Bonds II

Bonds II: Issuance Costs, Fair Value, Debt Covenants & Disclosures | CFA Level I FSA

Welcome back! In this friendly tutorial, we’ll dive into part 2 of bonds, covering the effects of issuance costs of bonds, the fair value reporting option, debt covenants, and the required presentation and disclosures on financial statements. Let’s get started!

A Quick Recap of Bonds I

Before diving in, let’s quickly revise what we learned in the previous lesson:

Issuance Costs and Accounting Issues

Issuing a bond involves legal and accounting fees, printing costs, sales commissions, and other fees. Let’s see how these issuance costs are handled under U.S. GAAP and IFRS:



Fair Value Reporting Option

Market yields of bonds may fluctuate, causing differences between the market price of the bond and the book value of the bond liability. In some cases, it may be more accurate to value the bond at fair value instead. Both IFRS and US GAAP provide firms the irrevocable option to report debt at fair value. Gains and losses resulting from changes in bonds’ market price are reported in the income statement.

Derecognition of Debt

When a bond is derecognized at maturity, its book value and face value are the same. However, bonds can be redeemed before maturity, which may lead to differences between the market price and book value. In such cases, the gain or loss is reported in the income statement, usually under continuing operations.

Debt Covenants

Debt covenants are restrictions imposed by lenders to protect their position, reduce default risk, and potentially lower borrowing costs. These restrictions can be in the form of affirmative covenants or negative covenants.

Affirmative covenants require the borrower to do certain things, such as:

  • Make timely principal and interest payments.
  • Maintain specific ratios (e.g., current, debt-to-equity, and interest coverage ratios).
  • Keep collateral, if any, in working order.

Negative covenants require the borrower to refrain from activities that might adversely affect their ability to repay, such as:

  • Increasing dividends or repurchasing shares.
  • Issuing more debt.
  • Engaging in mergers and acquisitions.

Bond covenants are typically discussed in the financial statement footnotes. If a borrower violates any of the covenants, a technical default occurs, and the bondholder can demand immediate repayment of the principal.

An analyst should study covenants when valuing a firm’s equity, as these restrictions may affect the firm’s growth prospects.

Required Presentation and Disclosures

Firms usually report all outstanding long-term debt on a single line on the balance sheet. The portion due within the next year is reported as a current liability, and the rest as a non-current liability. More details about the long-term debt are often disclosed in the footnotes, which may be useful in determining the timing and amounts of future cash outflows.

Footnote disclosure typically includes:

  • Nature of the liabilities
  • Maturity dates
  • Stated and effective interest rates
  • Call provisions and conversion privileges
  • Restrictions imposed by creditors
  • Assets pledged as security
  • Amount of debt maturing in each of the next five years

A discussion of the firm’s long-term debt can also be found in the Management Discussion and Analysis section, which may include quantitative analysis (e.g., obligations due to mature in the future) and qualitative discussion (e.g., trends in the firm’s capital structure and material changes in the mix and cost of debt).


That wraps up this second part on bonds, where we discussed issuance costs, the fair value reporting option, debt covenants, and required presentation and disclosures on financial statements. In our next lesson, we’ll move on to leases. See you soon!

✨ Visual Learning Unleashed! ✨ [Premium]

Elevate your learning with our captivating animation video—exclusive to Premium members! Watch this lesson in much more detail with vivid visuals that enhance understanding and make lessons truly come alive. 🎬

Unlock the power of visual learning—upgrade to Premium and click the link NOW! 🌟