UNIT 4

AUDIT OF BONDS PAYABLE

Estimated Time: 3.0 HOURS

Discussion Question 4-1

1. Discuss the different types of bonds.
a. Terms and serial bonds
b. Secured and unsecured bonds
c. Registered and bearer bonds
d. Others
i. Convertible bonds
ii. Callable bonds
iii. Guaranteed bonds
2. Explain the measurement of bonds payable under PFRS.
3. Discuss convertible bonds and the related components.

Discussion Question 4-2: Substantive Procedures for Bonds Payable

Prepare an audit work program for bonds payable.

Problem 4-1:
On July 1, 2016, Gilmore Corporation issued 11% bonds in the face amount of
P2,000,000 that mature on June 30, 2020. The bond were issued to yield 10%, and
interest is payable every January 1 & July 1. Gilmore Corporation uses the effective
interest method of amortizing bond premium or discount.

Required: (Round off present value factors to four decimal places.)

How much is the carrying value of the debt instruments as of December 31, 2016?
Problem 4-2:
Sir Biz issued 10-year bonds on January 1, 2016. The amortization and interest
schedule payments are as follows:
12%

Interest paid

Interest

Amount

Carrying

expense

Unamortized

Value

1/1/2016

28,253.00

471,747.00

12/31/2016

55,000.00

56,610.00

26,643.00

473,357.00

12/31/2017

55,000.00

56,803.00

24,840.00

475,160.00

12/31/2018

55,000.00

57,019.00

22,821.00

477,179.00

12/31/2019

55,000.00

57,261.00

20,560.00

479,440.00

12/31/2020

55,000.00

57,533.00

18,027.00

481,973.00

12/31/2021

55,000.00

57,837.00

15,190.00

484,810.00

12/31/2022

55,000.00

58,177.00

12,013.00

487,987.00

12/31/2023

55,000.00

58,558.00

8,455.00

491,545.00

12/31/2024

55,000.00

58,985.00

4,470.00

495,530.00

12/31/2025

10

55,000.00

59,470.00

500,000.00

Required:
1. What is the nominal (stated) interest rate of the bonds?
2. What is the effective interest rate of the bonds?

Auditing Practice II
Workbook

Third Term, AY 2015-2016

Page 1-1

Problem 4-3: Bond Redemption Prior to Maturity Date Full Redemption

On January 2, 2016, Green Art Sir, Inc. (GASI) obtained an 8% bonds payable of
P500,000 less unamortized discount of P45,000. This bond was issued to yield 11%
and amortized using the effective interest rate method. Interest was paid on January
1 and July 1 of each year. On July 1, 2016, GASI retired the bonds at 106 before
maturity.

Required: How much is the carrying value of the bonds on the date of retirement?
Problem 4-4: Bond Redemption Prior to Maturity Date Partial Redemption
During the year, Sir Pent Property, Inc. (SPPI) obtained a 12%, 10-year bond dated
January 1, 2015. Cash proceeds from the issuance of 1,000, P1,000 bonds
amounted to P1,029,284. Prevailing market rate is 11.5%. On January 1, 2016 and
July 1, 2016, it paid interest amounting to P60,000. It accrued P60,000 in December
31, 2016 in addition to the P60,000 of the accrued interest balance at the beginning
of the year. Redemption price and interest to date on 200 bonds permanently retired
on December 31, 2016 amounted to P245,000.

Required: (Round off present value factors to four decimal places.)

1. How much is the carrying value of bonds payable as of December 31, 2016?
2. How much is the loss on bond redemption?
3. What is the balance of the accrued interest on bonds at December 31, 2016?
4. How much is the interest expense for the year December 31, 2016?
Problem 4-5: Convertible Debt
On January 1, 2014, Faith Company issued its 8%, 5-year convertible debt
instruments with a face amount of P8,000,00 for P7,700,000. Interest is payable
every December 31 of each year. The debt instrument is convertible into 50,000
ordinary shares with a par value of P100. When the debt instrument were issued, the
prevailing market rate of interest for similar debt without conversion option is 10%.
On December 31, 2016, all the convertible debt instruments were retired for
P8,000,000. The prevailing rate of interest on a similar debt instrument as of
December 31, 2016 is 9% without the conversion option.

Required: (Round off present value factors to four decimal places.)

1. On the date of issue, what amount of the proceeds represents the equity
component?
2. How much is the carrying value of the debt instruments as of December 31, 2016
prior to its retirement?
3. On the date of retirement, what amount of the proceeds represents the equity
component?
4. How much is the gain or loss that should be reported in the profit or loss on the
retirement of the convertible debt instruments?
5. How much is the gain on cancellation of the equity component to be reported in
the shareholders equity?

Auditing Practice II
Workbook

Third Term, AY 2015-2016

Page 1-2

Problem 4-6: Convertible Debt

On January 1, 2012, AAB Company issued a 10% convertible bond with a face value
of P4,000,000 maturing on December 31, 2021. Each P1000 bond is convertible into
ordinary shares of AAB at a conversion price of P25 per share. Interest is payable
half yearly in cash. At the date of issue, AAB Company could have issued
nonconvertible debt with a ten-year term bearing a coupon interest rate of 11%.
On January 1, 2017, the convertible bond has a fair value of P4,400,000. AAB
Company makes a tender offer to the holders to repurchase the bonds for
P4,400,000. The holders of the P2,000,000 bonds accepted the offer. At the date of
repurchase, AAB Company could have issued non-convertible debt with a five year
term bearing a coupon interest of 8%.
On December 31, 2017, to induce the holders of the remaining bonds to convert the
bonds promptly, AAB reduces the conversion price to P20 if the bonds are converted
before March 1, 2018 (i.e., within 2 months). The market price of AABs ordinary
shares on the date when the terms are amended is P32 per share.

Required: (Round off present value factors to four decimal places.)

1. How much is the equity component allocated from the proceeds of issuance of
convertible bonds?
2. How much is the carrying amount of the bonds on December 31, 2016?
3. How much is the amount to be recognized in the P/L as a result of the repurchase
of the bonds on January 1, 2017?
4. The repurchase of the bonds on January 1, 2017 decreased equity by how much?
5. The amount to be recognized in the profit or loss as a result of the amendment of
the terms on December 31, 2017 is?
Problem 4-7: Convertible Bonds Payable
On April 1, 2016, Sirius Black, Inc. issued P3,500,000 of 9% convertible bonds at par.
The bonds will mature on April 1, 2021 and interest is payable annually every March
31. The bond contract entitles the bondholders to receive 6, P100 par value, ordinary
shares in exchange for each P1,000 bond. On the date of issue the prevailing market
interest rate for similar debt without the conversion option is 12%.
On April 1, 2020, the holders of the bonds with total face value of P1,500,000
exercised their conversion privilege. On that date, the bonds were selling at P120 and
the ordinary share at P48.

Required: (Round off present value factors to four decimal places.)

1. How much of the proceeds from issuance of convertible bonds shall be allocated
to the equity component?
2. How much is the carrying amount of the bonds payable as of December 31,
2016?
3. How much is the gain to be recognized on the conversion of bonds?

Auditing Practice II
Workbook

Third Term, AY 2015-2016

Page 1-3