University of Santo Tomas

AMV College of Accountancy

IAC 11 – Integrated Review in Financial Accounting and Reporting

NON-CURRENT LIABILITIES
 In many instances, management and shareholders favor debt financing over equity financing
for the following reasons:
1. Present owners remain in control of the corporation.
2. Interest incurred is a deductible expense in arriving at taxable income.
3. Charge for interest may be less than the amount of dividends.
 Disadvantages: Debt Financing
1. Debtor must have adequate security offered to creditors.
2. Interests are required to be paid periodically regardless of performance.
3. If unpaid, creditors may bring legal action.

BONDS PAYABLE
 Normally, corporations sell all of its bonds to underwriter, which resells the bond to the investing
public.
 Bond Indenture – contract between the issuing corporation and the bondholder.
 Types of Bonds:
A. Term Bonds – bonds that mature on a single date.
B. Serial Bonds – bonds that mature in installments. Also, both nominal and effective interest
decreases.
C. Secure Bonds – protected by the pledge of a specific asset. (Ex: Real Estate Mortgage Bond,
Collateral Trust Bond (for investments), Chattel Mortgage Bond (for movable property)
D. Unsecured Bonds (Debentures) – backed only by the issuer’s general favorable credit
standing.
E. Registered Bonds – bondholders’ names are registered in the books and interest checks are
mailed to bondholders of record.
F. Bearer Bonds (Coupon Bonds) – accompanied by coupons representing periodic interest
payments.
G. Callable or Redeemable Bonds – give the debtor the right to call or retrieve bonds before
maturity date.
H. Convertible Bonds – give the bondholders the right to exchange the bond into a specified
or predetermined number of shares of stock.
I. Zero-interest Bonds (Deep-discount Bonds) – issued at significantly lower than their face.
 Initially recognized at the date of actual issue: At Discounted Value (or Net Proceeds)
 Contract Rate/Stated Rate/Nominal Rate – rate stated on the face of the bonds
 Market Rate/Yield/Effective Interest Rate – rate investors are willing to accept.
o Nominal Rate = Effective Rate (Sale at Face Value)
o Nominal Rate > or < Effective Rate (Sale at a Premium or Discount)
Journal Entry: Cash xx
Discount on Bonds Payable xx
Bonds Payable xx
Premium on Bonds Payable xx
 Market prices of Bonds:
1. Quoted as a percentage of face value
2. Discounting the bonds maturity value and all periodic interest payments at the market rate
 Alternative Computation of Premium or Discount:
 Premium/Discount = Difference in interest rates x Face Value x PV factor of ordinary annuity
 Accrued interest on bonds issued
Journal Entry:
At Issuance Date During Payment of Interest
Cash xx Interest Expense xx
Bonds Payable xx Cash xx
Interest Expense xx
 Bond Issue Costs
- Part of the initial carrying amount of the bond
- Reduces net proceeds
- Requires recomputation of the yield or effective interest rate
(Note: The higher the yield, the lower the present value)
Journal Entry: Cash xx Premium on B/P xx
Bonds Payable xx Cash xx
Premium on B/P xx
 Subsequent Measurement: At Amortized Cost
 Amortized Cost = Cost at Initial Recognition – Principal Repayments ± Cumulative Amortization
 Effective Interest Method
- Increasing premium or discount amortization per period
- Decreasing interest expense per period (for those bonds issued at a premium)
- Increasing interest expense per period (for those bonds issued at a discount)
 Retirement of bonds prior to maturity date
- Retirement Price > or < Carrying Value of Bonds = Loss or Gain taken to P/L
Note: If the retirement price is given using a quoted price, it is only for the payment of principal
(hence, exclusive of accrued interest, if any).
 Bond Refunding
- Replacement of an outstanding bonds payable with a new one
- Recognize gain or loss on the retirement of the original bonds payable and record the new
issue as a separate borrowing transaction
 Bonds with Non-detachable Share Warrants Issued
- Right to acquire a specific number of ordinary shares at a given price within a certain time
period
- (Residual Approach) Total Issue Price – Market Price of Bonds without Warrants1 = Price
assigned to the Warrants
Journal Entry:
At Issuance Date Upon Exercise of Warrants
Cash xx Bonds Payable xx
Discount of Bonds Payable xx Share Warrants Outstanding xx
Bonds Payable xx Ordinary Share Capital xx
Share Warrants Outstanding xx Share Premium - Ordinary xx
 Convertible Bonds2
- Right to exchange their bondholding into ordinary shares or other securities within a specific
period of time
- (Residual Approach) Total Proceeds – Market Value of Bonds without Conversion Privilege =
Paid in Capital arising from Bond Conversion Privilege
Journal Entry:
At Issuance Date Upon Conversion of Bonds

1 If the market price is not readily determinable, discount the maturity value and periodic interest.
2 When conversion takes place between interest payment dates, any accrued interest should be paid in cash.
 Cash xx Bonds Payable xx
Discount of Bonds Payable xx Share Premium – BCP xx
Bonds Payable xx Discount on Bonds Payable xx
Share Premium – Bond Share Premium - Ordinary xx
Conversion Privilege xx

Retirement of Convertible Bonds

Bonds Payable xx
Loss on Retirement of Bonds3 xx
Share Premium – Bond Conversion Privilege4 xx
Cash xx
Discount on Bonds Payable xx
Share Premium – Unexercised Bond Conversion Privilege5 xx
 Expenditures related to conversion are treated as a reduction in Share Premium and Expense
for any excess.

LONG-TERM NOTES PAYABLE

A. Interest Bearing Notes Payable
- Initial and Subsequent Measurement: At Face Value
- Presentation in the SFP:
o If principal matures in lump sum, it is classified as a non-current liability unless it is due
within the succeeding year.
o If principal is payable periodically, the portion due within the succeeding year shall be
classified as a current liability and the remaining portion shall be non-current.
B. Non-interest Bearing Notes Payable
- Face value includes an imputed interest
- Initial Recognition: At Amortized Cost
- Amortized Cost = Market value of the goods or services received; or Present value of the note
based on: (a) the prevailing interest on similar notes or (b) on the incremental borrowing rate
of the issuer.
- Subsequent Measurement: Face Value – Adjusted Amount of Discount

TROUBLED DEBT RESTRUCTURING

 Forms:
1. Asset Swap – settlement of debt by transfer of non-cash assets
Carrying Value of Debt > Fair Value of Asset > or < Carrying Value of Asset

Gain on Debt Restructuring G/L on Exchange of Asset

Total amount taken to P/L

Journal Entry: Notes Payable xx

Interest Payable xx
Loss on Disposal of Asset xx
Asset xx
Gain on Debt Restructuring xx

3 If the retirement price > carrying value of bonds retired

4 Carrying value of equity cancelled
5 If the retirement price of the BCP < carrying value of equity cancelled. This is a component of equity.
 2. Equity Swap
o Settlement of debt granting equity interest
o The equity instruments issued shall be measured at: (a) the fair value of the equity
instruments granted; or (b) the fair value of the financial liability settled.
o Fair Value of Equity Instruments – Carrying Value of Liability = Gain or Loss taken to P/L
Journal Entry: Notes Payable xx
Interest Payable xx
Gain on Debt Restructuring xx
Ordinary Share Capital xx
Share Premium – Ordinary xx
3. Modification of Terms
o May take the form of one or any combination of the following:
a. Reduction of stated interest rate
b. Reduction of the face amount of the debt
c. Reduction or condonation of accrued interest
d. Extension of maturity date
e. Moratorium on the payment of interest and/or principal
o An exchange between an existing borrower and lender of debt instruments with
substantially different terms shall be accounted for as an extinguishment of the original
liability and recognition of a new financial liability.
o Substantially Different = If the discounted present value of the net cash outflows under
the new terms and discounted using the original effective interest rate is at least 10%
different from the carrying amount of the original obligation (including accrued
interest, if any) at the date of the restructure. In such a case, the difference between
the carrying amount of the old debt and the initial measurement basis of the new debt
shall be taken to P/L.
Journal Entry: Notes Payable xx
Interest Payable xx
Discount on Restructured Notes Payable xx
Restructured Notes Payable xx
Gain on Debt Restructuring xx
o If an exchange of debt instruments is not accounted for as an extinguishment, any
costs or fees incurred adjusts the carrying amount of the liability and are amortized
over the remaining term of the modified liability. In effect, a new effective interest rate
has to be computed.
Journal Entry: Notes Payable xx
Interest Payable xx
Restructured Notes Payable xx
Premium on Restructured Notes Payable xx

 Present Value Factor Computation:

- For PV of 1: Present Value / Principal
- For PV of OA: Present Value / Periodic Payment

End of Handout.