What are Bonds?

- long-term debt instruments that are sold to large number of investors/bondholders in exchange for
regular interest payments. Upon maturity, the principal is repaid by the bond issuer.
- Bond certificates as a proof. Each certificate is worth a percentage of the total bonds.
- A bond is evidenced by the bond indenture, This outlines the terms of the bonds and rights and duties
of the borrower and other parties to the contract. This includes 'covenants' that may limit actions of
issuer that may be detrimental to the holder's interest.
- To ensure compliance, a bank is appointed as a trustee.

Types of bonds
1. Term bonds - bonds that mature on a single date.
2. Serial bonds - bonds in which the principal matures in installments.
3. Mortgage bonds are bonds secured by a mortgage on real properties.
4. Debenture bonds - bonds not secured by any collateral.
5. Corporate bonds - bonds issued by a corporation
6. Government or treasury bonds - bonds issued by a government
7. Convertible bonds - bonds that the holder can exchange for the issuer's shares of stocks
8. Callable bonds - bonds that the issuer can redeem prior to maturity date

Issuance of Bonds
- 1. Goes through an underwriter/investment banker - agrees on price and pays issuer.
- 2. the UW/IB resells the bonds at a higher price.
- 3. UW/IB charges fee for service and with commission deducted from sale proceeds.
- 4. Issuer agrees to pay face amount and periodic interest on maturity date. Usually every six
months/semi-annually.

Issue/Market Price of Bonds

- Price of Bond Payable is equal to the PRESENT VALUE OF THE PRINCIPAL + PRESENT VALUE
OF FUTURE INTEREST PAYMENTS.

Initial Measurement
- Fair Value Less Transaction Costs (Directly Attributable to issuance)
- Fair Value of Bonds is equal to issue price/net proceeds from issue of bonds excluding accrued
interest. Bond issue cost is deducted from fair value.

Subsequent Measurement
- Amortized Cost using Effective Interest Method.
- Amortized Cost is the amount at which the bond liability is measured INITIALLY MINUS
PRINCIPAL REPAYMENTS, PLUS OR MINUS THE CUMULATIVE AMORTIZATION USING
EFFECTIVE INTEREST METHOD of any difference between face amount and present value of
bonds.
- Difference is either discount or premium on issue of bonds.

Bond Issue Cost

- Examples of Bond Issue Costs are Legal ad Due Diligence Fees, Registration Fees, and Commissions
paid to underwriters.
- Deducted when determining the carrying amount. This transaction costs are also amortized using
effective interest method.
- Transaction Costs increase the effective interest rate.

What is EFFECTIVE INTEREST METHOD?

- PFRS 9, "Premium or Discount on Bonds must be amortized using effective interest method"
- This distinguishes two types of interest rates;
- 1. NOMINAL RATES - Aka "Stated Rate" is shown on the face of the bond certificate. Periodic
interest paid by issuer.
- 2. EFFECTIVE RATES - It's the rate that exactly discounts estimated cash future payments through
the expected life of the bonds.
- NOTE:
- When bonds issued = PREMIUM, effective rate < LOWER < Nominal Rate.
- When bonds issued = DISCOUNT, effective rate > HIGHER > Nominal Rate

BOND PREMIUMS
- When issued at premium, the CASH PROCEEDS is GREATER than the FACE AMOUNT.
- This is a gain for the ISSUER because they receive more than it is required to pay under the terms of
the bond.
- The gain is not reported as outright gain but rather deferred and amortized as a reduction to interest
expenses.
- When premium is fully amortized, the carrying amount is equal to face amount by the maturity date.

BOND DISCOUNTS
- When issued at discount, the CASH PROCEEDS is LESS than the FACE AMOUNT.
- This is a loss for the ISSUER because they receive less than it is required to pay under the terms of
the bond.
- The discount is not reported as outright loss but rather deferred and amortized as an addition to
interest expenses.
- Amortization of discount increases the periodic interest expense.
- When discount is fully amortized, the carrying amount is equal to face amount by the maturity date.
- When bonds are ISSUED AT FACE VALUE, there is no premium or discount. As a result, interest
expense = interest paid.

Amortization
- Under effective interest method ( Interest Expense = Carrying Amount of Bonds x Effective Rate )
- Carrying Amount of Bond changes every year as amount of prem/disc is amortized
- Effective interest is then compared with the interest paid. The difference is the prem/disc
amortization.

Presentation of Premium and Discount

- reported as adjustments to the Bonds Payable Account
- Premium - Normal Credit Balance - junct account (addition) to the Bonds Payable Account when
determining carrying amount.
- Discount - Normal Debit Balance - contra-account (deduction) to the Bonds Payable account when
determining carrying amount.
- Difference of Face Amount and Carrying Amount at a certain date is the unamortized balance of
premium or discount.
Retirement of Bonds Prior to Maturity
- The difference between retirement price and the carrying amount at date of retirement is recorded as
GAIN OR LOSS.