
Investments are assets held by an enterprise for earning income by way of
dividends, interest, and rentals, for capital appreciation, or for other
benefits to the investing enterprise.

An investment that is by its nature readily realizable and is intended to be
held for not more than one year from the date on which such investment
is made is termed as current/ short-term investment.

Such investments may be converted quickly to cash and are classified as
current assets.

Long-term investments are not current assets because they do not
represent resources available to meet working capital needs.
10/7/2023
BY MOTUMA .D
1

The basis of distinction between short-term investments and
long-term investments lies in the nature and purpose of the
investment. Investments that are readily marketable and that
may be sold without disrupting business relationships or
impairing the operations of the business enterprise are
classified as current assets. Investments made to foster
business relationships with other enterprises are classified as
long-term investments.
10/7/2023
BY MOTUMA .D
2

Companies have different motivations for investing in securities issued by
other companies.

to earn a high rate of return.

for investing (in securities) is to secure certain operating or financing
arrangements with another company;

to create close ties to major suppliers or to retail outlets;

to gain control of a competitor;

to acquire ownership of a company with a strong cash position, and

to diversify the business risk.
10/7/2023
BY MOTUMA .D
3

A company that acquires a controlling interest in the common stock
of another company is termed the parent company, and the
controlled company is the subsidiary.

The investment in the common stock of the subsidiary is a longterm investment for the parent company.

In addition to the separate financial statements prepared for the
parent company and for the subsidiary, consolidated financial
statement also are prepared.

Consolidated financial statements disregard the legal fact that each
enterprise is a separate legal entity and treat the parent company
and its subsidiaries as a single economic entity,
10/7/2023
BY MOTUMA .D
4

Acquisition Cost

The cost of an investment in securities includes:

the acquisition price plus brokerage fees and

any other expenditure incurred in the transaction.

If assets other than cash are given in payment for the securities, the cost of the
securities acquired and the value of the non-cash assets given in exchange may be
established by;

the fair value of the non-cash assets or

the current market price of the securities, whichever is more objectively
determinable.

If two or more securities are acquired for a lump sum or single price, the total cost
should be allocated among the various securities.
10/7/2023
BY MOTUMA .D
5

If the various securities acquired are publicly traded, the existing market prices serve as the basis for
apportionment or allocation of the total cost. This type of cost apportionment is termed relative
market value allocation.

To illustrate, let’s assume Company X acquires from Company Y 120 units of four shares of
common stock and 12 shares of preferred stock each at a price of Br. 500 a unit, when the
common stock is trading at Br. 40 and the preferred stock at Br. 120 a share. The lump-sum cost of
acquisition of Br. 60,000 (120 units X Br. 500) can be allocated to each kind of security as follows.

Each units of investment consists of 4 shares of common stock and 12 shares of preferred stock:

Market price of each unit = (Br. 40 x 4) + (Br. 120 x 2) = Br. 400



Portion of cost allocated to common stock = x Br. 60, 000
= Br. 24, 000
Portion of cost allocated to preferred stock = x Br. 60, 000
= Br. 36, 000
10/7/2023
BY MOTUMA .D
6


Accounting for long-term investments in common stock
There are three different methods of accounting for long-term investment
in common stock, depending on which return an investor wishes to
measure. These methods are:
1.
Cost method – investment income consists only of dividends received.
2.
Equity method – Investment income consists of the investor’s
proportionate share of the investee’s net income.
Market value method – investment income includes dividends received
3.
and changes in the market value of the investment.

Either the cost method or the equity method generally is used to account
for long-term investments in common stock.
10/7/2023
BY MOTUMA .D
7


The Cost Method
Under this method a long-term investment is originally recorded and
reported at cost. It continues to be carried and reported at cost in the
investments account until it is either partially or entirely disposed of, or
until some fundamental change in conditions makes it clear that the value
originally assigned can no longer be justified. Ordinary cash dividends
received from the investee are recorded as investment revenue.

This method is appropriate when an investor owns only a small portion
(for example, less than 20%) of the total outstanding common stock of an
investee
10/7/2023
BY MOTUMA .D
8

The investor has little or no influence over the investee.

the investor cannot influence the investee’s dividend policy

When the dividends received by the investor in subsequent periods exceed its share of
investee’s earnings for such periods, the dividends should be accounted for as a reduction
of the investment-carrying amount rather than as investment revenue. Such dividends are
called liquidating dividends. Receipt of such dividends is recorded by a credit to the
investment.

For example, let’s assume that X Company acquired 10% of Y Company’s outstanding
common stock at the beginning of 2002 for Br. 300,000. Y Company reported net income
of Br. 200,000 on December 31, 2002 and paid cash dividends of Br. 250,000 on January
10, 2003. X company then record these transactions using cost method as follows.

Beginning of 2002:
Investment in Y Company common stock 300, 000
Cash

300,000
10/7/2023
BY MOTUMA .D
9


(To record acquisition of the common stock)
January 10, 2003: Cash
Dividend revenue


25, 000
20, 000
Investment in Y Company common stoc5, 000

(To record cash dividends received)

Total cash dividend received by X Company = 0.10 x 250, 000 = Br. 25, 000

Post-acquisition earnings, share of X Company = 0.10 x 200, 000 = 20, 000

Liquidating dividend
Br. 5, 000
10/7/2023
BY MOTUMA .D
10


The Equity Method
When an investor Company acquires sufficient ownership in the voting
stock of an investee Company to have significant influence over the affairs
of the investee Company but less than a controlling interest, the investment
is accounted for using the equity method.

Under the equity method, the investor and the investee acknowledge a
substantive economic relationship.

The company originally records the investment at the cost of the shares
acquired but subsequently adjusts the amount each period for changes in
the investee’s net assets.
10/7/2023
BY MOTUMA .D
11

That is, the investor’s proportionate share of the earnings (losses) of the investee periodically increases
(decreases) the investment’s carrying amount.

All cash dividends received by the investor from the investee also decrease the investment’s carrying
amount.

The equity method recognizes that investee’s earnings increase investee’s net assets, and that investee’s
losses and dividends decrease these net assets.

Illustrate: Assume that on Jan. 5, 2002, X Company acquired 24, 000 shares (20%) of Y Company’s
common stock at a cost of Br. 10 a share. On Dec. 31, 2002, Y Company reported net income of Br.
100,000 and on Jan. 20, 2003, announced and paid a cash dividend of Br. 60,000. For year ended on
Dec. 31, 2003, Y Company reported a net loss of Br. 30, 000. The comparison of the cost and equity
methods of accounting to account for the investment in the books of X Company is presented as follows.

10/7/2023
BY MOTUMA .D
12

Cost method
Equity method

Jan. 5, 2002

Investment in Y Company C/S
Investment in Y Company C/S
Cash

240, 000
(24, 000 x 10)

240, 000
240, 000
Cash
240, 000
(2) Dec. 31, 2002

No entry
Investment in Y Company C/S
20,000
Investment income

20, 000
(3) Jan. 20, 2003

Cash (20% x Br. 60, 000)
12, 000
Investment income

12, 000
Cash

12, 000
Investment in Y Company C/S

12,000
(4) Dec. 31, 2003
No entry
Loss on investment (20% x 30, 000) 6, 000
Investment in Y Company C/ stock 6, 000
10/7/2023
BY MOTUMA .D
13


Accounting for Long-term Investment in Bonds
Debt securities represent a creditor relationship with another entity. Debt securities
include government securities, municipal securities, corporate bonds, convertible
debt, and commercial paper. Trade accounts receivable and loans receivable are
not debt securities because they do not meet the definition of a security. A bond
arises from a contract known as an indenture and represents a promise to pay:

a sum of money at a designated maturity date, plus

periodic interest at a specified rate on the maturity amount (face value)
10/7/2023
BY MOTUMA .D
14
 Computation of Acquisition price of long-term investments in bonds

Investments in bonds should be recorded on the date of acquisition at cost, which includes
brokerage fees and any other costs incidental to the purchase. The cost or purchase price of
a bond investment is its market value, which is determined by the market’s appraisal of the
risk involved and consideration of the stated interest rate in comparison with the prevailing
market (yield) rate of interest for that type of security. The cash amount of interest to be
received periodically is fixed by the stated rate of interest on the face value.

There are two types of interest on the bond:

Nominal interest rate (the rate at which the fixed interest is payable), and

Yield rate (the market rate of interest).

The cost of an investment in bonds (market value at acquisition) is the present value of the
future cash receipts pursuant to the bond contract, measured in terms of the market (yield)
rate of interest at the time of investment.
10/7/2023
BY MOTUMA .D
15

If the rate of return desired by the investors (yield rate) is exactly equal to
the stated rate, the bond will sell at its face amount.

If investors demand a higher yield than the normal rate, the bond will sell
at a discount.

If the yield rate is below the stated rate, investors will pay a premium,
more than maturity value, for the bond.
 Acquisition of Bonds between Interest dates

If bonds are purchased between interest payment dates, the investor must
pay the owner the market price plus the interest accrued since the last
interest payment date. The investor will collect this interest plus the
additional interest earned by holding the bond to the next interest date.
10/7/2023
BY MOTUMA .D
16

To illustrate, let’s assume that on July 1 an investor purchased bonds
having a Br. 100, 000 face values and paying 12% interest on May 1 and
November 1, for 97%. The Journal entry to record purchase of the bonds
and accrued interest is as follows:

Investment in Bonds (97% x Br. 100, 000)…………..97, 000
Interest receivable (Br. 100, 000 x 0.12 x 2/12)……….2, 000

Cash……………………………………………………..99, 000


On November 1, the investor will receive interest of Br. 6, 000 (Br. 100,
000 x 0.12 x 6/12) consisting of Br. 2, 000 paid at date of acquisition and
Br. 4, 000 earned for holding the bond for
10/7/2023
BY MOTUMA .D
17

four months (July 1 to November 1). On November 1 when the interest is
received the investor will present the following journal entry.
Cash……………………………..6,000


Interest receivable……………….2,000

Interest Revenue………………...4,000
 Discount and Premium on Long-Term Investment in Bonds

On the date of acquisition of bonds, the investment ledger account is
debited for the cost of acquiring the bonds, including brokerage and other
fees, but excluding any accrued interest. A separate discount or premium
ledger account as a valuation account is not usually used.
10/7/2023
BY MOTUMA .D
18

The subsequent treatment of the investment might be handled in one of the
following three ways:

The investment might be carried at cost, ignoring the accumulation of discount
or amortization of premium.

The investment ledger account balance might be revalued periodically to
reflect market value changes

The discount or premium might be accumulated or amortized to reflect the
change in the carrying amount of the bonds based on the effective rate of
interest prevailing at the time of acquisition

The first alternative is used primarily in accounting for short-term bond
investments, for convertible bonds, and for other bonds for which the discount
or premium is insignificant.
10/7/2023
BY MOTUMA .D
19

The second alternative is not in accord with the present interpretation of the
realization principle or the concept of conservatism, especially during periods of
rising bond prices. When the investment in bonds is in jeopardy because of
serious cash shortages of the issuer, it generally is acceptable to write the
investment down to its expected net realizable value and to recognize a loss.

The third alternative is the preferred treatment for long-term investments in
bonds. This approach recognizes that the interest revenue represented by the
discount, or the reduction in interest revenue represented by the premium,
accrues over the term of the bonds. This method is consistent with the principle
that requires assets other than cash and receivables to be recorded at cost.
There are two methods of discount accumulation or premium amortization:
interest method and straight-line method.
10/7/2023
BY MOTUMA .D
20

This method produces a constant rate of return on the investment in bonds. The interest
revenue is computed for each interest period by multiplying the balance of the
investment at the beginning of the period by the effective interest rate at the time the
investment was made.

Straight-Line Method

Under this method discount or premium is spread uniformly over the term of the bonds.
The periodic discount to be accumulated or premium to be amortized is the total
premium/discount divided by the number of periods.

Illustration: Assume that a Company acquired Br. 1,000,000, 10% bonds of another
Company that will mature after 25 years. The bonds yield (1) 12%; and (2) 8%
compounded semiannually. The bonds pay interest semiannually starting six months
from date of acquisition and the semiannual interest to be collected on the investment is
Br. 50,000 (Br. 1, 000, 000 x 10% x ½).
10/7/2023
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21

Case 1: Bonds Issued at a Discount (Effective interest of 12%)

Acquisition price of this investment is Br. 842,381 (present value of the face amount and ordinary annuity of 50
semiannual interest payments) computed as follows.

Present value of Br. 1, 000, 000 discounted at 6% for 50 six-month periods (Br. 1, 000, 000 x 0.054288)

Br. 54, 288

Add: Present value of ordinary annuity of 50 rents of Br. 50, 000 discounted at 6% (Br. 50, 000 x 15.76186)=788.093

Acquisition price of the bonds
Br. 842, 381

Because the investors required an effective-interest rate of 12 percent, they paid Br. 842,381 for the Birr 1,000,000 of
bonds, creating a Br. 157, 619 discounts computed as follows.

Face value of bonds

Less: Present value of bonds cash flows

Discount on bonds
10/7/2023
Br. 1,000,000
(842,381)
Br. 157, 619
BY MOTUMA .D
22

If the straight-line method is used a constant amount of the discount is accumulated each interest period (in this case 50 interest periods). Thus,
the amount of the periodic accumulation of discount will be Br. 3, 152 (Br. 157, 619 50). Then the company records the acquisition of the bonds
at a discount and receipt of interest at the end of the first six-month period as follows.

Investment - X Company bonds…………….842, 381
Cash…………………………………………….842, 381


Cash…………………………………………..50, 000

Investment - X Company bonds……………….3, 152
Interest Revenue…………………………………..53, 152


What if the interest method is used to accumulate the discount? Using the interest method the first semiannual interest revenue and discount
accumulated is computed and recorded as follows.

Interest Revenue (Br. 842, 381 x 12% x ½)…………Br. 50, 543

Less: Interest receipt……………………………………..50, 000

Accumulation of discount……………………………...Br. 543

Cash

Investment - X Company bonds
50, 000
543
Interest Revenue

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50, 543
BY MOTUMA .D
23

Case 2: Bonds Issued at a Premium (Effective interest of 8%)

Now, let’s assume that for the bond issue described above, the investor is willing
to accept an effective-interest rate of 8 percent. In that case, S/he would pay Br.
1,214,822 or a premium of Br. 214,822, computed as follows.

Present value of Br. 1, 000, 000 discounted at 4% for 50 semiannual periods
(Br. 1,000, 000 x 0.140713)

Br. 140, 713

Add: PV of ordinary annuity of 50 rents of Br. 50, 000 discounted at 4% (Br.
50, 000 x 21.482185)

1.074, 109
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BY MOTUMA .D
24

Acquisition price of bonds

Br. 1, 214, 822

If the straight-line method is used a constant amount of the premium is amortized each
interest period (in this case 50 interest periods). Thus, the amount of the periodic
amortization of premium will be Br. 4, 296 (Br. 214, 822 50). Then the company
records the acquisition of the bonds at a premium and receipt of interest at the end of
the first six-month period as follows.

Investment - X Company bonds………………..1, 214, 822
Cash……………………………………………………1, 214, 822

(to record the investment)


Cash
50, 000

Investment - X Company bonds

10/7/2023
Interest Revenue
BY MOTUMA .D
4, 296
45, 704
25


Introduction
Long-term debt may be collateralized (secured) by liens on business property of
various kinds, for example, equipment (equipment notes), real property
(mortgages), or securities (collateral trust bonds). The title of a long-term debt
obligation, such as First Mortgage Bonds payable, may indicate the nature of
collateral for the debt. Bonds may be issued that pay not interest (Zero – Coupon
bonds) or that pay an exceptionally low rate of interest (deep-discount bonds).

A bond arises from a contract known as a bond indenture.

A bond represents a promise to pay:

a sum of money at a designated maturity date, plus

Periodic interest at a specified rate on the maturity amount (face value).
10/7/2023
BY MOTUMA .D
26


Types of Bonds
Some of the more common types of bonds found in practice are defined as
follows.

Secured and Unsecured Bonds:

Secured bonds are backed by a pledge of some sort of collateral. Mortgage bonds
are secured by a claim on real estate. Collateral trust bonds are secured by stocks
and bonds of other corporations.

Bonds not backed by collateral are unsecured. A debenture bond is unsecured. A
“junk bond” is unsecured and also very risky, and therefore pays a high interest
rate. Companies often use these bonds to finance leveraged buyouts.

Term, Serial Bonds, and Callable Bonds:

Bond issues that mature on a single date are called term bonds;
10/7/2023
BY MOTUMA .D
27

Issues that mature in installments are called serial bonds. Serially maturing bonds are
frequently used by school or sanitary districts, municipalities, or other local taxing bodies that
receive money through a special levy.



Callable bonds give the issuer the right to call and retire the bonds prior to maturity.
Convertible, Commodity-Backed, and Deep-Discount Bonds:
If bonds are convertible into other securities of the corporation for a specified time after
issuance, they are convertible bonds.

Commodity-backed bonds (also called asset-linked bonds) are redeemable in measures of a
commodity, such as barrels of oil, tons of coal, or ounces of rare metal.

Deep-discount bonds, also referred to as zero interest debenture bonds, are sold at a discount
that provides the buyer’s total interest payoff at maturity.
10/7/2023
BY MOTUMA .D
28

Registered and Bearer (Coupon) Bonds:

Bonds issued in the name of the owner are registered bonds and require surrender
of the certificate and issuance of a new certificate to complete a sale.

A bearer or coupon bond, however, is not recorded in the name of the owner and
may be transferred from one owner to another by mere delivery.

Income and Revenue Bonds:

Income bonds pay no interest unless the issuing company is profitable.

Revenue bonds, so called because the interest on them is paid from specified
revenue sources, are most frequently issued by airports, school districts, counties,
toll-road authorities, and governmental bodies.
10/7/2023
BY MOTUMA .D
29

Accounting for Issuance of Bonds
The selling price of a bond issue is set by the supply and demand of buyers and sellers, relative risk, market

conditions, and the state of the economy.
The investment community values a bond at the present value of its expected future cash flows, which consist of

(1) interest and
(2) principal.

The rate used to compute the present value of these cash flows is the interest rate that provides an acceptable
return on an investment commensurate with the issuer’s risk characteristics.

The interest rate written in the terms of the bond indenture (and often printed on the bond certificate) is known
as the stated, coupon, or nominal rate. The issuer of the bonds sets this rate.

The stated rate is expressed as a percentage of the face value of the bonds (also called the par value, principal
amount, or maturity value).

If the bonds sell for less than face value, they sell at a discount.

If the bonds sell for more than face value, they sell at a premium.
10/7/2023
BY MOTUMA .D
30

The rate of interest actually earned by the bondholders is called the effective yield or market rate.

If bonds sell at a discount, the effective yield exceeds the stated rate.

If bonds sell at a premium, the effective yield is lower than the stated rate. Several variables affect
the bond’s price while it is outstanding, most notably the market rate of interest. There is an
inverse relationship between the market interest rate and the price of the bond.

Bond
Discount
and
Premium
in
the
Balance
Sheet
At the time of issue, the carrying amount of bonds payable is equal to the proceeds received,
because these proceeds are computed as the present value of all future payments at the yield rate
set by the money market. Bond discount and bond premium are valuation amounts relating to
bonds payable. The discount or premium should be reported in the balance sheet as a direct
addition to or deduction from the face amount of the bond. It should not be classified a deferred
change or deferred credit. Bonds are presented in balance sheet as follows:
10/7/2023
BY MOTUMA .D
31

Bonds issued at a discount

Long-term debt:
Bonds issued at a premium
Long-term debt:
Bond payable (face amount)…… xx

Bond payable (face
amount)…. xx

Less: discount
(xx)
Add: Premium
Carrying amount
xx
Carrying amount
xx

xx
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BY MOTUMA .D
32
 Term Bond Interest Expense

Bonds Issued at Par on Interest Date

When a company issues bonds on an interest payment date at par (face value), it accrues
no interest. No premium or discount exists. The company simply records the cash
proceeds and the face value of the bonds.

To illustrate, if Balcha Company issues at par 10-year term bonds with a par value of birr
800,000, dated January 1, 2012, and bearing interest at an annual rate of 10 percent
payable semiannually on January 1 and July 1, it records the following entry.
Cash………………………..800,000

Bonds Payable ……………….800,000


Balch records the first semiannual interest payment of Birr 40,000 (birr 800,000 x 0.10 x
1/2) on July 1, 2012, as follows.
10/7/2023
BY MOTUMA .D
33
Interest Expense………………40,000
Cash…………………………………40,000

It records accrued interest expense at December 31,
2012 (year-end), as follows.
Interest Expense………………….40,000
Interest Payable……………………..40,000
10/7/2023
BY MOTUMA .D
34


Bonds Issued at Discount or Premium
If bonds are issued at a yield rate greater than the nominal rate, the
discount represents an additional amount of interest that will be paid by
the issuer at maturity.

if the bonds are issued at a yield rate less than the nominal rate, the
premium represents an advance paid by bond holders for the right to
receive layer annual interest checks and is viewed as a reduction in the
effective interest expense.

The premium in effect is returned to bond holders in the form of larger
periodic interest payments.
10/7/2023
BY MOTUMA .D
35

The process of amortizing the bond discount or premium in
conjunction with the computation of periodic interest expense is
a means of recording the change in the carrying amount of the
bonds as they approach maturity.

In the bond discount case, the increase in the carrying amount of
the bonds is caused by the decrease in bond discount through
amortization.

Similarly, in the bond premium case, the decrease in the carrying
amount of the bonds is caused by the decrease in bond premium
through amortization.
10/7/2023
BY MOTUMA .D
36

Methods Of Bond Discount And Premium Amortization

Effective-Interest Method

The preferred procedure for amortization of a discount or premium is the
effective-interest method (also called present value amortization). Under the
effective-interest method, companies: b

Compute bond interest expense first by multiplying the carrying value (book value)
of the bonds at the beginning of the period by the effective-interest rate.

Determine the bond discount or premium amortization next by comparing the
bond interest expense with the interest (cash) to be paid.

The Computation of the amortization is as follows:
10/7/2023
BY MOTUMA .D
37

Straight- Line Method of Amortization

Under this method the additional interest expense (discount) or reduction
of interest expense (premium) may be allocated evenly over the term of
the bonds. It results in a uniform periodic interest expense. The use of
straight-line method is acceptable if it is applied to immaterial amounts of
discount or premium.

The effective-interest method produces a periodic interest expense equal
to a constant percentage of the carrying value of the bonds. Since the
percentage is the effective rate of interest incurred by the borrower at the
time of issuance, the effective-interest method matches expenses with
revenues better than the straight-line method.
10/7/2023
BY MOTUMA .D
38

Both the effective-interest and straight-line methods result in the same total amount
of interest expense over the term of the bonds. However, when the annual
amounts are materially different, generally accepted accounting principles require
use of the effective-interest method.

To illustrate, Assume that Br. 5,000,000 of five-year, 10% term bonds are
authorized and issued by a corporation. Assume also that the effective (yield) rate
of interest for such types of bonds is: (1) 12%, and (2) 8%. The amount of the
annual interest on this bond is Br. 500,000 ( 0.10 x Br. 5000, 000). However the
proceed from this bond varies depending on the effective interest rate.

Case 1: Bonds Issued at a Discount (Effective interest of 12%)
10/7/2023
BY MOTUMA .D
39

Because the investors required an effective-interest rate of 12 percent, they paid Br.
4,639,540 for the Birr 5,000,000 of bonds, creating a Br.
360,460 discounts
computed as follows.
Face value of bonds
Br. 5000,000
Less: Present value of bonds
(4,639,540)
Discount on bonds

Br. 360,460
The corporation records the issuance of its bonds at a discount on date of issuance, as
follows.
Cash
4,639,540
Discount on Bonds payable
10/7/2023
360,460
BY MOTUMA .D
40

Bonds payable
5000,000

The amount of effective interest expense over the term of the bonds issued at a
discount is presented below.
Nominal interest (Br. 500,000 x 5)


Br. 2,500,000
Add: Discount
360,460
Five-year interest expense

Br. 2,860,460


The five-year discount amortization schedule using interest method appears as
follows.
10/7/2023
BY MOTUMA .D
41

It records the first annual interest payment, and amortization of the discount as follows.
End of year 1: Bond interest Expense
Br. 556,745
Cash
500,000
Discount on bonds payable

56,745
Annual interest payments for the remaining four year are also recorded using the same
approach.

The straight-line method amortizes a constant amount each interest period (in this case 5
interest periods). For example, using the bond discount of Birr 360,460, the corporation
amortizes Br. 72,092 to interest expense each period for 5 periods (Birr 360,460 / 5). If
straight-line method is used, the five-year discount amortization schedule could appear as
follows.
10/7/2023
BY MOTUMA .D
42

The journal entries to record annual interest payment under straight-line method are
similar to the interest method except the mounts to be credited and debited. For
example, at the end of every year for five years the annual interest payment and
amortization of the discount can be recorded as follows.
Bond interest Expense …………….Br. 572,092
Cash……………………………………..500,000
Discount on bonds payable……………….72,092

Case 2: Bonds Issued at a Premium (Effective interest of 8%)

Now, let’s assume that for the bond issue described above, investors are willing to accept
an effective-interest rate of 8 percent. In that case, they would pay Br. 5,399,255 or a
premium of Br. 399,255, computed as follows.
10/7/2023
BY MOTUMA .D
43

Present value of Br. 5000,000 due in 5 years at 8% (Br. 5000,000 x 0.68068)
Br.
3,402,900

Present value of ordinary annuity of Br. 500,000 interest Payable every year
for 5 years at 8% (Br. 500,000 x 3.99271)

1,996,355

Proceeds from bond issue………………………………………………...
Br. 5,399,255

Amount of premium on bonds = Br. 5399,255 – Br. 5,000,000 = Br. 399,255


The corporation records the issuance of its bonds at a premium on date of issuance, as
follows.
Cash
Br. 5,399,255
Premium on Bonds Payable

399,255
Bonds Payable
10/7/2023
5,000,000
BY MOTUMA .D
44

Bond Issue Costs

The issuance of bonds involves:

engraving and printing costs,

legal and accounting fees,

commissions,

promotion costs, and

Other similar charges.

To illustrate the accounting for costs of issuing bonds, assume that Microchip Corporation sold Br. 20,000,000 of 10-year
debenture bonds for Br. 20,795,000 on January 1, 2012 (also the date of the bonds). Costs of issuing the bonds were Br.
245,000. Microchip records the issuance of the bonds and amortization of the bond issue costs as follows.
January 1, 2012
Cash…………………………………………20,550,000
Unamortized Bond Issue Costs…………………245,000
Premium on Bonds Payable…………………….…….795,000
Bonds Payable……………………………………..20,000,000
(To record issuance of bonds)
10/7/2023
BY MOTUMA .D
45


Bonds Issued Between Interest Dates
Companies usually make bond interest payments semiannually, on dates specified in the bond indenture.
When companies issue bonds on other than the interest payment dates, buyers of the bonds will pay the
seller the interest accrued from the last interest payment date to the date of issue.

The purchasers of the bonds, in effect, pay the bond issuer in advance for that portion of the full sixmonths’ interest payment to which they are not entitled because they have not held the bonds for that
period. Then, on the next semiannual interest payment date, purchasers will receive the full six-months’
interest payment.

To illustrate, assume that on June 1, 2012, Tujji Corporation issues 5-year bonds, dated March 31, 2012,
with a par value of Birr 100,000. These bonds have an annual interest rate of 8 percent and effective
interest rate of 10 percent, payable semiannually on September 30 and March 31. Because Tujji issues the
bonds between interest dates, it computes the price of the bond at immediately preceding interest date
(March 31, 2012) as follows.
10/7/2023
BY MOTUMA .D
46
Present value of Br. 100,000 at 5% for 10 periods (Br. 100,000 x 0.61391) Br. 61,391 Present value of ordinary

annuity of 5 rents of Br. 4000 interest payments
at 5% (Br. 4,000 x 7.72173) 30,187
(Br. 100,000 x 8% 2/12) ....................................................... (1,333)
Price of bond at June 1, 2012...................................................... Br. 92,483

Effective interest rate per interest period = 10%/2 = 5%,

Interest payment per period = 100,000 x 0.04 = Br. 4,000 Because Tujji issues the bonds
between interest dates, it records the bond issuance at bond price plus accrued interest as follows.

Cash (Br. 92,483 + Br. 1,333) 93,816

Discount on bonds payable (Br. 100,000 - Br. 92,483) 7,517


Interest payable 1,333

Bonds payable 100,000
The purchaser advances two months’ interest. On September 30, 2012, four months after the date of purchase,
Tujji pays the purchaser six months’ interest. Tujji makes the following entry on September 30, 2012. (Interest
method is used)

Interest payable 1,333

Interest expense 3,076
10/7/2023

Discount on bonds payable 409

Cash
4,000
BY MOTUMA .D
47



Issuance of Serial Bonds
Serial bond provides for payment of the principal in periodic installments.
Serial bonds have the advantage of gearing the issuer’s debt repayment to its periodic cash inflow
from operations.

The proceeds of a serial bond issue are the present value of the series of principal payments plus
the present value of the interest payments, all at the effective interest rate equals the proceeds
received for the bonds.

If interest method is to be used in accounting for serial bond interest expense, the procedure is
similar to the illustrated in connection with term bonds. A variation of the straight-line method,
known as the bonds outstanding method, results in a decreasing amount of premium or discount
amortization each accounting period proportionate to the decrease in the amount of outstanding
serial bonds.
10/7/2023
BY MOTUMA .D
48

To illustrate, assume that in early January, 2003, a company issued Br. 500,000 of tenyear, 10% serial bonds, to be repaid in the amount of Br. 50,000 each year. Assume
that interest payments are made annually and that the bond issue costs were Br. 25,000.
Assume also that the effective (yield) rate of interest for such types of bonds is: (1) 9%,
and (2) 11%.

The proceeds received on this serial bonds issued at an effective interest rate of 9% is
Birr 519, 780 which is the present value of future cash flows consisting of interest
and principal payments. It is computed as follows.

Case 1: Serial Bonds Issued at a Premium (Effective interest of 9%)
Br 519,780 for the Birr 500,000 of serial bonds, creating a Br. 19,780 premium computed
as follows.

Proceeds received Br. 519,780

Bond Face value 500,000

Premium Br. 19,780

Under this case, the company records the bond issuance as follows.
10/7/2023
BY MOTUMA .D
49
Year
Carrying
Interest
Interest
Premium
Bond
Cumulativ
amount
expense
Payment
Amortizatio
Premium
e principal
(9%)
(10%)
n
Balance
Payment
-
-
-
Br. 519,780
2003
466,560
Br. 46,780
Br. 50,000
Br. 3,220
16,560
2004
413,550
41,990
45,000
3,010
13,550
2005
360,770
37,220
40,000
2,780
10,770
308,239
32,469
35,000
2,531
8,239
255,981
27,742
30,000
2,258
5,981
250,000
204,019
23,038
25,000
1,962
4,019
300,000
152,381
18,362
1,638
2,381
350,000
101,095
13,714
1,095
400,000
50,194
9,099
901
194*
450,000
-
4,517
483*
-
500,000
2006
2007
2008
2009
2010
2011
2012
10/7/2023
20,000
15,000
10,000
5000
1,286
BY MOTUMA .D
Br. 19,780
-
Issue
100,000
100,000
150,000
200,000
50

Dec. 31, 2003:

Bonds payable
50,000
Premium on bonds payable 3,220
Bond interest expense
Cash
46,780
100,000
4.4. Bond Sinking Funds

Some bond indentures require that a sinking fund be established for the
retirement of the bonds. Ordinarily, a sinking fund would not be created
in connection with the issuance of serial bonds; such bonds are retired
periodically in lieu of making sinking fund deposits.
10/7/2023
BY MOTUMA .D
51

Bonds Issued at a Discount

To illustrate amortization of a discount under the effective-interest method, Ever master Corporation
issued €100,000 of 8 percent term bonds on January 1, 2015, due on January 1, 2020, with interest payable
each July 1 and January 1. Because the investors required an effective-interest rate of 10 percent, they paid
€92,278 for the €100,000 of bonds, creating a €7,722 discount. Ever master computes the €7,722 discount
as follows:





Maturity value of bonds payable
PV of €100,000 due in 5 years at 10%, interest payable semiannually
[FV(PVF10,5%); (€100,000 x 0.61391)]= €61,391
PV of €4,000 interest payable semiannually for 5 years at 10% annually
[R(PVF- OA10,5%); (€4,000 x 7.72173)]= 30,887
Proceeds from sale of bonds

(92,278)
Discount on bonds payable


€100,000
€ 7,722
The five-year amortization schedule appears below:

10/7/2023
BY MOTUMA .D
52
10/7/2023
BY MOTUMA .D
53

Ever master records the issuance of its bonds at a discount on January 1, 2015, as
follows:

Cash
Bonds Payable


92,278
It records
the
first
92,278
interest
payment on
July
1,2015, and
amortization of the discount as follows:

Interest Expense
4,614

Bonds Payable

Cash

614
4,000
Ever master records the interest expense accrued at December 31, 2015 (year-end), and
amortization of the discount as follows.


Interest Expense
Interest Payable

Bonds
10/7/2023
Payable
4,645
4,000
645
BY MOTUMA .D
54


Bonds Issued at a Premium
Now assume that for the bond issue described above, investors are
willing to accept an effective-interest rate of 6 percent. In that case,
they would pay €108,530 or a premium of €8,530, computed as
follows:

Maturity value of bonds payable
€100,000

PV of €100,000 due in 5 years at 6%, interest/P semiannually €74,409

FV (PVF10,3%); (€100,000 x 0.74409)

PV of €4,000 interest/P semiannually for 5 years at 6% annually
34,121

( R (PVF-OA10,3%); (€4,000 x 8.53020)

10/7/2023

Proceeds from sale of bonds
(108,530)
BY MOTUMA .D
Premium on bonds payable
€ 8,530
55

Bonds Issued Between Interest Dates

Companies usually make bond interest payments semiannually, on dates specified
in the bond indenture.

When companies issue bonds on other than the interest payment dates, bond
investors will pay the issuer the interest accrued from the last interest payment date
to the date of issue.

The bond investors, in effect, pay the bond issuer in advance for that portion of the
full six-months’ interest payment to which they are not entitled because they have
not held the bonds for that period.

Then, on the next semiannual interest payment date, the bond investors will
receive the full six-months’ interest payment.
10/7/2023
BY MOTUMA .D
56


Bonds Issued at Par:
To illustrate, assume that instead of issuing its bonds on January 1, 2015,
Ever master issued its five-year bonds, dated January 1, 2015, on May 1,
2015, at par (€100,000). Ever master records the issuance of the bonds
between interest dates as follows:

May 1, 2015

Cash


Bonds Payable
100,000
100,000
(To record issuance of bonds at par)
10/7/2023
BY MOTUMA .D
57


Bonds Issued at Discount or Premium
The illustration above was simplified by having the January 1, 2015, bonds issued on May 1, 2015,
atpar. However, if the bonds are issued at a discount or premium between interest dates, Ever master
must not only account for the partial cash interest payment but also the amount of effective
amortization for the partial period's

o illustrate, assume that the Ever master 8-percent bonds were issued on May 1, 2015, to yield 6
percent. Thus, the bonds are issued at a premium; in this case, the price is €108,039.6 Ever master
records the issuance of the bonds between interest dates as follows:

May 1, 2015

Cash

108,039
Bonds Payable
108,039

(To record the present value of the cash flows)

Cash

Interest Expense (€100,000 x 0.08 x 4/12)

(To record accrued interest; Interest Payable might be credited instead)
10/7/2023
2,667
2,667
BY MOTUMA .D
58

Carrying value of bonds
€108,039

Effective-interest rate (6% x 2/12)
x 1%

Interest expense for two months
€ 1,080

The bond interest expense therefore for the two months (May and June) is€1,080.

The premium amortization of the bonds is also for only two months. It is computed by
taking the difference between the net cash paid related to bond interest and the effectiveinterest expense of €1,080. The computation of the partial amortization, using the
effective-interest rate of 6 percent is as follows:

Cash interest paid on July 1, 2015 (€100,000 x 8% x 6/12)€4,000

Less: Cash interest received on May 2, 2015 2,667

Net cash paid €1,333

Bond interest expense (at the effective rate) for two months(1,080)
10/7/2023
Premium
amortization €253
BY MOTUMA .D
59


LONG-TERM NOTES PAYABLE
The difference between current notes payable and long-term notes payable is the
maturity date.

Short-term notes payable are those that companies expect to pay within a year or
the operating cycle—whichever is longer.

Long-term notes are similar in substance to bonds in that both have fixed maturity
dates and carry either a stated or implicit interest rate.

Accounting for notes and bonds is quite similar. Like a bond, a note is valued at
the present value of its future interest and principal cash flows.

The company amortizes any discount or premium over the life of the

note, just as it would the discount or premium on a bond.
10/7/2023
BY MOTUMA .D
60

Notes Issued at Face Value

To illustrate the discounting of a note issued at face value, assume that
Scandinavian Imports issued at face value €10,000, three-year note bearing interest
at 10 percent annually to Bigelow Corp. The market rate of interest for a note of
similar risk is also 10 percent. Because the present value of the note and its face
value are the same, €10,000, Scandinavian would recognize no premium or
discount.

Cash
10,000
Notes Payable 10,000


Scandinavian Imports would recognize the interest incurred each year as follows:

Interest Expense (€10,000 x 0.10)

10/7/2023
1,000
Cash
1,000
BY MOTUMA .D
61

Notes Not Issued at Face Value

Zero-Interest-Bearing Notes

If a company issues a zero-interest-bearing (non-interest-bearing) note solely for cash, it
measures the note’s present value by the cash received. The implicit interest rate is the
rate that equates the cash received with the amounts to be paid in the future. The issuing
company records the difference between the face amount and the present value (cash
received) as a discount and amortizes that amount to interest expense over the life of the
note.To illustrate the entries and the amortization schedule, assume that Turtle Cove
Company issued the three-year, $10,000, zero-interest- bearing note to Jeremiah
Company. The implicit rate that equated the total cash to be paid ($10,000 at maturity)
to the present value of the future cash flows ($7,721.80 cash proceeds at date of issuance)
was
9
10/7/2023
BY MOTUMA .D
percent.
62

(The present value of $1 for three periods at 9 percent is$0.77218.)

Cash
7,721.80
Notes Payable7,721.80


Interest-Bearing Notes

To illustrate a more common situation, assume that Marie Co. issued
for cash a €10,000, three-year note bearing interest at 10 percent to
Morgan Corp. The market rate of interest for a note of similar risk is
12 percent. In this case, because the effective rate of interest (12%) is
greater than the stated rate (10%), the present value of the note is less
than the face value.

That is, the note is exchanged at a discount.

Cash

10/7/2023
9,520
Notes Payable
9,520
BY MOTUMA .D
63

Reporting of non-current liabilities is one of the most controversial areas in
financial reporting. Because non- current liabilities have a significant
impact on the cash flows of the company.

Four additional reporting issues related to non-current liabilities are
addressed in this section:

Extinguishment of non-current liabilities

Fair value option

Off-balance-sheet financing

Presentation and analysis.
10/7/2023
BY MOTUMA .D
64

Extinguishment of Non-Current Liabilities

How do companies record the payment of non-current liabilities— often referred to
as extinguishment of debt? If a company holds the bonds (or any other form of
debt security) to maturity, the answer is straightforward: The company does not
compute any gains or losses. It will have fully amortized any premium or discount
and any issue costs at the date the bonds mature.

In this section, we discuss extinguishment of debt under three common additional
situations:

Extinguishment with cash before maturity,

Extinguishment by transferring assets or securities, and

Extinguishment with modification of terms.
10/7/2023
BY MOTUMA .D
65

Extinguishment with Cash before Maturity

A company extinguishes debt before its maturity date. The amount paid on
extinguishment or redemption before maturity, including any call premium and expense
of reacquisition, is called the reacquisition price.. Any excess of the net carrying amount
over the reacquisition price is a gain from extinguishment.

The excess of the reacquisition price over the carrying amount is a loss from
extinguishment.

At the time of reacquisition, the unamortized premium or discount must be

amortized up to the reacquisition date.

To illustrate, we use the Ever master bonds issued at a discount on January 1,

2015. These bonds are due in five years. The bonds have a par value of

€100,000, a coupon rate of 8 percent paid semiannually, and were sold to yield 10
percent. The amortization schedule for the Ever master bonds is presented as follows:
10/7/2023
BY MOTUMA .D
66
10/7/2023
BY MOTUMA .D
67

Two years after the issue date on January 1, 2017, Ever master calls the
entire issue at 101 and cancels it. As indicated in the amortization
schedule, the carrying value of the bonds on January 1, 2017, is €94,925.

Computation of loss on redemption of bonds is as follows:
10/7/2023
BY MOTUMA .D
68

Ever master records the reacquisition and cancellation of the bonds as follows.
Bonds Payable
94,925
Loss on Extinguishment of Debt 6,075
Cash


101,000
Extinguishment by Exchanging Assets or Securities
In these situations, the creditor should account for the non-cash assets or equity interest
received at their fair value.

The debtor must determine the excess of the carrying amount of the payable over the
fair value of the assets or equity transferred (gain). The debtor recognizes a gain equal to
the amount of the excess. In addition, the debtor recognizes a gain or loss on disposition
of assets to the extent that the fair value of those assets differs from their carrying
amount (book value).
10/7/2023
BY MOTUMA .D
69

Transfer of Assets

Assume that Hamburg Bank loaned €20,000,000 to Bonn Mortgage Company. Bonn,
in turn, invested these monies in residential apartment buildings. However, because of
low occupancy rates, it cannot meet its loan obligations. Hamburg Bank agrees to
accept from Bonn Mortgage real estate with a fair value of €16,000,000 in full
settlement of the

€20,000,000 loan obligation. The real estate has a carrying value of €21,000,000 on the

books of Bonn Mortgage. Bonn (debtor) records this transaction as follows:

Notes Payable (to Hamburg Bank)

Loss on Disposal of Real Estate (€21,000,000 – €16,000,000) 5,000,000
Real Estate


20,000,000
Gain on Extinguishment of Debt (€20,000,000 – €16,000,000)
10/7/2023
BY MOTUMA .D
21,000,000
4,000,000
70

The creditor offers these concessions to ensure the highest
possible collection on the loan. For example, a creditor may
offer one or a combination of the following modifications:

Reduction of the stated interest rate.

Extension of the maturity date of the face amount of the debt.

Reduction of the face amount of the debt.

Reduction or deferral of any accrued interest.
10/7/2023
BY MOTUMA .D
71

Of the three primary forms of business organization the proprietorship, the
partnership, and the corporation the corporate form dominates.

The corporation is by far the leader in terms of the aggregate amount of resources
controlled, goods and services produced, and people employed.

Although the corporate form has a number of advantages (as well as disadvantages)
over the other two forms, its principal advantage is its facility for attracting and
accumulating large amounts of capital.
10/7/2023
BY MOTUMA .D
72

The special characteristics of the corporate form that affect accounting
include:
1. Influence of state corporate law.
2. Use of the capital stock or share system.
3. Development of a variety of ownership interests.

Components of Stockholders’ Equity
The following three categories normally appear as part of stockholders’ equity:
1.
Capital stock.
2.
2. Additional paid-in capital.
10/7/2023
BY MOTUMA .D
73
3. Retained earnings.

The first two categories, capital stock and additional paid-in capital, constitutes
contributed (paid-in) capital. Retained earnings represent the earned capital of the
company.

Contributed (paid-in) capital is the total amount paid in on capital stock—the
amount provided by stockholders to the corporation for use in the business.

Contributed capital includes items such as the par value of all outstanding stock
and premiums less discounts on issuance.

Earned capital is the capital that develops from profitable operations. It consists of
all undistributed income that remains invested in the company.
10/7/2023
BY MOTUMA .D
74


Issuance of Stock
The corporation generally makes no entry in the general ledger accounts
when it receives its stock authorization from the state of incorporation. We
discuss the accounting problems involved in the issuance of stock under the
following topics.
1. Accounting for par value stock.
2. Accounting for no-par stock.
3. Accounting for stock issued in combination with other securities (lump-sum
sales).
4. Accounting for stock issued in noncash transactions.
5. Accounting for costs of issuing stock.
10/7/2023
BY MOTUMA .D
75

Par Value Stock

The par value of a stock has no relationship to its fair value. At present, the par value
associated with most capital stock issuances is very low.

For example, PepsiCo’s par value is 12/3¢, Kellogg’s is $0.25, and Hershey’s is $1. Such
values contrast dramatically with the situation in the early 1900s, when practically all
stock issued had a par value of $100.

Low par values help companies avoid the contingent liability associated with stock sold
below par.

To show the required information for issuance of par value stock, corporations maintain
accounts for each class of stock as follows.

1. Preferred Stock or Common Stock. Together, these two stock accounts reflect the par
value of the corporation’s issued shares.
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
The company credits these accounts when it originally issues the shares. It
makes no additional entries in these accounts unless it issues additional
shares or retires them.
2. Paid-in Capital in Excess of Par (also called Additional Paid-in Capital). The
Paid-in Capital in Excess of Par account indicates any excess over par
value paid in by stockholders in return for the shares issued to them. Once
paid in, the excess over par becomes a part of the corporation’s additional
paid-in capital. The individual stockholder has no greater claim on the
excess paid in than all other holders of the same class of shares.

No-Par Stock
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
Many states permit the issuance of capital stock without par value, called
no-par stock.

The reasons for issuance of no-par stock are twofold.

First, issuance of no-par stock avoids the contingent liability that might
occur if the corporation issued par value stock at a discount.

Second, some confusion exists over the relationship (or rather the absence
of a relationship) between the par value and fair value.

If shares have no-par value, the questionable treatment of using par value
as a basis for fair value never arises.

This is particularly advantageous whenever issuing stock for property
items such as intangible or tangible fixed assets.
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
For example, Video Electronics Corporation is organized with authorized
common stock of 10,000 shares without par value. Video Electronics
makes only a memorandum entry for the authorization, inasmuch as no
amount is involved. If Video Electronics then issues 500 shares for cash at
$10 per share, it makes the following entry.
Cash………….5,000
Common Stock (no-par value)……………5,000

If it issues another 500 shares for $11 per share, Video Electronics makes
this entry:
Cash…………….. 5,500
Common Stock (no-par value)………… 5,500
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

Stock Issued with Other Securities (Lump-Sum Sales)
Generally, corporations sell classes of stock separately from one another. The
reason to do so is to track the proceeds relative to each class, as well as relative to
each lot.
(1) the proportional method and
(2) the incremental method.

Proportional Method: If the fair value or other sound basis for determining relative
value is available for each class of security, the company allocates the lump sum
received among the classes of securities on a proportional basis.

For instance, assume a company issues 1,000 shares of $10 stated value common
stock having a market price of $20 a share, and 1,000 shares of $10 par value
preferred stock having a market price of $12 a share, for a lump sum of $30,000.
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
Incremental Method: In instances where a company cannot determine the
fair value of all classes of securities, it may use the incremental method.

It uses the fair value of the securities as a basis for those classes that it
knows, and allocates the remainder of the lump sum to the class for which
it does not know the fair value.

For instance, if a company issues 1,000 shares of $10 stated value
common stock having a fair value of $20, and 1,000 shares of $10 par
value preferred stock having no established fair value, for a lump sum of
$30,000, it allocates the $30,000 to the two classes as shown below
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
Stock Issued in Noncash Transactions

Accounting for the issuance of shares of stock for property or services involves an
issue of valuation. The general rule is: Companies should record stock issued for
services or property other than cash at either the fair value of the stock issued or
the fair value of the noncash consideration received, whichever is more clearly
determinable.
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

Costs of Issuing Stock
When a company issues common stock, it should report direct costs incurred to sell
stock, such as underwriting costs, accounting and legal fees, printing costs, and taxes, as
a reduction of the amounts paid in.

Therefore the company debits issue costs to Paid-in Capital in Excess of Par Common
Stock because they are unrelated to corporate operations. In effect, issue costs are a
cost of financing. As such, issue costs should reduce the proceeds received from the
sale of the stock.

The Company should expense management salaries and other indirect costs related to
the stock issue because it is difficult to establish a relationship between these costs and
the sale proceeds. In addition, Walgreens expenses recurring costs, primarily registrar
and transfer agents’ fees, as incurred.
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
DIVIDEND POLICY AND RETAINED EARNING

As a consequence, dividend-paying companies will make every effort to
continue to do so. In addition, the type of shareholder the company has
(taxable or nontaxable, retail investor or institutional investor) plays a large
role in determining dividend policy.
1. To maintain agreements (bond covenants) with specific creditors, to retain
all or a portion of the earnings, in the form of assets, to build up additional
protection against possible loss.
2. To meet State Corporation requirements, that earnings equivalent to the
cost of treasury shares purchased be restricted against dividend
declarations.
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3. To retain assets that would otherwise be paid out as dividends,
to finance growth or expansion. This is sometimes called
internal financing, reinvesting earnings, or “plowing” the
profits back into the business.
4. To smooth out dividend payments from year to year by
accumulating earnings in good years and using such
accumulated earnings as a basis for dividends in bad years.
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
5. To build up a cushion or buffer against possible losses or errors in the
calculation of profits.

The reasons above are self-explanatory except for the second. The laws of
some states require that the corporation restrict its legal capital from
distribution to stockholders, to protect against loss for creditors.12 The
applicable state law determines the legality of a dividend.

Financial Condition and Dividend Distributions

Effective management of a company requires attention to more than the
legality of dividend distributions. Management must also consider economic
conditions, most importantly, liquidity.

The existence of current liabilities strongly implies that the company needs
some of the cash to meet current debts as they mature. In addition, day-to-day
cash requirements for payrolls and other expenditures not included in current
liabilities also require cash.
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
Types of Dividends

Companies generally base dividend distributions either on accumulated
profits (that is, retained earnings) or on some other capital item such as
additional paid-in capital. Dividends are of the following types.
1. Cash dividends.
2. Property dividends (dividends in kind).
3. Liquidating dividends.

Although commonly paid in cash, companies occasionally pay dividends in
stock or some other asset. All dividends, except for stock dividends, reduce
the total stockholders’ equity in the
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
Cash Dividends

The board of directors votes on the declaration of cash dividends. Upon
approval of the resolution, the board declares a dividend. Before paying it,
however, the company must prepare a current list of stockholders.

To illustrate, Roadway Freight Corp. on June 10 declared a cash
dividend of 50 cents a share on 1.8 million shares payable July 16 to all
stockholders of record June 24. The entries for declaration and
payment of a cash dividend are presented as
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
Property Dividends

Dividends payable in assets of the corporation other than cash are called
property dividends or dividends in kind. Property dividends may be
merchandise, real estate, or investments, or whatever form the board of
directors designates.

The corporation may then record the declared dividend as a debit to
Retained Earnings (or Property Dividends Declared) and a credit to
Property Dividends Payable, at an amount equal to the fair value of the
distributed property. Upon distribution of the dividend, the corporation
debits Property Dividends Payable and credits the account containing the
distributed asset (restated at fair value).
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
For example, Trendler, Inc. transferred to stockholders some of its
equity investments costing $1,250,000 by declaring a property
dividend on December 28, 2016, to be distributed on January 30,
2017, to stockholders of record on January 15, 2017. At the date of
declaration, the securities have a fair value of $2,000,000. Trendler
makes the following entries.
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
Liquidating Dividends

Some corporations use paid-in capital as a basis for dividends. Without proper
disclosure of this fact, stockholders may erroneously believe the corporation has been
operating at a profit. To avoid this type of deception, intentional or unintentional, a clear
statement of the source of every dividend should accompany the dividend check.

Dividends based on other than retained earnings are sometimes described as liquidating
dividends. This term implies that such dividends are a return of the stockholder’s
investment rather than of profits.

For example, McChesney Mines Inc. issued a “dividend” to its common stockholders of
$1,200,000. The cash dividend announcement noted that stockholders should consider
$900,000 as income and the remainder a return of capital. McChesney Mines records
the dividend as follows.
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

Stock Dividends
If management wishes to “capitalize” part of the earnings (i.e.,
reclassify amounts from earned to contributed capital) and thus
retain earnings in the business on a permanent basis, it may issue a
stock dividend.

In this case, the company distributes no assets. Each stockholder
maintains exactly the same proportionate interest in the corporation
and the same total book value after the company issues the stock
dividend. Of course, the book value per share is lower because each
stockholder holds more shares.
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
A stock dividend therefore is the issuance by a corporation of its own
stock to its stockholders on a pro rata basis, without receiving any
consideration.

In recording a stock dividend, some believe that the company should
transfer the par value of the stock issued as a dividend from retained
earnings to capital stock.

Others believe that it should transfer the fair value of the stock issued its
market value at the declaration date from retained earnings to capital stock
and additional paid-in capital.
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
To illustrate a small stock dividend, assume that Vine Corporation has outstanding
1,000 shares of $100 par value common stock and retained earnings of $50,000.

If Vine declares a 10 percent stock dividend, it issues 100 additional shares to
current stockholders. If the fair value of the stock at the time of the stock dividend
is $130 per share, the entry is:
At date of declaration
Retained Earnings
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13,000
Common Stock Dividend Distributable
10,000
Paid-in Capital in Excess of Par—Common Stock
3,000
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

Stock Splits
If a company has undistributed earnings over several years and accumulates a
sizable balance in retained earnings, the market value of its outstanding shares
likely increases.
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
REACQUISITION OF SHARES

Companies often buy back their own shares. In fact, share buybacks now exceed
dividends as a form of distribution to stockholders.

Corporations purchase their outstanding stock for several reasons:

To provide tax-efficient distributions of excess cash to shareholders. Capital gain
rates on sales of stock to the company by the stockholders have been
approximately half the ordinary tax rate for many investors.

To increase earnings per share and return on equity. Reducing both shares
outstanding and stockholders’ equity often enhances certain performance ratios.
However, strategies to hype performance measures might increase performance in
the short run, but these tactics add no real long-term value.
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1.
To provide stock for employee stock compensation
contracts or to meet potential merger needs.
2.
To thwart takeover attempts or to reduce the number of
stockholders.
3.
To make a market in the stock. As one company
executive noted, “Our company is trying to establish a
floor for the stock.”
4.
Purchasing stock in the marketplace creates a demand.
This may stabilize the stock price or, in fact, increase it.
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

Purchase of Treasury Stock
Companies use two general methods of handling treasury stock in
the accounts: the cost method and the par value method. Both
methods are generally acceptable. The cost method enjoys more
widespread use.

The cost method results in debiting the Treasury Stock account for
the reacquisition cost and in reporting this account as a deduction
from the total paid-in capital and retained earnings on the balance
sheet.

The par (stated) value method records all transactions in treasury
shares at their par value and reports the treasury stock as a
deduction from capital stock only.
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

Sale of Treasury Stock
Companies usually reissue or retire treasury stock. When selling treasury
shares, the accounting for the sale depends on the price. However, the sale
of treasury stock either above or below cost increases both total assets and
stockholders’ equity.

To illustrate, assume that Pacific acquired 10,000 shares of its treasury
stock at $11 per share. It now sells 1,000 shares at $15 per share on March
10. Pacific records the entry as follows.
March 10, 2017
Cash
15,000
Treasury Stock
11,000
Paid-in Capital from Treasury Stock
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

EARNINGS PER SHARE
Earnings per share indicate the income earned by each share of common
stock. The exception, due to cost-benefit considerations, is nonpublic
companies. Generally, companies report earnings per share information
below net income in the income statement.

To illustrate this assume if Oscar Co. has net income of $300,000 and a
weighted average of 100,000 shares of common stock outstanding for the
year, then it will report
Net Income
300,000
Earning Per-Share (300,000/100,000)
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3 per-share
103
Net Income 300,000
Earning Per-Share (300,000/100,000)
share


3 per-
Preferred Stock Dividends
As we indicated earlier, earnings per share relates to earnings per
common share.
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
IFRS 16 defines Lease as a contract that conveys to the customer (‘lessee’) the right to use an
identified asset in exchange for consideration for agreed period of time.


Period of time can also be expressed in terms of use of the asset.
an entity might want to transport a specified cargo by ship from location A to location B, in
accordance with a stated timetable, for a period of five years.

To achieve this, it could either charter a ship over this period or it could contract to buy the
transport service from a freight carrier/operator (for example, through a contract of
affreightment).

In both cases, the goods will arrive at location B — but the accounting might be quite different.

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
IFRS 16 provides more guidance for the identification of Leases

Criteria

There is an identifiable asset- can be portion of an asset

Lessee obtains economic benefits- including benefit from
sub lease.

Lessee directs the use – how to use and for what purpose

The guidance helps to assesses whether the lease conveys the right to
control the use of an identified asset to the customer.
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
An asset is typically identified by being explicitly specified in a contract. However, an
asset can also be identified by being implicitly specified in a contract.

If an arrangement identifies the asset to be used, but the supplier has a substantive
contractual right to substitute that asset, the arrangement does not contain an identified
asset.

A substitution right is substantive if (a) the supplier can practically use another asset to
fulfill the arrangement throughout the term of the arrangement, and (b) it is
economically beneficial for the supplier to do so.

The supplier’s right or obligation to substitute an asset for repairs, maintenance,
malfunction, or technical upgrade does not preclude the customer from having the
right to use an identified asset.
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
An identified asset must be physically distinct. A physically distinct asset
might be an entire asset or a portion of an asset.

For example, a building is generally considered physically distinct, but one
floor within the building could also be considered physically distinct if it
can be used independently of the other floors (for example, point of entry
or exit, access to lavatories, etc).

A capacity portion of an asset is not an identified asset if (a) the asset is not
physically distinct (for example, the arrangement permits use of a portion
of the capacity of an oil tanker), and (b) a customer does not have the right
to substantially all of the economic benefits from the use of the asset (for
example, several customers share an oil tanker, and no single customer
uses substantially all of the capacity).
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
A customer controls the use of the identified asset by possessing the right to:

(a) obtain substantially all of the economic benefits from the use of such asset
(‘economics’ criterion); and

(b) direct the use of the identified asset throughout the period of use (‘power’
criterion).

A customer meets the ‘power’ criterion if it holds the right to make decisions
that have the most significant impact on the economic benefits derived from
the use of the asset.

The standard gives several examples of relevant decision-making rights. The
following questions need to be considered when evaluating which party holds
the relevant decision-making rights in the shipping industry:
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
Which party decides …

which goods are transported?

how often goods are transported?

where goods are transported?

how often the asset is used?

the minimum capacity at which the asset operates?

which route is taken?

If the lease makes the above decisions, the contract will meet the
definition of a lease.
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
contract. If the use of the asset is pre-determined, the contract

contains a lease if the charterer has the right to direct the operations of the asset without
the owner having the right to change those operating instructions, or if the charterer has
designed the asset in a way that pre-determines how and for what purpose the asset will
be used throughout the period of use. There can be terms in the contract that are
protective in nature. Such terms might be included to protect the supplier’s asset, the
supplier’s personnel and to comply with regulations.

For example, a charterer is normally prevented from sailing a ship into waters with a high
risk of piracy or from transporting dangerous materials/cargo.

The existence of such protective rights alone does not prevent a customer from having
the right to direct the use of an asset.
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•
Charterer enters into a contract with ship owner for the transportation
of cargo from Rotterdam to Sydney. The ship is explicitly specified in
the contract, and ship owner does not have substitution rights.
Charterer has not specified any modifications to the ship. The cargo
will occupy substantially all of the capacity of the ship. The contract
specifies the cargo to be transported on the ship and the dates of
loading and discharging. Ship owner operates and maintains the ship
and is responsible for the safe passage of the cargo on board the ship.
Charterer is prohibited from hiring another operator for the ship or
operating the ship itself during the term of the contract. Also,
charterer cannot alter the routes or the dates for the transportation.
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
Discussion: The contract does not contain a lease.

There is an identified asset. The ship is explicitly specified in the contract, and
ship owner does not have the right to substitute that specified ship.

Charterer has the right to obtain substantially all of the economic benefits
from use of the ship over the period of use. Its cargo will occupy substantially
all of the capacity of the ship, thereby preventing other parties from obtaining
economic benefits from use of the ship.

However, charterer does not have the right to control the use of the ship,
because it does not have the right to direct its use.

Charterer does not have the right to direct how and for what purpose the ship
is used. How and for what purpose the ship will be used is pre- determined in
the contract (that is, the transportation of specified cargo from Rotterdam to
Sydney within a specified time frame), and charterer did not design the ship.
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
Charterer has no right to change how and for what purpose the ship
is used during the period of use.

1.
An
Components, contract consideration and allocation
arrangement
might
contain
lease
and
non-lease
components that are subject to different accounting models.
Non-lease components are those items or activities that
transfer a good or service to the lessee.
2.
Arrangements might also contain multiple lease components.
IFRS 16 requires each separate lease component to be
identified and accounted for separately.
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Charterer enters into a time charter with ship owner in which ship owner
1.
will provide transportation services to charterer for a five-year period, using
a ship that is explicitly specified in the contract. Ship owner does not have
substitution rights in relation to the ship that is specified in the contract.
Ship owner cannot use the ship for any other purpose when it is not being
used by charterer. Charterer will pay to ship owner:
(a) a fixed amount per day for chartering the ship;
(b) a fixed amount per month for CVE
(communication/victuals/entertainment); and
(c) a fixed amount for each holds cleaning.

Question: What are the components in this arrangement?
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
Discussion: The contract contains one lease component, which is the lease of the ship,
and two non-lease components, which are the services to operate the ship and cleaning
services.

Insurance does not represent a separate good or service. Therefore, the element of the
fixed payment per day for chartering the ship, which covers the ship’s insurance, is not
considered a separate component, and it instead forms part of the overall contract
consideration to be allocated to the lease and non-lease components.

Charterer can either:

a) separate the lease from the non-lease components and allocate consideration to each
component or;

b) apply the practical expedient and account for both the lease and the associated nonlease components as a single combined lease component.
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
In the book of Lessee , IFRS 16 requires that :
all leases are treated as if lessee acquired “the
right of use asset.” and

Lessee recognizes and reports lease asset (Right
of use) and lease liability (if payment made
over time) on the balance sheet.
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
RECOGNITION & MEASUREMENT OF LEASES-LESSEE

lessees will recognize almost all leases on the balance sheet (as a

“right of-use asset "and “lease liability”)-single model

the lessee recognizes:

a lease liability at the present value of future lease payments;

a right-of-use asset at an amount prepaid plus lease liability plus initial direct
costs
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
I. LESSEE

The lessee recognizes, at commencement date, the right to use as ‘an asset’ at cost
and a lease liability at present value.

How much is the cost?

Right-of use asset = Lease LiabilityXX

+ Initial Direct cost

+ Prepaid lease payment
XX

- lease incentives
(XX)

+ Estimated cost to dismantle, remove or restore

Right of use asset
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XX
XX
XXX
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
Initial measurement and recognitions of leases

Lessee

Discount rate to compute the PV of lease liability:

Implicit rate or Incremental borrowing rate (if the lessee cannot
determine the former)

Lease term (discounting period):

non-cancellable period of lease contract plus any additional period of
renewal option (if extension is certain).

Once cost is determined, initial recognition:

Debit: Right-of-use asset(lease) XX

Credit: Cash/Lease Liability
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XX
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Types of lease

IFRS 16 requires that Lessor classifies leases in to two :
1.
Financing Lease
2.
Operating Lease

A lease is classified as a finance lease if it transfers substantially all
the risks and rewards incidental to ownership of an underlying asset.

Other wise, Operating Lease.

Finance leases- de-recognize the asset and recognize a lease
receivable

Operating leases- continue to recognize the underlying asset and
rent income
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

MEANING OF ACCOUNTING POLICIES
Meaning Accounting policies are the specific principles, bases,
guidelines, conventions, rules, practices, and similar norms applied
by an entity in preparing and presenting financial statements.

Example:

Valuation of inventory using FIFO, Average Cost or other suitable
basis as per [IAS 2]

Valuation of PPE using cost model or revaluation model [IAS 16]

Classification, presentation and measurement of financial assets and
liabilities under categories specified [IAS 32/IAS 39/IFRS 9]
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

SELECTION OF ACCOUNTING POLICIES
IAS 8 establishes the hierarchy that firms must follow when dealing
with an accounting issue (transaction or item). The IFRS
ACCOUNTING POLICY HIERARCHY is:
Apply
1.
specifically
relevant standards
(IASs,
IFRSs, Interpretations).
If there is no applicable standard(use IAS 8):
2.

Refer to other IASB standards(analogy).

Refer to the IASB Framework for guidance(conceptual FW).

Consider the most recent pronouncements of other standardsetting bodies (FASB), practices….
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
CHANGES IN ACCOUNTING POLICIES

Why/When to Change?

MANDATORY: When it is required by another IFRS.

This will be the case when new IFRS is issued and you HAVE
TO apply it mandatorily.

VOLUNTARY: When new accounting policy provides
better, more

faithful and relevant information.

Change from cost to revaluation model.
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

CHANGES IN ACCOUNTING POLICIES
Accounting Treatment (Rule)- Retrospective Method – Restatement &
cumulative effect adjustment.

Exemptions from Retrospective Treatment
•
Change in accounting policy is immaterial [Materiality]
•
Change in accounting policy is impracticable [Cost & Undue Effort]
•
Requirement by transitional guidance of new accounting policy

(mandatory in the guidance)

Application of a new accounting policy to a transaction different in substance to
those undertaken previously.

Application of a new accounting policy for transactions that did not occur
previously or were immaterial.
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
Meaning

A change in either some amount of an asset or a liability, or pattern of its consumption
in both current and future reporting periods that result from changes in the
circumstances in which the estimate was based.

As a result of a new information

As a result of new development

More experience

Examples:

Depreciation rates and useful lives of assets

Provisions for warranty repairs


Impairment of non-current assets
Pattern of economic benefits expected to be received from non- current assets for
calculating depreciation

Impairment of receivables (bad debt provisions)
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

CHANGES IN ACCOUNTING ESTIMATES
Changes in accounting policy vs. accounting estimate Accounting
policy is a principle or rule, or a measurement basis,

Accounting estimate is the amount determined based on selected basis or some
pattern of future consumption of the asset.

For example:

Choice of Fair value vs. Historical cost is a choice in accounting policy
(remember, measurement basis),

But updating some provision based on fair value change is a

change in accounting estimate.
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

Accounting Treatment (Rule)
Change in accounting estimates are accounted prospectively, either:

In the current reporting period (e.g. bad debt estimate) or;

In both the current and future reporting periods, if the change affects
both (for example, change in useful lives affects depreciation charges
in both the current and the future reporting periods).

“Prospectively” means that comparatives and equity NOT restated.
Financial statements in the previous reporting periods not restated and
simply adjust calculations in the current and future reporting periods.

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