the
investor.
– It is evidenced by a certificate and the contractual agreement between issuer and investor is contained in a
document known as “bond indenture”.

TERM AND SERIAL BONDS

Term Bonds - Bonds with a single date of maturity.
- May require the issuing entity to establish a sinking fund to provide adequate money to retire the bond issue
at one time.
Serial Bonds - Bonds with a series of maturity date instead of a single one.
- In other words, serial bonds allow the issuing entity to retire the bonds by installments.

SECURED AND UNSECURED BONDS

o Mortgage Bonds - Bonds secured by a mortgage on real properties.
o Collateral Trust Bonds - Bonds secured by shares and bonds of other corporations.
o Debenture Bonds - Unsecured or bonds without collateral security.

REGISTERED AND BEARER BONDS

Registered Bonds
- Require the registration of the name of the bondholders on the books of the corporations
- If the bondholder sells a bond, the old bond certificate is surrendered to the entity and a new bond
certificate is issued to the buyer. Interest is periodically paid by the issuing entity to bondholders of record.
Coupon Or Bearer Bonds
- Unregistered bonds in the sense that the name of the bondholder is not recorded on the entity books.
- The issuing entity does not maintain a record of who owns the bonds at any point in time.
- Thus, interest on coupon bonds is paid in the person submitting a detachable interest coupon.

OTHER TYPES OF BONDS

o Convertible Bonds - Bonds that can be exchanged for shares of the issuing entity.
o Callable Bonds - Bonds which may be called in for redemption prior to the maturity date.
o Guaranteed Bonds - Bonds issued whereby another party promises to make payment if the borrower fails to
do so.
o Junk Bonds - High-risk, high-yield bonds issued by entities that are heavily indebted or otherwise in weak
financial condition.
o Zero-Coupon Bonds - Bonds that pay no interest but the bonds offer a return in the form of a “deep
discount” or huge discount from the face amount.
FEATURES OF BOND ISSUE
1. A bond indenture or deed of trust is the document which shows in the detail the terms of the loan and the
rights and duties of the borrower and other parties to the contract.
2. Bond certificates are used. Each bond certificate represents a portion of the total loan. The usual minimum
denomination in business practice is P1,000, although smaller denominations may be used occasionally.
3. If property is pledged as security for the loan, a trustee is named to hold title to the property serving as
security. The trustee acts as the representative of the bondholders and is usually a bank or trust entity.
4. A bank or trust entity is usually appointed as registrar or disbursing agent. The borrower deposits interest
and principal payments with the disbursing agent, who then distributes the funds to the bondholders.

CONTENTS OF BOND INDENTURE

a. Characteristics of the bonds
b. Maturity date and provision for repayment
c. Period of grace allowed to issuing entity
d. Establishment of a sinking fund and the periodic deposit therein.
e. Deposit to cover interest payments
f. Access to corporate books and records of trustee
g. Provisions affecting mortgaged property, such as taxes, insurance coverage, collection of interest or
dividends on collaterals
h. Certification of bonds by trustee
i. Required debt to equity ratio
j. Minimum working capital to be maintained, if any.
INITIAL MEASUREMENT OF BONDS PAYABLE
1. PFRS 9, paragraph 5.1.1, provides that 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 the
bonds payable.
2. The fair value of the bonds payable is equal to the present value of the future cash payments to settle the
bond liability.
3. Bond issue costs shall be deducted from the fair value or issue price of the bonds payable in measuring
initially the bonds payable.
4. However, if the bonds are designated and accounted for "at fair value through profit or loss", the bond issue
costs are treated as expense immediately.
5. Actually, the fair value of the bonds payable is the same as the issue price or net proceeds from the issue of
the bonds, excluding accrued interest.

SUBSEQUENT MEASUREMENT OF BONDS PAYABLE

PFRS 9, paragraph 5.3.1, provides that after initial recognition, bonds payable shall be measured either:
a. At amortized cost, using the effective interest method
b. At fair value through profit or loss
Amortized Cost Of Bonds Payable
• The amortized cost of bonds payable is 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 face amount and present value of the bonds payable.
• Actually, the difference between the face amount and present value is either discount or premium on the
issue of the bonds payable.

ACCOUNTING FOR ISSUANCE OF BONDS

1. Memorandum Approach
The following memorandum entry is made in the general journal and a notation of the amount authorized:
On January 1, 2020, the entity is authorized to issue face amount, 10-year 12% bonds, interest payable
January 1 and July , consisting of 5,000 units of P 1,000 face amount.
To record the sale of the bonds at face amount:

Cash P5,000,000

Bonds payable P5,000,000

In the succeeding discussions, the memorandum approach of accounting for bonds will be employed, as this is the
one generally followed.

2. Journal Entry Approach

To record the authorization of the bonds:

Unissued bonds payable P 5,000,000

Authorized bonds payable P 5,000,000

To record the gale of the bonds at face amount:

Cash P 5,000,000

Unissued bonds payable P 5,000,000

PRESENTATION OF DISCOUNT AND PREMIUM

 1. Discount on bond payable and premium on bond payable are reported as adjustments to the bond liability
account.
2. The discount on bond payable is a deduction from the bond payable and the premium on bond payable is an
addition to the bond payable.
3. This treatment is on the theory that the discount represents an amount that the issuer cannot borrow
because of interest differences, and the premium represents an amount in excess of face amount that the
issuer is able to borrow.
4. The discount on bonds payable and the premium on bonds payable shall not be considered separate from
the bonds payable account. Both accounts shall be treated consistently as valuation accounts of the bond
liability.
Observe the following presentation in the statement of financial position:
Noncurrent liabilities: (discount)

Bonds payable P 5,000,000

Discount on bonds payable (250,000) P 4,750,000

and

Noncurrent liabilities: (Premiums)

Bonds payable P 5,000,000

Premium on bonds payable 250,000 P 5,250,000

BOND ISSUE COSTS

1. Bond issue costs are transaction costs directly attributable to the issue of bonds payable.
2. Such costs include printing and engraving cost, legal and accounting fee, registration fee with regulatory
authorities, commission paid to agents and underwriters and other similar charges.
3. Under PFRS 9, bond issue costs shall be deducted from the fair value or issue price of bonds payable in
measuring initially the bonds payable.
4. Under the effective interest method o/ amortization, the bond issue cost must be "lumped" with the discount
on bonds payable and "netted" against the premium on bonds payable.
5. However, if the bonds are measured at fair value through profit or loss, the bond issue costs are expensed
immediately.

ISSUANCE OF BONDS BETWEEN INTEREST DATES

 On April 1, 2020, an entity issued bonds with face amount of P5,000,000 at P5,228,000 plus accrued interest.
 The bonds are dated January 1, 2020, mature in 5 years and pay 12% interest semiannually on January 1 and
July 1.
To record the issue of the bonds on April 1, 2020:
Cash P 5,378,000

Bonds payable P 5,000,000

Premium on bonds payable 228,000

Interest expense 150,000

Note:
o The accrued interest on the date of sale for 3 months from January I to April 1, 2020 is paid by the investor
because on July 1, 2020, three months after the sale, the investor is going to receive interest for 6 months
from January 1 to July 1,
o The accrued interest "sold" is credited to interest expense.
o If the bonds are issued between interest dates, an accrued interest is involved.
 o Normally, when bonds are issued between interest dates, the accrued interest is paid by the buyer or
investor.

On July 1, 2020, the journal entry to record the payment of semiannual interest is:
Interest expense (5,000,000 x 12% x 1 / 2) P 300,000

Cash P 300,000
o Note that if at this point the interest expense account is posted, it has a debit balance of which represents
the correct amount of interest expense from April 1 to July 1, 2020.
o Another approach is to credit the accrued interest date of sale to accrued interest payable account.
Cash P 5,378,000

Bonds payable P 5,000,000

Premium on bonds payable 228,000

Accrued interest payable 150,000

BOND RETIREMENT PRIOR TO MATURITY DATE

1. The bond premium or bond discount should be amortized up to the date of retirement
2. The balance of the bond premium or bond discount should be determined. This balance is important
because the amount related to the bonds retired is canceled
3. The accrued interest to dale of retirement determined.
4. The total cash payment should be computed. This is equal to the retirement price plus the accrued interest.
The retirement price is a certain percent of the face of the bonds.
5. The carrying amount of the bonds retired is determined, The face amount of the bonds plus the unamortized
premium or minus the unamortized discount gives the carrying amount of the bonds.
6. The gain or loss on the retirement of the bond is computed.
- This is the difference between the retirement price and the carrying amount of the bonds.
- If the retirement price is more than the carrying amount of the bonds, there is loss.
- If the retirement price is less than the carrying amount of the bonds, there is gain.
7. The retirement of the bonds is then recorded by canceling the bond liability together with the unamortized
premium or discount. Any accrued interest is debited to interest.
Illustration:
 On March 1, 2020, bonds with face amount of P5,000,000 are issued for P4,730,000
 The bonds are dated March 1, 2020 and mature in 5 years, and pay 12% interest semiannually on March 1
and Sept. 1.
 The straight line method of amortization is used for simplicity.
All of the bonds are retired on July 1, 2023 at 97.
1. The amortization of the bond discount is recorded up to July 1, 2023. If the entity uses the calendar period,
presumably, the last amortization was on December 31, 2022.
Thus, an amortization of the discount for 6 months from January 1 to July 1, 2023 should be recorded.
Interest expense P 27,000

Discount on bonds payable P 27,000

(270,000 / 5 years = 54,000 annual amortization)

(54,000 x 1/2 = 27,000)

2. Balance of the discount on bonds payable.

Discount on bonds payable — March 1, 2020 P 270,000
 Less: Amortization from March 1, 2020 180,000
to July 1, 2023 or 40 months (40 / 60 x 270,000)

Balance, July 1, 2023 P 90,000

3. The accrued interest on the date of retirement, July 1, 2023 is computed as x 12% x 4/ 12 = P200,000.
- The last payment of interest was March 1, 2023. Thus, the accrued interest is for 4 months, from March 1
to July 1, 2023.
4. Total cash payment
Retirement price (5,000,000 x 97) P 4,850,000

Add: Accrued interest 200 000

Total cash payment P 5,050,000

5. Carrying amount of the bonds payable.

Bonds payable P 5,000,000

Discount on bonds payable (90,000)

Carrying amount on July 1, 2023 P 4,910,000

6. Gain on the early retirement or extinguishment

Carrying amount of bonds payable P 4,910,000

Less: Retirement price 4,850,000

Gain on early retirement P 60,000

7. To record the retirement of the bonds on July 1, 2023.

Bonds payable P 5,000,000

Interest expense 200,000

Cash P 5,050,000

Discount on bonds payable 90,000

Gain on early retirement of bonds 60,000

- The gain on early retirement or extinguishment of bonds may be presented as component of finance cost or
other income.

TREASURY BONDS
1. Treasury bonds are an entity's own bonds originally issued and reacquired but not canceled. The acquisition
of treasury bonds calls for the same accounting procedures accorded to a formal retirement of bonds prior
to the maturity date.
2. In other words, the treasury bonds should be debited at face amount and any related unamortized premium
or discount should be canceled. Any accrued interest paid is charged to interest expense.
3. 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 bonds with face amount of at 105 or a premium of P250,000
 Subsequently, the entity reacquired P 1,000,000 face amount 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 P30,000 which is paid in cash.
To Record The Acquisition Of The Treasury Bonds
Treasury bonds P 1,000,000

Premium on bonds payable 40,000

Interest expense 30,000

Cash P 1,060,000

Gain on acquisition of treasury bonds 10,000

Face amount of treasury bonds P 1,000,000

Applicable premium (1,000,000/5,000,000 x 200,000) 10,000

Carrying amount 1,040,000

Less: Reacquisition price (1,000,000 x 103%) 1,030,000

Gain on acquisition of treasury bonds P 10,000

Reacquisition price P 1,030,000

Accrued interest on the bonds 30,000

Total cash payment P 1,060,000

- The treasury bonds when subsequently sold are recorded in the same manner as bonds originally issued.

REISSUANCE AT A PREMIUM
- The treasury bonds are reissued for P 1,200,000.
Cash P 1,200,000

Treasury bonds P 1,000,000

Premium on bonds payable 200,000

REISSUANCE AT A DISCOUNT
- The treasury bonds are reissued for P900,000.
Cash P 900,000

Discount on bonds payable 100,000

Treasury bonds P 1,000,000

 The premium or discount on the reissue of the treasury bonds should be amortized over the remaining life of
the treasury bonds.
 The treasury bonds when not subsequently sold are simply canceled against the bonds payable account on
the date of maturity.
Bonds payable P 1,000,000

Treasury bonds P 1,000,000

BOND REFUNDING
- Bond refunding is the floating of new bonds the proceeds from which are used in paying the original bonds.
- Simply stated, bond refunding is a premature retirement of the old bonds by means of issuing new bonds.
Bond refunding is also known as bond refinancing.
- Where refunding is made on the date of maturity of the old bonds, no accounting problem arises as this
would simply call for the cancelation of the bond liability. There is no unamortized premium or discount
involved.
- Refunding may be made on or before the date of maturity of the old bonds.
- The retirement is handled in the usual manner and the new bond issue is recorded in the normal way.
1. However, where refunding is made prior to the maturity date of the old bonds, consideration must be given to
the refunding charges pertaining to the old bonds.
2. The refunding charges include the unamortized bond discount or premium and redemption premium on the old
bonds being refunded.
3. The accounting problem is the treatment of these refunding charges.
4. Bond refunding shall be accounted for as an extinguishment of a financial liability.
5. The difference between the carrying amount of the financial liability extinguished and the consideration paid
shall be included in profit or logs.
6. Accordingly, the refunding charges are charged to loss on extinguishment.
Illustration:
1. Issuance of new 10-year 10% bonds, with face amount of P1,500,000, for P1,600,000.
2. Refunding of old 12% bonds, with remaining life of 4 years, at 102.
Bonds payable - old P 1,000,000

Discount on bonds payable 30,000

Retirement price (1,000,000 x 102) 1,020,000

JOURNAL ENTRIES:
1. To record the issuance of the new bonds payable:

Cash P 1,600,000

Bonds payable P 1,500,000

Premium on bonds payable 100,000

2. To record the retirement of the old bonds payable:

Bonds payable P 1,000,000

Loss on extinguishment of bonds 50,000

Cash P 1,020,000

Discount on bonds payable 30,000

Unamortized discount P 30,000

Redemption premium (1,000,000 x 2%) 20,000

Total refunding charges P 50,000

Bonds payable P 1,000,000

Discount on bonds payable (30,000)

Carrying amount 970,000

 Less: Retirement price 1,020,000

Loss on extinguishment P (50,000)

AMORTIZATION OF BOND DISCOUNT OR PREMIUM

- There are three approaches in amortizing bond premium or bond discount, namely:
Straight line
o The straight line method provides for an equal amortization of bond premium or bond discount.
o The procedure is simply to divide the amount of bond premium or bond discount by the life of the bonds to
arrive at the periodic amortization.
o The life of the bonds is that period commencing on the date of sale of the bonds up to the maturity date.
Bond Outstanding Method
o The bond outstanding method is applicable to serial bonds whether issued at discount or premium.
o It is based on the theory that interest expense shall decrease every year by reason of the decreasing
principal bond liability.
o As the name implies, the bond outstanding amortization approach gives recognition to the diminishing
balance of the bonds.
o For example, bonds with face amount ofP5,000,000 are issued and mature at the rate of P 1,000,000 every
year for 5 years.
o Serial bonds are those with a series of maturity dates.
Effective interest method or simply "interest method" or scientific method

PFRS 9 requires the use of the effective interest method in amortizing discount, premium and bond issue cost.
PFRS 9
- Paragraph 4.2.2, provides that at initial recognition, bonds payable may be irrevocably designated as at fair
value through profit or loss.
- There is no more amortization of bond discount and bond premium. Any transaction cost or bond issue cost
should be expensed immediately.
- In other words, under the fair value option, the bonds payable shall be measured initially at fair value and
remeasured at every year-end with any changes in fair value generally recognized in profit or loss.
- As a matter of fact, interest expense is recognized using the nominal or stated rate.

CHANGE IN FAIR VALUE RECOGNIZED IN OCI

PFRS 9, paragraph 5.7.7, provides that the gain or loss on financial liability designated at fair value through profit, or
loss shall be accounted for as follows:
a. The change in fair value the credit risk of the liability is recognized in other comprehensive income.
- Credit risk is the risk that the issuer of the liability would cause a financial loss to the other party by failing to
discharge the obligation.
- Credit risk does not include market, risk such as interest risk, currency risk and price risk.
b. The remaining amount of the change in fair value is recognized in profit or loss.