BALIUAG UNIVERSITY

Integrated Accounting Course II

Summer 2017

MODULE 7: Note Payable & Debt Restructure LVC

 RELATED STANDARDS: IFRS 9 - Financial Instruments; IFRIC 19 - Extinguishing Financial Liabilities with Equity
Instruments; Act No. 2031 - Negotiable Instruments Law; SFAS 15 - Accounting by Debtors and Creditors for Troubled
Debt Restructurings

I. Notes Payable

 Definition (Act No. 2031, Sec. 184)

 Promissory note/Note payable – an unconditional promise in writing made by one person to another, signed by the
maker, engaging to pay on demand, or at a fixed or determinable future time, a sum certain in money to order or to
bearer.

 Initial measurement of note payable (IFRS 9)

 An entity shall measure a financial liability at its fair value minus, in the case of financial liability not at fair value
through profit or loss, transaction costs that are directly attributable to the acquisition or issue financial liability.
 The fair value of the note payable is equal to the present value of future cash payment to settle the liability.
 When a note is issued solely for cash, present value is equal to the cash proceeds.
 Transaction cost is deducted from fair value of the note payable if it is classified as a financial liability at amortized
cost.
 Transaction cost is expensed immediately if the note payable is classified as financial liability at fair value through
profit and loss.

 Subsequent measurement of note payable (IFRS 9)

1. Financial liabilities at amortized cost
 Amortized cost of the note payable is the initial measurement minus principal repayment, and minus discount
amortization (if any) or plus premium amortization (if any).
 Difference between the face amount and the present value of the note payable is treated as discount or
premium.
 Discount or premium on note payable is amortized to interest expense using effective interest method.

2. Financial liabilities at fair value through profit or loss (irrevocable designation)

 An entity shall present a gain or loss on a note payable that is designated as at fair value through profit or loss
as follows:
a. The amount of change in the fair value that is attributable to changes in the credit risk of the note payable
shall be presented in other comprehensive income.
b. The remaining amount of change in the fair value of the note payable shall be presented in profit or loss.
 If presenting the change in fair value attributable to credit risk would create or enlarge an accounting mismatch
in profit or loss, an entity shall present all gains or losses on that liability (including the effects of changes in the
credit risk of that liability) in profit or loss.
 Amount recognized in other comprehensive income shall not be subsequently transferred to profit or loss.
 Cumulative gain or loss in other comprehensive income may be transferred within equity (retained earnings)
 Interest expense is measured using the stated or nominal rate.

II. Debt Restructure

 Definition (SFAS 15)

A restructuring of a debt constitutes a troubled debt restructuring if the creditor for economic or legal reasons related
to the debtor's financial difficulties grants a concession to the debtor that it would not otherwise consider.

 Forms of debt restructuring (SFAS 15)

 A troubled debt restructuring may include, but is not necessarily limited to, one or a combination of the following:
1. Asset swap – Transfer from the debtor to the creditor of receivables from third parties, real estate, or other
assets to satisfy fully or partially a debt (including a transfer resulting from foreclosure or repossession).
2. Equity Swap – Issuance or granting of an equity interest to the creditor by the debtor to satisfy fully or partially a
debt unless the equity interest is granted pursuant to existing terms for converting the debt into an equity
interest.
3. Modification of terms – Modification of terms of a debt, such as one or a combination of:

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a. Reduction (absolute or contingent) of the stated interest rate for the remaining original life of the debt.
b. Extension of the maturity date or dates at a stated interest rate lower than the current market rate for new
debt with similar risk.
c. Reduction (absolute or contingent) of the face amount or maturity amount of the debt as stated in the
instrument or other agreement.
d. Reduction (absolute or contingent) of accrued interest.

 Accounting for asset swap (IFRS 9)

 Dation in payment/dacion en pago (R.A. 386, Art. 1245), whereby property is alienated to the creditor in
satisfaction of a debt in money is accounted as asset swap.
 The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or
transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities
assumed, shall be recognized in profit or loss.

 Accounting for equity swap (IFRIC 19)

 When equity instruments issued to a creditor to extinguish all or part of a financial liability are recognized initially,
an entity shall measure them at the fair value of the equity instruments issued, unless that fair value cannot be
reliably measured
 If the fair value of the equity instruments issued cannot be reliably measured then the equity instruments shall be
measured to reflect the fair value of the financial liability extinguished.
 Order of priority for measurement of equity instruments issued to extinguish a financial liability:
a. Fair value of equity instruments issued
b. Fair value of the financial liability extinguished
c. Carrying amount of the financial liability extinguished – no gain or loss on extinguishment of debt
 If only part of the financial liability is extinguished, the entity shall assess whether some of the consideration paid
relates to a modification of the terms of the liability that remains outstanding. If part of the consideration paid does
relate to a modification of the terms of the remaining part of the liability, the entity shall allocate the consideration
paid between the part of the liability extinguished and the part of the liability that remains outstanding

 Accounting for modification of terms (IFRS 9)

 A substantial modification of the terms of an existing financial liability or a part of it (whether or not attributable to
the financial difficulty of the debtor) shall be accounted for as an extinguishment of the original financial liability
and the recognition of a new financial liability.
 The terms are substantially different if the discounted present value of the cash flows under the new terms,
including any fees paid net of any fees received and discounted using the original effective interest rate, is at least
10 percent different from the discounted present value of the remaining cash flows of the original financial liability.
 If there is substantial modification, gain or loss on extinguishment is equals to the carrying amount of the old
liability minus the present value of the new liability, including net fees incurred.
 If there is no substantial modification of terms, gain or loss on extinguishment of debt is not recognized.
 If an exchange of debt instruments or modification of terms is accounted for as an extinguishment, any costs or fees
incurred are recognized as part of the gain or loss on the extinguishment.
 If the exchange or modification is not accounted for as an extinguishment, any costs or fees incurred adjust the
carrying amount of the liability and are amortized over the remaining term of the modified liability.
 Interest expense under the new liability is computed using effective interest method.
 The rate used to compute the present value of the new financial liability is the interest rate of the old financial
liability.

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Illustrative Problems

1. An unconditional promise in writing made by one person to another, signed by the maker, engaging to pay on
demand, or at a fixed or determinable future time, a sum certain in money to order or to bearer.
A. Present obligation C. Financial liability
B. Constructive obligation D. Note payable
2. A situation whereby the creditor for economic or legal reasons related to the debtor's financial difficulties grants a
concession to the debtor that it would not otherwise consider.
A. Derecognition of debt C. Extinguishment of debt
B. Debt restructuring D. Debt reorganization
3. The issuance or granting of an equity interest to the creditor by the debtor to satisfy fully or partially a debt unless
the equity interest is granted pursuant to existing terms for converting the debt into an equity interest.
A. Equity swap C. Dacion en pago
B. Asset swap D. Modification of terms.
4. An entity shall measure a note payable designated at fair value through profit or loss at
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A. Face amount C. Fair value plus transaction cost
B. Fair value D. Fair value minus transaction cost
5. An entity shall measure a note payable designated at amortized cost at
A. Face amount C. Fair value plus transaction cost
B. Fair value D. Fair value minus transaction cost
6. Subsequent measurement of a note payable may be at
A. Fair value through profit and loss and fair value through other comprehensive income
B. Fair value through other comprehensive income and amortized cost
C. Fair value through other profit and loss and amortized cost
D. Fair value through profit and loss, fair value through other comprehensive income and amortized cost
7. An entity borrowed cash from a bank and issued a three-year note payable. The bank discounted the note at 10%
and remitted the proceeds to the entity. The effective interest rate of the note payable
A. Equal to 10% C. Lower than 10%
B. Higher than 10% D. Cannot be determined
8. Discount resulting from the determination of the present value of the note payable should be reported on the
statement of financial position as
A. Deduction from the face amount of the note. C. Deferred charge separate from the note
B. Addition to the face amount of the note. D. Deferred credit separate from the note
9. Gain or loss on extinguishment of debt accounted as asset swap is equals to
A. Carrying amount of liability extinguished minus carrying amount of asset transferred.
B. Fair value of liability extinguished minus fair value of asset transferred.
C. Carrying amount of liability extinguished minus fair value of asset transferred.
D. Fair value of liability extinguished minus carrying amount of asset transferred.
10. For equity swap debt restructure, the measurement of the equity instrument issued to extinguish the financial
liability shall be measured at
A. Par value of the equity instrument issued C. Fair value of the financial liability extinguished
B. Fair value of the equity instrument issued D. Carrying amount of the financial liability extinguished
11. There is substantial modification of terms of the old liability if the gain or loss on extinguishment of debt is
A. More than 10% of the present value of the new liability.
B. At least 10% of the present value of the new liability.
C. More than 10% of the carrying amount of the old liability.
D. At least 10% of the carrying amount of the old liability.
12. No gain or loss shall be recognized for extinguishment of debt when
A. There is no substantial modification of terms C. Both A and B
B. There is substantial modification of terms D. Neither A nor B
13. Gain or loss on extinguishment of debt shall be presented as
A. Adjustment to retained earnings C. Component of other comprehensive income
B. Component of finance cost D. Recognized in profit or loss
14. On March 01, Year 1, ABC Company issued a P90,000, 8% interest-bearing note payable from a financial institution
in exchange for cash. Interest and principal are payable after one year. How much is the interest expense for Year
1?
A. 7,200 C. 5,400
B. 6,000 D. 7,000
15. DEF Company issued a 2-year, P100,000 face value note payable. Interest of 7% per annum is deducted in advance.
The effective interest rate for the discounted note is 7.8328%. The note was issued on January 01, Year 1. PV of 1 at
7% for 2 periods is 0.87 and PV of 1 at 7.8328% for 2 periods is 0.86. How much is the interest expense for Year 1?
A. 6,736 C. 7,000
B. 7,833 D. 6,020
16. Refer to no. 17. How much is the carrying amount of the note payable as of December 31, Year 1?
A. 86,000 C. 92,736
B. 100,000 D. 92,020
17. GHI Company issued a 3-year, P150,000 face value noninterest-bearing note payable in exchange for a new
machinery on January 01, Year 1. The note is payable in three equal annual installments every January 01, starting
Year 1. No cash price of the machinery is available. The prevailing rate for similar note is 12%. PV of 1 at 12% for 3
periods is 0.7118. PV of an ordinary annuity of 1 at 12% for 3 periods is 2.4018. PV of an annuity due at 12% for 3
period is 2.6900. How much is the interest expense for Year 1?
A. -0- C. 10,140
B. 18,000 D. 5,357
18. Refer to preceding problem. How much is the carrying amount of the note payable as of December 31, Year 2?
A. 84,500 C. 100,000
B. 44,640 D. 50,000
19. JKL Company issued a 2-year, 10% interest-bearing, P100,000 face value note payable on January 01, Year 1. JKL
elected fair value option in measuring the note payable Transaction cost paid by JKL to issue the note is P1,000. On
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December 31, Year 1, the fair value of the note is P92,000. The P5,000 decline in fair value is associated with credit
risk. How much is the loss from change in fair value to be recognized in profit and loss?
A. 8,000 C. 3,000
B. 5,000 D. 2,000
20. MNO Company is experiencing financial difficulty and is renegotiating debt restructuring with the creditor to relieve
its financial distress. The entity has carrying amount of P4 million note payable and P80,000 accrued interest expense.
The following are the options contemplated upon by ABC Company for its debt restructuring arrangements:
 Transferring its real property consisting of a parcel of land and a building to the creditor as payment of debt. The
land has a cost of P2 million and fair market value of P2.5 million. The building has a cost of P5 million, P2,850,000
accumulated depreciation, and fair market value of P1.8 million.
 Offering its own 35,000 ordinary shares as payment of debt. Fair value per share is P110 and par value is P100.
Fair value of the note payable is P3.9 million.
What amount of gain/(loss) on extinguishment of debt shall be recognized if the asset swap was chosen?
A. 70,000 loss C. 220,000 loss
B. 70,000 gain D. 220,000 gain
21. Refer to preceding problem. What amount of gain/(loss) on extinguishment of debt shall be recognized if the asset
swap was chosen?
A. 230,000 loss C. 100,000 loss
B. 230,000 gain D. 100,000 gain
22. On December 31, Year 1, ABC Company and an overdue 10% note payable to DBO Bank at P8 million and accrued
interest expense of P800,000. On that date, DBO Bank offered modification of terms of the liability as follows:
 Principal is reduced by P2 million and accrued interest is condoned
 Maturity is extended to December 31, Year 5
 The new interest rate of 12% is payable every December 31
 PV of 1 at 10% for 4 periods is 0.683 and PV of 1 at 12% for 4 periods is 0.636
 PV of an ordinary annuity of 1 at 10% for 4 period is 3.17 and PV of an ordinary annuity of 1 at 12% for 4 period
is 3.037
What amount of gain/(loss) on extinguishment of debt shall be recognized for Year 1?
A. 2,797,360 loss C. 2,419,600 loss
B. 2,797,360 gain D. 2,419,600 gain
23. Refer to preceding problem. How much is the carrying amount of note payable as of December 31, Year 1?
A. 6,380,400 C. 4,098,000
B. 6,002,640 D. 3,816,000
24. Refer to preceding problem. How much is the interest expense for Year 2?
A. 600,000 C. 638,040
B. 720,000 D. 629,844
25. Refer to preceding problem. How much is the carrying amount of note payable as of December 31, Year 2?
A. 6,380,400 C. 6,208,284
B. 6,002,640 D. 6,298,440
26. Refer to preceding problem. Assuming there is no substantial modification of terms. The entry to record the new
liability will include a credit to
A. Premium on note payable, P2,800,000 C. Premium on note payable, P800,000
B. Gain on extinguishment of debt, P2,800,000 D. Gain on extinguishment of debt, P800,000

- End of discussion

“Most people say that it is the intellect which makes a great scientist. They are wrong: it is character.” – Albert Einstein

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