CHAPTER
FINANCIAL
5
LIABILITIES
SS
Intended Learning Outcomes
After reading tits chapter, you should be able to
1,
2.
3.
define liabilities by explaining their essential characteristics;
explain the nature of financial Gabilities;
explain the nature of accounts payable, notes payable, and
bonds payable;
journalize the initial recognition of accounts payable, notes
4,
payable and bonds payable;
7
journalize transactions after initial recognition of accounts |
payable, notes payable, and bonds payable;
journalize the settlement of financial Gabilities;
measure financial habifties at the reporting date; and
present financial fiabilities and relevant information in the
6.
,
8.
fine nctal statements.
a
—-
_
Introduction
For
financing
businesses
a
number
to increase
to
expand
risks involved;
the risks.”
of
the
years,
most
shareholders’
operations.
One
enterprises
earnings.
have
Debts
businessman
says,
used
have
debt
helped
“there
are
but if you’re successful, the benefits definitely outweigh
The
same
businessman
says,
“if you
want your business
to
succeed, monitoring and controlling labilities is a must.”
DEFINITION AND
NATURE
OF LIABILITIES
The IASB’s 2018 Conceptual Framework for Financial Reporting
defines liability as “a present obligation of an entity to transfer an
economic resource as a result of past event.” This definition enumerates
the following essential characteristics of a liability:
(1)
(2)
present.obligation;
past event; and
(3)
transfer of an economic resource.
be8} CamScanner
CamScanner
Chapter 5- Financial Liabilities
An obligation is a duty or responsibility to act or perform in a
certain way which may be legally enforceable as a consequence of a
binding contract or statutory requirement; or it may be an obligation an
enterprise acknowledges because it makes other parties believe that i
will carry out an undertaking or certain action.
The new
Conceptual
Framework
clarifies that an obligation is a
duty or responsibility that the entity has no practical ability to avoid.
Such duty or responsibility arises from an obligating event that is either
a legal obligation or a constructive obligation.
A legal obligation derives from a contract (through its explicit or
implicit terms), legislation, or other operations of law.
Examples of
liabilities that arise from legal obligations are accounts payable (arising
from a contract with a supplier), withholding taxes payable, and value
added taxes payable {arising from legislation and other operations of
law).
A
constructive obligation derives from an enterprise’s actions
whereby an established pattern of past practice, published policies, ora
sufficiently specific current statement, the enterprise has indicated to
other parties that it will accept certain responsibilities. As a result, the
enterprise has created a valid expectation on the part of those other
parties that it will discharge those responsibilities (paragraph 10, IAS
37,
Provisions,
Contingent
Liabilities
and
Contingent
Assets).
An
example of a hability recognized as a constructive obligation 1s provision
for clean-up costs where the enterprise has a widely published policy of
cleaning up all contamination it causes.
For example;
Liabilities arise from past events or transactions.
the mere signing of a purchase contract with a supplier does not give
rise to a liability. The liability arises when the entity acquires legally or
constructively from the supplier the economic control over the goods.
The past event in that case is the acceptance by the entity of the goods
the supplier delivers. Similarly, the mere signing of an employment
contract with an employee does not give rise to a lability. The liability
for'salaries arises when the employees render services to the entity.
An enterprise settles a present obligation by giving up economic
resources. Such settlement of a present obligation may occur in a
number of ways, such as by
(a)
payment of cash;
(b)
(c}
transfer of other assets;
provision of services;
(d)
replacement of an obligation with another obligation; and
(e)
conversion of the obligation to equity.
284
be8} CamScanner
CamScanner
Chapter
5 — Financial Liabilities
In
some
exceptional
cases,
an
entity
settles
its
obligation
(hraugh condonation by the creditor.
An obligation always involves another party to whom the
obligation is owed. However, it is not necessary to know the identity of
the party to whom the obligation is owed for it to qualify as a liability.
FINANCIAL LIABILITIES
The
International
Accounting
Standards
32
Financial
Instruments:
Presentation (now superseded by IFRS 9 Financial
Instruments) defines a financial liability as a contractual obligation
(a)
to deliver
entity, or
(b)
to
cash
exchange
or
another
financial
another entity under
to the entity, or
assets
financial
asset
or financial
potentially
|
unfavorable
to
another
liabilities
to
conditions
(c)
that will or may be settled in the entity’s own equity
instruments and is a non-derivative for which the entity
may be obliged to deliver a variable number of the entity’s
own equity instruments, or
(d)
that will or may
be settled
in the entity’s own
equity
instruments and is a derivative that will or may be settled
other than by exchange of a fixed amount of cash or a
financial asset for a fixed number of the entity’s own
equity instruments.
A financial liability arises from a contract to pay cash, or
or incur another financial liability.
exchange a financial asset,
Examples of this nature are accounts payable, notes payable, bonds
payable, and mortgage payable. Financial liabilities also include those
contractual obligations that will or may be settled by issuing equity
However, rights, options and
instruments (e.g., convertible bonds).
warrants that an entity issues on a pro rata basis to its existing owners
and impose on the entity to issue its share capital are not financial
liabilities but are classified as equity.
Initial Recognition
An entity shall recognize a financial lability when and only
a party to the contractual provisions of the
when it becomes
instrument; that is, when the entity issues the financial instrument or
235
be8} CamScanner
CamScanner
Chapter
5 - Financial Liabilities
acknowledges in whatever
provisions of a contract.
form
as
obligation
its
a
result
1p,
of
An entity recognizes a financial liability at fair value, which is the
transaction
price.
It also
includes
in
the
initial
measurement
financial liabilities measured at amortized cost the transactions
directly attributable to the issuance of the financial instrument.
of
costs
Measurement After Initial Recognition
Except
for financial
liabilities
that
are
measured
at fair value,
financial liabilities are subsequently measured at amortized cost.
ACCOUNTING
FOR
SPECIFIC
FINANCIAL
LIABILITIES
Accounts Payable
Accounts
payable,
or
trade
accounts
payable,
arise
from
purchasing goods, materials, supplics, or services on an open cChargeaccount basis. The credit time period generally varies (e.g., from 30 to
120 days) without any interest being charged on the deferred paymeni,
Most accounting systems are designed to record liabilities for purchases
of goods when the goods are received, or practically, when the invoices
are received from the supplier. Theoretically, however, an entity must
recognize the accounts payable when it acquires the economic control
over the goods ordered, because that is the date when the entity
becomes a party to the financial instrument.
Attention
must be given to the transactions
occurring near the
end of a reporting period and the beginning of the next reporting period.
In most cases, an entity acquires economic control over the goods
purchased upon the transfer of the legal title, which depends on the
An enterprise shall recognize accounts payable for
terms of purchase.
goods in transit at the end of the reporting period shipped F.O.B.
Similarly, it shall recognize the liability for the goods
shipping point,
purchased under the terms F.O.B. destination when it receives the
goods. Thus, no liability shall be recognized yet for goods in transit al
The record of goods
year-end purchased under F.O.B. destination.
with the
agree
should
(inclusion in ending inventory)
received
The company should reflect the
recognition of accounts payable.
liability and the inventory in the financial statements
of the appropriate
reporting period.
286
be8} CamScanner
CamScanner
Chapter 5 ~ Financial Liabilities
vethods of Accounting
The
agreement
for Cash Discounts
for
the
purchase
of goods
usually
includes
incentives for early payment of the account; thus, supphers offer cash
discounts. The buyer may record the purchase transaction using either
the gross method or the net method.
Under the gross method and when the entity adopts the periodic
inventory
system,
it initially
records
the Purchases
and
the Accounts
Payable at the gross invoice price. The entity records the cash discount
as a credit to Purchase Discounts when it pays the account within the
discount period. The balance of the Purchase Discounts is reported in
profit or loss as a deduction from the gross purchases.
When
the entity uses the perpetual inventory system, it records
the purchase transaction and credits the cash discounts it takes in the
Inventory account. When it has already sold the related goods, it credits
the Cost of Goods Sold account for the cash discounts it takes.
Under
the
inventory system,
net
method
it records
and
when
the entity adopts
the Purchases
and Accounts
invoice price less the cash discounts available. When
beyond the discount period, if pays the gross invoice
the cash discount not taken as Purchase Discounts
date, it presents the balance of this account in profit
finance cost.
the periodic
Payable at the
it pays an account
price and records
Lost. At reporting
or loss as part of
To
ilhustrate,
assume
that
ABC
Corporation
purchased
merchandise from DEF Company with an invoice price of P200,000;
terms: FOB shipping point, 3/10; n/30.
The
purchase
took
place
on
December
2, 2022.
DEF
Company
ABC paid the full account on
prepaid the freight charges of P2,000.
Assume further that ABC Corporation uses the
December 10, 2022.
periodic inventory system. ABC Corporation shall prepare the following
entries for the purchase and payment under the gross and net methods:
Net Method
Gross Method
December 2,
2022
Purchases
Freight-in
Accounts Payable
200,000
Purchases
Freight-in
2,000
Accounts Payable
202,000
194,000
2,000
196,000
287
be8} CamScanner
CamScanner
Chapter
December
5 — Financial Liabilities
10, 2022
Suppose ABC
pays beyond
196,000
Accounts Payable
Cash
202,000
Accounts Payable
6,000
Purchase Discount
Cash
196,000
period.
the discount
196,000
In that case, ;;
shall prepare this entry:
Net Method
Gross Method
Accounts Payable
Cash
196,000
Accounts Payable
Purchase Discounts Lost 6,000
Cash
202,000
202,000
202,000
Note that the 3% cash discount is based
purchased, excluding the freight cost.
on the cost of goods
The buyer shall prepare a year-end adjustment
under the gross
method if it has not paid the account at year-end but subsequently
settled it during the subsequent reporting period within the discount
period,
The adjustment is not
dated at the end of the year.
necessarily
made
at year-end
but is
The adjusting entry is
Allowance for Purchase Discount
Purchase Discounts
Ie
xX
This entry reduces the amortized cost of accounts payable to the
amount of cash that the buyer would disburse to settle the account in
the subsequent period.
The adjustment also matches the purchase
discounts against the recorded purchases in the same reporting period.
The entity shall deduct the balance of the Allowance for Purchase
Discount from the Accounts Payable in the statement of financial
position, and Purchase Discounts from the recorded cost of Purchases
in the statement of comprehensive income.
On the first day of the next
reporting period, the enterprise may reverse the above adjustment for it
to record the payment of the account in the usual manner, as follows:
Accounts Payable
Purchase Discounts
Cash
the
xX
xx
xx
Suppose ABC has not paid the account at the reporting date and
discount period has already lapsed, the buyer shall prepare an
adjusting entry under the net method, as follows:
288
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
Purchase Discounts Lost
6,000
Accounts Payable
This
p202,000.
adjusting
The
6,000
entry brings
adjustment
the
accounts
payable
balance
to
reflects in the accounts the true amount
of
the resources it expects to give up to settle the obligation in the next
period.
Between the two methods, the net method is more theoretically
sound because it results in separate recognition of finance cost that
arises from the non-payment of the account within the discount period.
The gross method incorporates the discounts lost in the cost of
purchases, thereby not showing the actual situation thai an entity
incurs an expense due to a credit related transaction.
Under this
method, any discount Jost is not accounted for separately and is
absorbed by the cost of purchases, thereby increasing the operating
cost.
Notes Payable
A promissory
note is a written promise to pay a certain sum
money to the bearer at a designated future time.
of
The promissory notes
may arise out of a trade situation (purchasing goods or services
credit) or the borrowing of money from a bank, or other transactions.
on
Note Bearing a Realistic Interest Rate
The accounting for the issuance of interest-bearing note is
relatively straightforward. An entity initially recognizes the note at face
value,
which
equals
its fair value
at the
date
of issuance,
under
the
presumption that the stated interest rate approximates the prevailing
market interest rate. Suppose an enterprise issued a note in settlement
of an overdue trade account. In that case, the entry is
Accounts Payable
|
XXX,
Notes Payable
XIOK
On maturity date, the maker
interest and make the following entry:
shall pay the principal
plus
the
XXX
XXX
Notes Payable
Interest Expense
Cash
IOXX
An entity shall accrue the interest from the date of the note to the
end of the reporting period when the maturity falls on a date in the next
289
be8} CamScanner
CamScanner
Tapes.
—.
¢t
Chapter 5 — Financial Liabilities
reporting period and the entity has not settled the note yet. The make,
shall prepare the following entry: |
Xx
Interest Expense
Interest Payable
XXX
This adjusting entry may be reversed at the beginning of the new
reporting period so that the subsequent payment of the note anq
interest may be recorded in the usual manner, debiting Notes Payable
for the principal and Interest Expense for the total interest paid.
Long-term Notes - Principal and Interest are Payable Periodically
On March
31, 2022,
the ABC
Corporation
issued
a P3,000,000,
Equal principal
12% promissory note for a machinery it purchased.
amount of P1,000,000 and interest on the unpaid balance of the
principal are payable annually every March 31 starting March 31, 2023.
Thus, the following are the amounts to be paid during 2022 through
2025.
Due
March
March
March
Date
31, 2023
3], 2024
31, 2025
Principal Due
1,000,000
1,000,000
1,000,000
Interest
3M x 12% =
2M x 12% =
IM x 12% =
Due
Total Amount Due
1,360,000
360,000
1,240,000
240,000
1,120,000
120,000
Assuming that the company reports on a calendar year basis,
the following are the entries for 2022 through 2025.
2022
Mar. 31 Machinery
Notes Payable
3,000,000
3,000,000
Dec. 31 Interest Expense
Interest Payable
360,000 x 9/12 = 270,000
270,000
270,000
2023
Mar. 31 Notes Payable
1,000,000
Interest Expense (360,000 x 3/12)
Interest Payable
90,000
270,000
Cash
1,360,000
Dec. 31 Interest Expense
180,000
Interest Payable
180,000
240,000 x 9/12 = 180,000
-~
}
~*
tr
-_—
290
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
4
Mar. 3] Notes Payable
Interest Expense (240,000 x 3/12)
1,000,000
60,000
Interest Payable
180 000
Cash
1,240,000
Nec.3] Interest Expense
Interest Payable
90,000
90,000
120,000 x 9/12 = 90,000
2025
Mar, 31 Notes Payable
1,000,000
Interest Expense {120,000 x 3/12)
30,000
Interest Payable
90, 000
Cash
1,120,000
At the end
present as current
of each reporting period, ABC Corporation shall
liabilities the amount of Interest Payable and the
portion of the Notes Payable due the succeeding year.
2022,
Thus,
in
2023,
and
its statement
2024,
ABC
of financial
position
Corporation
shall
on
December
present
the
31,
Notes
Payable and Interest Payable as follows:
2022
Current Liabilities
Notes Payable
Interest Payable
Non-current Liabilities
Notes Payable
Long-Term Notes - Principal
Payable Periodicaiiy
2023
2024
P1,000,000
270,000
P1,000,000
180,000
P1,000,000
90,000
P2,000,000
P1,000,000
P
Matures
in Lump
Sum,
OQ
Interest
is
Assume that on March 31, 2022, the MNO Corporation issued a
for a machinery
note
promissory
12%
P4,000,000,
three-year,
The interest on this note is payable annually on its
purchased.
anniversary date. The company reports on a calendar year.
The following are the entries for years 2022 through 2029.
2022
Mar. 31
4,000,000
Machinery
4,000,000
Notes Payable
Dec, 31
360,000
Interest Expense
Interest Payable
360, 000
(4Mx 12% x 9/12)
291
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
2023
Mar.31
Dec. 31
2024
Mar.31
Interest Expense
Interest Payable
Cash
120,000
360,000
480,000
Interest Expense
Interest Payable
360,000
Interest Expense
120,000
Interest Payable
360,000
360,000
Cash
Dec. 31
480,000
Interest Expense
360,000
,
Interest Payable
2025
Mar.31
360,000
Interest Expense
Interest Payable
Notes Payable
120,000
360,000
4,000,000
Cash
4,480,000
On December 31, 2022 and 2023, MNO
Corporation shall
classify the Notes Payable as non-current liabilities and the Interest
Payable as current liabilities, since the interest is payable periodically.
On December 31, 2024, MNO shall classify both the Notes Payable and
Interest Payable as current habilities since the promissory note matures
three months from the end of the reporting period.
Note Bearing an UnrealisticInterest Rate
A note bears an unrealistic interest rate when
these two situations exist:
(a)
the interest
significantly
notes; and
rate appearing
different from
(b)
the consideration
received
on
on
the
any one or both of
the face of the note is
market rate of similar
account
has a fair value that is significantly
face value of the note.
of the note issued
different
from
the
In such cases, the note and the interest to be paid based on the
stated rate are discounted at the market rate of interest on the date of
the issuance.
If the
market
rate
stated
rate of interest,
on
the face
the discounted
of the
amount
note
is higher
is higher
than
than
the
the
face
292
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
value of the note, resulting in premium on notes payable. If the rate
stated on the face of the note is lower than the market rate of interest,
the discounted
amount
is
lower
than
the
face
value
of
the
note,
resulting in discount on notes payable.
Short-Term Note- Stated Rate of Note is More than the Market Rate
To illustrate, assume that on May 1, 2022, Diana Corporation
purchased from Smith Company, a piece of special equipment by
issuing a 14%, one-year note for P320,000. There is no equivalent cash
price for this equipment,
but the market rate of interest on similar notes
iS 8%.
The present value
obligation is:
(PV) of the future cash outflow to settle the
Principal
Stated interest (320,000 x 14% x 1 year)
Total future cash outflow
PV factor at 8% for 1 period
P320,000
44,800
P364,800
0.9259
Present value of the note
P337,768
The following are the entries in 2022 relating to
assuming that the company reports on a calendar year basis:
the
note,
2022
May 1 Equipment
337,768
Notes Payable
320,000
Premium on Notes Payable
17,768
Dec. 31 Interest Expense (337,768 x 8% x 8/12)
18,014
Premium. on Notes Payable
Interest Payable (320,000 x 14% x 8/12)
At December 31, 2022,
is computed as follows:
the amortized
11,853
29,867
cost of the Notes Payable
Notes Payable (at face value)
Premium on Notes Payable
Interest Payable
Total
Assuming no reversing entries were made
P320,000
9,915
29,867
P329,/82
at January
1, 2023,
the company shall prepare the following entries relating to the note.
293
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
2023
May I Premium on Notes Payable
Interest Expense
17,768 — 11,853
9,915
—
320,000
29,867
14,933
1 Notes Payable
Interest Payable
Interest Expense
Cash
computation
The
and
interest rate of 8%
expense
interest
the
5,915
364,800
of interest
expense
on the present value
included
2022
in
the effective
on
is based
of the obligation.
statements
2023
and
Thus,
of
comprehensive income are P18,014 and P9,018, respectively, computed
as follows:
2022 interest expense
P337,768 x 8% x 8/12 =
P18,014
2023 interest expense
P337,768 x 8% x 4/12 = P_9,018*
|
‘(The difference
factor.)
in computation
is due
to
Short-term Note - Stated Rate of Note is Less
present
off of the
rounding
value
than the Market Rate
Assume instead that the note issued by Diana Corporation bears
a 5% interest rate, but the market interest rate on similar notes on May
1, 2022 is 10%.
_
The present value of the note on May
1, 2022
is computed as
follows:
Face
P320,000
Stated interest for one year (320,000 x 5%)
16,000
Total future cash outflow
P336,000
PV factor at 10% for 1 period
0.9091
Present value of future cash outflow
P305.458
The following are the entries related to the notes,
assuming thal
the company
reports on a calendar year basis.
2022
May 1 Equipment
|
Discount on Notes Payable
ar
Notes Payable
. f
320,000
294
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
nec. 31 Interest Expense
20,364
Interest Payable
Discount on Notes Payable
Interest expense
305,458 x 10% x 8/12
Interest payable
320,000 x 5% x 8/12
Amortized discount
10,667
9,697
P20, 364
10,667
P_9,697
On the December 31, 2022 statement of financial
liability on the note is P325,822, computed as follows:
Notes Payable
position,
P320,000
10,667
Interest Payable
( 4,845)
P32.9,822
Discount on Notes Payable (14,542 — 9,697)
Total
Assuming
the
no reversing
entries were
made
at January
1, 2023,
the company shall prepare the following entries relating to the note.
2023
May 1 Interest Expense
4,845
1 Notes Payable
Interest Payable
Interest Expense
Cash
320,000
10,667
cn
Discount on Notes Payable
Interest expense
income
comprehensive
computed as follows:
336,000
included in 2022 and 2023 statements of
respectively,
P10,178,
and
P20,364
are
2022 interest expense
P305,458 x 10% x 8/12
2023 interest expense
P305,458 x 10%
x 4/12
*The
difference
4,845
in computation
P20,364
P10, 178*
is due to rounding off of present
value
factor.
Long-Term Notes with Unrealistic Interest Rate
The accounting for long-term notes with a stated rate differing
significantly from the market rate follows the principles that apply to
bonds payable
issued
at a discount
or premium,
discussed
in the
section under Bonds Payable.
295
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
Non-Interest-Bearing
Note
The accounting for a non-interest-bearing note is slightly mor.
It applies the same principle for notes carrying an interes;
complex.
rate lower than the market rate. A non-interest-bearing note does no;
It does no;
explicitly state an interest rate on the face of the note.
mean, however, that there is no
A non-interest-bearing
obligation.
interest
note is
imputed on the origina!
simply written in a forn
Thus, the
where the interest is imputed on the face value of the note.
face value represents the present value of the obligation plus the
imputed interest for the term of the note.
The transaction price of the non-interest-bearing note at the
date of issuance is the amount of cash received, or the fair value of
goods and services received. If the note is issued in exchange for goods
and
services whose
fair value
cannot
be reliably
determined,
the note is
initially measured based on the prevailing market rate of mterest for qa
similar obligation. The discounted amount (face value less an imputed
interest) of the note should be used initially to record the liability.
The
Notes Payable account is credited equal to the face value of the note and
a corresponding debit is made to the account Discount on Notes
Payable. The net credit account (Notes Payable less Discount on Notes
Payable) is the initial amortized cost of the liability. Interest expense is
then recognized over the term of the note, using the effective interest
method, as an adjustment of this discounted amount. This is done by
charging Interest Expense and crediting Discount on Notes Payable.
At
on notes
difference
statement
when it
remaining
the reporting date, an entity presents the balance of discount
payable as a deduction from the face valuc of the note. The
is the amortized cost of the note that the entity presents in its
of financial position. The discount that an entity records
issues the note represents the interest expense over the
term of the note.
Iilustrative Problem — Short Term Non-Interest-Bearing Note
To illustrate, assume the following information:
On October |,
2022, ABC Company purchased
a piece of equipment by paying
P100,000 down and issuing a one-year, non-interest-bearing note for
P200,000.
There is no known
market value for the equipment.
The
prevailing market interest rate for similar transactions is 12%.
The cost of the equipment is P278,571,
computed
Down
lao
Present value of note (200,000 x 0.892857
Total cost of equipment
|
as follows:
P100,000
178,57
Seer
296
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
The initial discount on Notes Payable is P21,429, computed as:
Face value of the note
P200,000
Present value at date of issuance
_178,571
Discount on Notes Payable
ABC
as follows:
Company
P_
21429
shall record
the transaction
on October
Equipment
278,571
Discount on Notes Payable
Cash
Notes Payable
On
December
period is the
entry:
1, 2022
21,429
100,000
200,000
31, 2022, assuming that the company’s
calendar
year,
ABC
shall
prepare
Interest Expense
Discount on Notes Payable
the
following
reporting
adjusting
6,357
Hsor
178,571 x 12% x37 12
On
Notes
December
Payable
carrying
amount
is
31, 2022,
P16,072,
of the
the adjusted balance of the Discount on
which
note
is
P21,429
is P183,928
which
.minus
P5,357.
equals
the
The
P200,000
face value of the note minus P16,072 discount. Such carrying amount is
referred to as amortized cost.
On October 1, 2023, ABC
the payment of the note:
shall prepare the following entries for
Interest Expense
Discount on Notes Payable
Notes Payable
Cash
The
16,072
16,072
200,000
200,000
first entry updates
the
recognizes the remaining balance
as interest expense in 2023.
the obligation.
amortization
of the discount.
of the discount on December
ABC
31, 2022
The second entry records the payment
of
Based
on
the preceding journal
entries, ABC
Company
recognized interest expense of P5,357 and P16,072 for years 2022 and
2023, respectively.
An entity may
also issue a non-interest-bearing note for money
borrowed from a bank or a financing institution.
The present value.of
297
be8} CamScanner
CamScanner
Chapter5 — Financial Liabilities
such
received.
the proceeds
note equals
The
entity shall record the
difference between the proceeds and the face value of the note ag.4 dehit
to Discount on Notes Payable.
Assume
that
XYZ
Company
discounted
its
own
oOné~-year
P120,000, non-interest-bearing note on May
1, 2022 with Amihan
at a discount
received
P105,600,
rate of 12%.
equals
which
The
proceeds
less
P120,000
the
from
Bank
this loan ig
P14,409
of
discount
(P120,000 x 12%}.
On
May
1,
2022,
XYZ
Company
records
the transaction
ag
follows!
105,600
14,400
Cash
Discount on Notes Payable
Notes Payable
120,000
The interest rate imputed on the above note is more than 12%,
The effective interest on a one-year note can be computed by dividing
the initial discount by the proceeds. The effective interest rate on the
note issued by XYZ 1s, therefore, 13.64%, which is P14,400 divided by
P105,600.
For a one-year note, the effective interest rate may also be
computed
by
dividing
the
discount
rate
of
12%
by
the
proceeds
expressed as percentage ol! lace value.
Face
Discount
rate
Net proceeds
100%
12%
:
88%
_
The effective interest rate is 12%/88%, which is 13.64%. The
above computations shall only apply to notes covering a one-year term.
Suppose XYZ Company uses the calendar year as its reporting
period. In that case, XYZ shall make an adjustment on December 31 as
follows:
Interest Expense
Discount on Notes Payable
14,400x 8/12 = 9,600
9,600
9,600
for 105,600x 13.64%
x 8/12}
In its December
31,
2022
statement
of financial
position,
XYZ
shall report, as. part of its current liabilities, Notes Payable with carrying
amount of P115,200, supported by the following ledger balances:
Notes Payable
P120,000
Amortized cost of Notes Payable
P115,200
Discount on Notes Payable (P14,400 - P9,600)
4,800
298
be8} CamScanner
CamScanner
Chapter 5 ~ Financial Liabilities
The computation
of amortized
cost at December
31, 2022
may )
as follows:
also be made
Amortized cost of Notes Payable, May 1, 2022
P105,600
Add amortization of discount for 8 months
105,600 x 13.64% x 8/12
9,600
Amortized cost of Notes Payable, December 31, 2022
On May
PJ15,200
1], 2023, the following entries shall be prepared by XYZ:
Interest Expense
Discount on Notes Payable
4,800
4, 800
Notes Payable
120,000
Cash
120,000
Itustrative Problem - Long-term Note - Maturity value is payable in_hampSulit
Assume
three-year,
that on March
P4,000,000,
31, 2022, the MNO
non-interest-bearing
Corporation issued a
promissory
machinery with an equivalent cash price of P3,005,200,
uses the calendar year as its reporting period.
a
for
note
The company
The present value factor is computed by dividing the present
value (P3,005,200) by the maturity value of the note (P4,000,000}.
Thus, the. present value factor for three periods is 0.7513. Finding the
appropriate interest rate in Table IJ in the Appendix (Present value of a
Single Payment), on line 3, corresponding to the number of periods, the
factor is under
10%.
the
column
10%.
Thus,
the
effective
interest
rate
is
The following amortization table applies to the preceding note.
(A)
Discount Amortization
Previous (B) x 10%
Date
March 31, 2022
(B)
Carrying Amount
Previous (B) + {A)
3,005,200
March 31, 2023
300,520
3,305,720
March 31, 2024
330,572
3,636,292
March 31, 2025
"Adjusted.
363,708*
4,000,000
The difference is due to rounding off.
229
CamScanner
Chapter 5 —- Financial Liabilities
The following are the entries
relating
to the
note
from
2022
through 2025,
2022
Mar. 31
Dec. 31
3,005,200
994,800
Machinery
Discount on Notes Payable
Notes Payable
4,000, 000
225,390
Interest Expense
225,390
Discount on Notes Payable
300,520 x 9/ 12
2023
Dec. 31
323,059
Interest Expense
323,059.
Discount on Notes Payable
(300,520 x 3/12) +
(330,572 x 9/12)
2024
Dec. 31
355,424
Interest Expense
355,424
Discount on Notes Payable
(330,572 x 3/12) +
{363,708 x 9/ 12)
2025
Mar.
37
90,927
4,000,000
Interest Expense
Notes Payable
90,927
4,000,000.
Discount on Notes Payable
Cash.
363,708x 3/12 = 90,927
amortizes only at year-end.
In the given illustration, MNO
Alternatively, MNO may amortize every anniversary date of the note,
with appropriate adjustment at year-end to update the amortization.
Iitustrative Problem
installments
— Long-term Note - Matunty
value
is payabie
in
Assume that on March 31, 2022, the MNO Corporation issued ‘a
three-year, P3,000,000, non-interest-bearing promissory note for a.piece
of machinery with an equivalent cash price of P2,401,800. The note is
payable in installments of P1,000,000 every March 31, starting March
31, 2023. MNO company uses the calendar year as its reporting period.
The
present value
factor is computed
value P2;401,800 by the periodic
present value factor for three
by
dividing
payment of P1,000,000.
Thus,
periods
is 2.4018.
Finding.
appropriate interest rate in Table IV in the Appendix
an
Ordinary
Annuity),
on
line
the present
3, corresponding
to
the
the
(Present value-of
the
number
ol
300
CamScanner
Chapter 5 — Financial Liabilities
Thus, the effective
periods, the factor 2.4018 is under the column 12%.
interest rate is 12%.
The following table shows the discount amortization on the note
payable.
Date
03/31/22
03/31/23
03/31/24
03/31/25
Periodic
Payment
P1,000,000
1,000,000
1,000,000
Payment Applied to
Interest
Principal
P288,216
202,802
107,182*
P711,784
797,198
892,818
Balance of
Principal, end
P2,401,800
1,690,016
892,818
-0-
*Adjusted. The difference is due to rounding off.
The following are the entries for years 2022 through 2025.
2022
Mar. 31
Dee. 31
Machinery
Discount or Notes Payable
Notes Payable
Interesl Expense
Discount on Notes Payabie
288,216 x 9/12
2023
Mar. 31
2,401,800
598,200
3,000,000
216,162
216,162
72,054
Interest Expense
Discount on Notes Payable
72,054
288,216 -216,162
31
1,000,000
Notes Payable
1,000,000
Cash
Dec, 31
Interest Expense
Discount on. Notes Payable
202,802 x 9/12
2024
Mar, 3]
3]
3]
152,102
152,102
50,700
Interest Expense
50,700
Discount on Notes Payable
202,802 — 152,102
1,000,000
Notes Payable
Cash
|
Interest Expense
e
bl
ya
Pa
s
te
No
on
nt
ou
sc
Di
80,387
1,000,000
80,387
22
x 9/1
107,18
301
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
2025
26,795
Interest Expense
Mar. 31
26,795
Discount on Notes Payable
107,182 — 80,387
1,000,000
Notes Payable
Cash
31
1,000,000
Notes Payable
Less: Discount on Notes Payable
Carrying amount
*Portion classified as
P711,784 + interest
P216,162 = P927,946
Total
P3, 000, 000
382,038
P2,617,962
retated
the
On December 31, 2022, the Notes Payable and
Discount on Notes Payable have the following balances:
Non-Current
FP2,000,000
309,984_
Pil ,690 016
Current
P1,000,000
72,054
P927,946*
current liabilities = Principal due next year
from March 31, 2022 to Dec. 31, 2022 of
BONDS
PAYABLE
Nature of Bonds
A bond is a certificate
agrees to pay a sum of money
interest payments
of indebtedness whereby the borrower
at a specified future date plus periodic
at the stated rate.
They
are
commonly
issued in
denominations of P1,000, P5,000, or P10,000, referred to as face
or par value.
Normally, a corporation sells all its bonds
investment firm, referred to as an underwriter, which resells the
to the investing public. In some instances, a corporation sclis the
directly to the investors.
The
contract
between
the
issuing
corporation
value
to an
bonds
bonds
and
the
bondholder is known as a bond indenture.
The bond indenture
specifies the terms of the bonds, the rights and duties of the issuer and
the
bondholders,
the restrictions
on the issuing corporation,
and
all
other important details affecting the contracting parties.
Types of Bonds
The more common
types of bonds are term bonds, serial bonds,
secured bonds, unsecured bonds, registered bonds,
convertible bonds, and callable or redeemable bonds.
bearer
bonds,
302
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
Term Bonds and Serial Bonds
Bonds that mature on a single date are called term bonds while
bonds that mature in installments are called serial bonds.
Secured Bonds and Unsecured Bonds
Secured bonds provide security and protection to investors in
the form of specific assets of the issuer, such as real estate or other
collateral, A real estate mortgage bond is secured by a lien against real
estate; a collateral trust bond is secured by shares of stocks and bonds
that the issuer holds as investments; a chattel mortgage bond is secured
by alien against movable property like motor vehicles.
On the other hand, unsecured bonds, frequently termed as
debentures, are not protected by the pledge of any specific asset of the
issuing corporation.
The issue of debenture bonds is generally based
on the credit rating of the company, as these bonds are backed only by
the issuer’s general favorable credit standing.
An issuer of debenture
bonds must be financially strong to attract investors to buy at favorable
interest rates.
|
Registered Bonds and Bearer for Coupon} Bonds
Registered bonds require the registration of the owners’ names in
When a bondholder sells these
the books of the issuing corporation.
bonds, the transfer agent cancels the original surrendered certificate
and issues a new certificate to the new bondholder.
The corporation
mails interest checks periodically to the bondholders of record,
Bearer
bonds
or
coupon
bonds
are
not recorded
in the name
of
the owner. Each bond is accompanied by coupons representing periodic
interest payments,
covering
the
life of the
issue.
The
issue
of bearer
bonds eliminates the need for recording changes in the ownership,
well as preparing and mailing periodic interest checks.
as
Callable Bonds and Convertibie Bonds
Callable or redeemable bonds give. the issuing company the right
to call or retire the bonds before maturity date, usually specified on the
bond indenture. The issuing company pays the bondholder an amount
based on the call provisions.
Convertible bonds give the bondholders the nght to exchange
their bond holdings into a specified or predetermined number of the
Issuing corporation’s shares of stock.
303
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
Zero-Interest Bonds
Zero-interest
bonds,
as
known
also
deep-discount
bonds,
are
The issuing
issued at significantly lower than their face value.
corporation pays the total interest on these bonds during their entire
term together with the principal amount on the maturity date.
Issuance
of Bonds
An entity shall recognize financial liability in its statement of
financial position when, and only when, the it becomes a party to the
contractual provisions of the instrument (par. 3.1.1, IFRS 9). Thus,
bonds payable are initially recognized at'the date of the actual issue of
the bonds.
An entity that issues the bonds recognizes the bond liabilities at
their discounted value, which equals the net proceeds. The issue price
of the bond is the market price of the bond, which varies with the safety
of the investment and the prevailing market interest rate for similar
instruments.
The interest rate stated on the face of the bond is called the
contract rate, stated rate, or nominal interest rate. This interest rate
generally depends on the financial condition and earnings of the issuing
corporation.
When the financial condition and earnings of the issuing
corporation provide certainty of interest and principal payments, the
interest rate a company offers to sell a bond issue is relatively low.
As
needs
the risk factor increases, the company
rate to attract investors.
to offer a higher interest
The interest rate which investors are willing to accept on a bond
ai the time of its issuc depends on some factors such as the market
evaluation of the bond issue quality, as evidenced by the financial
strength of the business, the firm’s earnings prospects, and the
particular provisions of the bond issue. This rate is referred to as the
market rate, yield, or effective interest rate.
The sale of bonds at face value implies an agreement between
the bond stated interest rate and the prevailing market interest rate. If
the effective interest rate exceeds the stated rate, the issue price of the
bonds will fall below the face amount of the bonds.
When the issue
price is less
discount.
than
the
face
value,
the
difference
is referred
to as a
Similarly, if the bond interest rate exceeds
the market
interest
rate for comparable instruments at the time of the issue, the price of the
bonds will
premium.
exceed
the
face
amount;
that is,
the
bonds
will
sell at a
304
CamScanner
Chapter 5 — Financial Liabilities
When
transaction
proceeds,
an
entity
sells
bonds
by debiting
cash
and
at
face
value,
crediting bonds
it records
payable
the.
at the
which equals the face value.
The sale of bonds at a premium is recorded as
Cash (at the selling price)
XX
Bonds Payable fat face value)
Premium on Bonds Payable (selling price—face value)
XX
xx
The sale of bonds at a discount is recorded as
Cash (at the selling price)
Discount on Bonds Payable {face value-selling price)
Bonds. Payabie
xx
xx
|
xx
The discount on bonds is reported as a direct deduction from the
face value of bonds payable, whereas premium on bonds is an adjunct
account and reported as an addition to the face valuc of bonds payable.
yalue.
Bond prices are quoted in the market as a percentage of the face
For example, a bond quoted at 97 1/2 means that the market
price is 97.5%
of face value; thus,
the bond
sells at a discount.
A
quotation of 105 means that the market price is 105% of face value;
thus, the bond trades at a premium.
When bond quotations are not available, the market price can be
determined by discounting the maturity value of the bond and all
interest payments
date.
at the market
rate of interest for similar debt on
that
Note that the computation of bond price is similar to that of the
investor’s viewpoint.
information:
To reiterate the computation, assume the following
On January 1, 2022, an entity issues a 5-year, P1,000,000, 15%
bonds. The effective interest rate for similar bonds is 12%. Interest on
the bonds is payable semi-annually on June 30 and December 31.
The issue price of the bonds is equal to the present value of the
maturity valuc plus the present value of the penodic interest payment,
discounted at the market interest rate at the date the bonds are issued.
For the purpose of computing the proceeds, the discount rate to
be used is 6% (which is 12% x 6/12) since the interest is payable semi-
annually and the number of periods to be used is 10 (which is 5 years x
2).
Thus,
the
proceeds
from
the
issue
of the
P1,000,000
bonds
described is computed as follows:
305
be8} CamScanner
CamScanner
s
e
i
t
i
l
i
b
a
i
L
l
a
i
c
n
a
n
i
F
5
r
Chapte
Present value of maturity value
s
od
ri
pe
10
for
6%
at
P]
of
F
PV
x
Face value
1,000,000 x 0.558395
P 558,395
Present value of 10 interest payments
Interest per period x PVAF of Pl
at 6% for 10 periods
Interest per period = P1.M x 7.5% = 75,000
75,000 x 7.36008
952,006
P1,110,40)
Bond Price
Alternatively, the bond price may be computed
Difference in interest rates x Face value
= Discount or Premium
=
Face value — Discount (or + premium)
as follows:
x PVAF
Bond price
7.5% - 6% = 1.5% x 1,000,000 x 7.36008 =110,401 Premium
(Premium situation because the nominal rate per period of
7.5% is greater than the market rate per period of 6%)
1,000,000
The
+
issuance
110,401
=
1,110.401 bond price
of the bonds
on January
1, 2022
is recorded as
follows:
1,110,401
Cash
1,000,000
Bonds Payable
Premium. on Bonds Payable
Assume, a reverse scenario regarding interest rates.
110,40]
On January
The
12% bonds.
1, 2022, a company issues a 5-year, P1,000,000,
The interest on the
market interest rate for similar bonds is 15%.
bonds is payable semi-annually on June 30 and December 31.
The bond price is computed as follows:
Present value of maturity value
Face value x PVF of Pl at 7.5% for 10 periods
1,000,000'x 0.485194 |
P
Present value of 10 interest payments
Interest per period x PVAF of P1 at 7.5%
for 10 periods
Interest per period = P1.M x 6% = 60,000
60,000 x 6.86408
485,194
411,845
P_ 897,039
‘Bond Price
306
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
The bond price may also be computed as follows:
Difference in interest rates x
= Discount or Premium
Face value
Face value — Discount (or + premium)
x PVAF
=
Bond price
7.5% - 6% = 1.5% x 1,000,000 x 6.86408 = 102,961 Discount
(Discount situation because the nominal rate per period of 6% is
lower than the market rate per period of 7.5%)
1,000,000 - 102,961 = 897,039 bond price
The issuance
of the bonds
on January
1, 2022
is recorded
as
follows:
Cash
897,039
Discount on Bonds Payable
Bonds Payabie
Accrued Interest
on Bonds
102,961
- 1,000,000
Issued
Bonds are often issued at any date between the interest payment
dates. Since the issuing corporation will pay the full periodic interest
on all bonds outstanding at an mterest date, the bond investor is
usually required
to pay
the
interest that has
accrued
the
from
most
previous interest date to the date of purchase. This accrued interest is
added to the issue price of the bond to determine the total cash
proceeds from the bond issuance.
Assure
that an entity issued
January
bonds dated
1, 2022,
on
1,000 of 15%,
March
1, 2022
P1,Q00
face value,
accrued
112 plus
at
The bonds pay interest on June 30 and December 31.
interest.
The
issuing
corporation
shall prepare
this
entry
on
March
1,
2022:
1,145,000
Cash
Bonds Payable
Premium on Bonds Payable
Interest Payable
.1,000,000 x .15 x 2/12 = 25,000
The payment of accrued interest on June
interest payment) is recorded as follows:
1,000,000
120,000
25,000
30 (the first periodic
50,000
25,000
Interest Expense
Interest Payable
75,000
Cash
1,000,000 x .15x 6/12
307
be8} CamScanner
CamScanner
Chapter
5 — Financial Liabilities
1, 2022, the corporation may credit th,
Interest Expense account (instead oy
Alternatively, on March
accrued interest received to
Interest Payable). This nominal approach is more convenient since the
corporation may record the subsequent transactions, such as payment
of interest, in the usual manner. The payment of interest on June 30
is, then, recorded as:
Interest Expense
:
75,000.
|
75,000
Cash
Transaction
Costs on Issue of Bonds
Bond issue costs are expenditures that the issuing corporation
incurs for legal fees, printing and engraving of bond certificates, taxes,
commissions and similar charges. An entity shall initially recognize the
bond liability at its fair value (issue price) and consider the transaction
costs directly attributable to the issue.
Hence, the bond issue costs
form part of the initial carrying amount of the bond liability. In effect,
the bond issue costs reduce the net proceeds and require a
computation of the yield or effective interest rate on the bond issue.
re-
To illustrate accounting for bond issue costs, assume that XYZ
sold its P1,000,000 face value, five year, 12% bonds on the bond date,
January
1,
2022
consisting
of
commission.
at
110.
XYZ
promotions,
paid
bond
engraving,
The entries for the issuance
bond issue costs are as follows:
costs
printing
of the
Cash
issue
bonds
and
and
of
P15,000,
underwriter’s
the payment of
1,100,000
Bonds Payable
1,000,000
Premtum on Bonds Payable
Issue of bonds @ 110
100,000
15,000
Premium on. Bonds Payable
Cash
Paid bond issue costs
15,000
After recording the payment of bond issue costs, the premium on
bonds
payable
liability on issue
is reduced
date
to P&85,000.
is, therefore,
The
carrying
P1,085,000,
which
amount
of the
is the basis
for
the computation of the bond yield.
The bond yield is lower than 12% because the bonds were sold
at a premium. Such yield may be computed on a trial-and-error basis.
308
be8} CamScanner
CamScanner
Chapter
If the
yield
is
10%,
the
p1,075,815, computed as follows:
5 — Financtal Liabilities
proceeds
should
Present value of maturity value
P1,000,000 x 0.62092
Present value of periodic interest
P120,000
be
approximately
P620,920
x 3.79079
454,895
Total present value
P1,075,815
A principle in mathematics of investment indicates that the
higher is the yield, the lower is the present value, and the lower is the
yield, the higher is the present value.
Discounting the future cash
outflows at 10% gives a present value lower than the net proceeds of
P1,085,000, indicating that the yield is slightly lower than 10%.
If the yield 1s 9.5% the
P1,095,995, computed as follows:
proceeds
should
Present value of maturity value
P1,000,000 x 0.63523
Present value of periadic interest
P120,000 x 3.83971
Total present value
P
be
approximately
635,230
460,765
P1,095,995
The yield should be higher than 9.5% but lower than 10%
because the computed present value is higher than P1,085,000.
To
approximate the yield, the process of interpolation is applied.
To interpolate:
P1,085,000 - P1,075,815
P1,095,995 — P1,075,815
x (10% -9.5%)
0.4552 x 0.5%
=
0.23%
Approximate yield is 10% - 0.23%
=
9.77%
=
P627 493
=
— _497,580
P1.089,033
To check:
Using a discount rate of 9.77%
Present value of maturity value
P1,000,000 x 0.62745
Present value of periodic interest
Total
P120,000 x 3.81317
309
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
the
net
proceeds
computed
in
the
preceding
oo
approximates P1,085,000, the approximated yield on the bonds issued
is 9.77%. The issuer shall record the interest expense during the bond
term based on 9.77%. An entity may also use a financial calculator or
an Excel Worksheet to compute the effective interest rate.
———
Because
Premium
Entities
and Discount Amortization
generally
present
bond
liabilities
in
their
financial
statements at amortized cost. The amortized cost of a financial liability
is the amount at which it is measured at initial recognition minus the
principal
repayments
plus
or minus
the
cumulative
amortization of
discount and premium, respectively, using the effective interest method.
When bonds are issued at a premium or discount, the periodic
interest payments made by the issuer to the investors over the bond life
do not represent the complete interest expense for the periods involved,
The entity shall allocate the bond premium or discount over the bond
term using the effective interest method to reflect the total interest cost
of the bonds. This allocation, called amortization, is a deduction from
The amortization of premium or
or addition to the interest expense.
discount gradually adjusts the bond’s carrying amount to the bond's
face value, and the nominal interest to the effective interest.
Effective
Interest Method
Under
the
effective
interest
method,
an
entity
recognizes
a
constant interest rate based on the beginning of period bond carrying
value
as interest
expense
each
period,
resulting in unequal
recorded
amounts of interest expense. The effective interest method provides an
increasing premium
—
bonds.
or
amortization
discount
each
period
for term
Under the effective interest method, the interest expense equals
the
carrying
bond's
multiplied
by the
amount
at the
beginning
effective interest rate.
The
of each
interest
difference
period
between
the
interest expense amount and the interest paid or accrued (nominal
interest rate x face value of the bonds) is the discount or premium
amortization.
Illustration for Effective Interest Method of
Amortization
Premium
Situation
Assume that a corporation issued a P1,000,000, S-year, 15%
bonds on January 1, 2022, for P1,110,401, an issue price that provides
310
be8} CamScanner
CamScanner
Chapter
5 — Financial Liabilities
a yield of 12%. Interest on the bonds is payable semi-annually on June
30 and December 31.
The bond premium amortization table for the entire bond term
and the detailed computations
are shown below.
(A)
Nominal interest = Face value x semi-annual stated interest rate
(B)
Effective interest = Bond
annual market
carrying value, beg of period x semi-
rate
(C)
Premium Amortization = (A) — (B)
(D)
Carrying value,
end
beg.
carrying value,
= Bond
of period -
premium amortization for the period
Bond Premium Amortization Table
Effective Interest Method
(B)
|
(A)
«- Effective
Interest
Nominal
Interest
| Date
01/01/22
PIM x 7.5%
12/31/22
06/30/23
75,000
75,000
(C)
(D)
Premium
Bond Carrying
Amortizalion
Value
ie
Previous (D)x |
6%
_75,000
66,624
66,122
65,589
8,878
9,411
12/31/23 _
75,000
65,0224
9,976
‘The effective
adjusted.
75,000
75,000
75,000
75,000
75,000
75,000
interest
for
1,102,025
8,376
|
64,426 |
63,791
63,199 _|
62,406
61,650
60,848" __
the
period
ending
1,093,147
1,083,736
1,073,760
1,063,186
1,051,977
1,040,096
1,027,502
1,014,152
1,000,000
10,574
11,209
11,881
12,594
13,350
14,152
December
|
Previous (D}-(C)
1,110,401
(A} — (B)
06/30/22
06/30/24
12/3) /24
06/30/25
12/31/25
06/30/26 |
| 12/31/26
ee
31,
2026
has
been
The difference is due to rounding off.
The amortization
reduces
the
bond
appropriate premium
of premium, as shown in the preceding table,
carrying value. On the maturity date, after
amortization
for the entire bond
term, the bond’s
Carrying value will equal its face value.
The journal entries for the years 2022 and 2023 relating to this
bond are as follows:
311i
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
2022
Jan.
1
Jun 30
1,110,401
Cash
Premium on Bonds Payable
Bonds Payable
66,624
8,376
Interest Expense
Premium on Bonds Payable
Cash
66,122
Jun 30 Interest Expense
Premium on Bonds Payable
65,589
8,878
75,000
2023
9,411
75,000
Cash
65,024
9.976
Dec.31] Interest Expense
Premium on Bonds Payable
75,000
Cash
Based
on
the preceding
|
75,000
Interest Expense
Premium on Bonds Payable
Cash
Dec.31
|
110,40]
1,000,000
amortization
table
and journal
entries
for 2022 and 2023, the statement of financial position on December 31,
2022 and December 31, 2023 would show bonds payable at carrying
amounts of P] 093,147 and P1,073,760, respectively.
Bonds Payable
Premium or Bonds Payable
Carrying amount
The
profit or loss
section
12/31/22
P1,000,000
1,000,000
P1,093,147
PI1,073,760
12/31/23
93,147 ___—_—*73,760°
statement
of the
income for 2022 and 2023 will show interest expense
P130,613, respectively, computed as follows:
of comprehensive
of P132,746 and
2022
66,624
66,122
January 1 to June 30
July I to December
31
Totai interest expense
2023
65,589
65,024
132,746
Notice the following trends using
the
effective
_130,613
interest method
when an entity issues bonds at a premium:
1.
Interest expense decreases each period,
carrying value
also decreases
as
the
amortized.
because the
premium is
312
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
2
The amount of premium amortization increases each
period as the difference between the nominal and the
effective interest becomes wider each period.
On maturity
interest
and
date, in addition to the entry for the payment of
premium
amortization,
payment of the bonds at face value.
the
company
has
to record
On the maturity date of the bonds (December 31,
issuer of these bonds shall prepare the following entries:
Interest Expense
Premium.on Bonds Payable
Cash
Payment of periodic interest
2026),
the
the
60,848
14,152
75,000
and amortization of premium
Bonds Payable
Cash
1,000,000
1,000,000
Payment on maturity date
Discount Situation
Assume
P917,039, and
that a corporation sold
paid P20,000 transaction
P1,000,000
costs. The
12% bonds for
yield on the net
proceeds 1s computed at 15%.
The table below shows the bond discount amortization under the
effective interest method for the entire bond term.
(A)
(B)
Nominal Interest = Face value x semi-annual stated interest rate
Effective Interest
= Bond carrying value, beg. of period x semi-
(C)
(D)
annual market rate
Discount amortization = (B) — (A)
Carrying value, end = Carrying value, beg. of period + discount
|
amortization
Bond
Ty
Date
01/01/22
06/30/22
12/31/22
06/30/23
|
Discount Amortization Table
Effective Interest Method
Effective
Interest
Previous
Nominal
Interest
67,278
60,000
60,000
a
|
67,824
68,410
|
Previous (D)+(C)
(B) — (A)
7,278
7,824
8,410
(D)
Bond Carrying
Value
Discount
Amortization
(D)x7.5%
6%xPIM |
60,000 _
(C)
(B)
A)
——
897,039
904,315
|
|
912,139
920,549
313
CamScanner
Chapter 5 - Financial Liabilities
Bond Discount Amortization Table
Effective Interest Method (continued)
(A)
12/31/23
06/30/24
12/31/24
06/30/25
| 12/31/25
06/30/26
12/31/26
(C)
(D)
Interest
Discount
Bond Carrying
Effective
Nominal
Date
=)
(B)
Interest
6% x P1M
Previous
(D) x 7.5%
Amortization
(B) — (A)
Value
Previous (D)+(C) |
_60,000
60,000
60,000
60,000
60,000
60,000
60,000
69,041
69,719
70,448
71,232
72,074
72,980
73,957+
9,041
9,719
10,448
11,232
12,074
12,980
13,957
929,590|
939,309
949,757
960,989
973,063
986,043.
_ —i|
1,000,000
|
*The effective interest for the period ending December 31, 2026 has been
adjusted.
The difference is due to rounding off.
The journal entries for the years 2022 and 2023 are as follows:
2022
Jan.
917,039
82,961
1 Cash
Discount on Bonds Payable
Bonds Payable
20,000
1 Discount on Bonds Payable
Cash
Jun.30 Interest Expense
Discount on Bonds Payable
Cash
67,278
Dec. 31 Interest Expense
67,824
7,824
60,000
Cash
Jun. 30 Interest Expense
Discount on Bonds Payable
68,410
8,410
60,000
Cash
Dec. 31 Interest Expense
Discount on Bonds Payable
Cash
20,000
7,278
60,000
Discount on Bonds Payable
2023
1,000,000
69,041
9,04]
60,000
Based on the preceding amortization table and journal entries
for 2022 and 2023, the statement of financial position on December 31,
314
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilit
ies
2022 and December
amounts of P912,139
are as follows:
31, 2023 would show bonds
and P929,590,
payable at carrying
respectively.
The ledger balances
|
12/31/22
P1,000,000
87,861
P 912,139
Bonds Payable
Less: Discount on Bonds Payable
Carrying amount
12/31/23
P1,000,000
_70,410
P 929,590
The profit or loss section of the statements of comprehensive
income for the years 2022 and 2023 will show interest expense of
P135,102 and P137,451, respectively, computed as follows:
2022
P 67,278
67,824
P135,102
January 1] to June 30
July 1 to December 3]
Total interest expense
In contrast to
amortization increases
the
the
2023
P 68,410
69,041
P132451
effect of premium amortization, discount
carrying value of the bonds, such that on
maturity date, the carrying value will equal the face value.
For term bonds, the following are the observed trends using the
effective interest method when an entity sells bonds at a discount:
1.
The
interest expense increases cach period, because the
carrying
value
amortized.
2.
The
discount
also
increases
as
amortization increases
difference between the nominal
interest becomes wider.
the
discount
is
each period as the
interest and the effective
When the Bond Year Does Not Coincide with the Reporting Period
If the
bond
year
does
not
coincide
with
the
entity’s
reporting
period, the entity should prepare an adjusting entry at year-end in
addition to the entries every interest payment date. The adjustment
accrues the interest expense and updates the premium or discount
amortization from the last interest date.
To illustrate, let us reproduce a portion of the previous
amortization table. Assume instead, that the bonds are dated March l,
E
B
¥
=
st
Augu
and
28
uary
Febr
every
y
uall
-ann
semi
est
inter
pay
2022 and
The issuer uses the calendar year as its reporting period.
315
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
Table
Bond Discount Amortization
Effective Interest Method
|
DD
J
c
B
A
Effective
Date
03/01/22
02/28/23
60,000
| 60,000
67,278
7,278
08/31/23
02/28/24
60,000
60,000
| 68,410
__ 69,041
8,410
9,041
08/31/22 |
67,824
2022
904,315 7
|:
7,824
92,130
920,549
929,590
The journal entries for 2022 relating to this bond
Mar.
Bond Carrying
Value
PreviousD+¢
897,039 —
Discount
Interest
Nominal
Amortization
7.5% X
Interest
A-B___ |
6%xP1M | PreviousD |
are as follows:
1 Cash
Discount on Bonds Payable
Bonds Payable
917,039
82,961]
1 Discount on Bonds Payable
Cash
20,000
1,000,000
20,000
Aug.31 Interest Expense
Discount on. Bonds Payable
Cash
67,278
|
Dec.31 Interest Expense
Discount on Bonds Payable
Interest Payable
67,824 x 4/6 = 45,216
7,824 x 4/6 = 5,216
IM x 12% x 4/12 = 40,000
45,216
7,278
60,000
5,216
40,000
The above adjusting entry on December 31 is preferably reversed
at the beginning of the ensuing accounting period so that the payment
of interest in that period will be recorded in the usual manner.
The following are the entries for the year 2023:
2023
Jan.
1 Discount on Bonds Payable
5,216
Interest Payable
40
Interest Expense
O00
45,216
316
be8} CamScanner
CamScanner
Chapter 5 ~ Financial Liabilities
Feb.28 Interest Expense
67.824
Discount on Bonds Payable
,
Cash
7,824
60,000
Aug.31 Interest Expense
68,410
Discount on Bonds Payable
Cash
8,410
60,000
46,027
Dec.31 Interest Expense
Discount on Bonds Payabie
Interest Payable
6,027
40,000
69,041 x 4/6 = 46,027
9,041 x4/6=
6,027
The interest expense
for 2022 is broken down as follows (refer to
the amortization table):
March
1 to August 31
P
67,278
45,216
P112,494
September 1 to December 31 (67,824 x 4/6)
Total] interest expense for 2022
The interest expense for 2023 is computed as follows:
January 1] to February 28 (67,824 — 45,216)
March 1 to August 31
August 3] to December 31 (69,041 x 4/6)
Total interest expense for 2023
P
|
The carrying amount of the bonds on December
computed as follows (refer to the amortization table)
Amortization of discount
from September 1 to December 31
support
the
Bonds Payable
Less: Discount on Bonds Payable
(82,961 + 20,000 — 7,278 — 5,216 + 5,216
- 7,824 — 8,410 — 6,027)
Carrying amount, December 31, 2023
31, 2023
is
___ 6,027
P926,976
(9,041 x 4/6)
Carrying amount, December 31, 2023
The following ledger balances
computed on December 31, 2023:
46,027
P137,045
P920,549
Carrying amount, August 31, 2023
Add:
22,608
68,410
carrying
amount
P1,000,000
___ 13,422
P_926,578°*
* The difference of P2 is due to rounding off.
317
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
Retirement
of Bonds
The issuing corporation generally retires the issued bonds on t},.
maturity date.
On such a date, the corporation should have complete},
It records the retirement as ay
amortized the premium or discount.
Hence, the
ordinary payment of debt and recognizes no gain or loss.
entry for the settlement of the bonds on maturity date is:
Xx
Bonds Payable
Cash
The amount
value of the bonds.
of cash
XX
paid
to
the
bondholders
equals
the
fac:
A corporation may also settle the liabilities for the bonds before
the maturity date either by redeeming the bonds or repurchasing them
in the open market.
When an entity retires the bonds before their
maturity, it shall recognize the difference between the bond carrying
value and the retirement price as a gain or joss in profit or loss. When
the retirement price is less than the carrying amount of the bonds, the
entity realizes a gain on the retirement.
Similarly, if the retirement
price is greater than the carrying value, the entity incurs a loss on the
retirement of the debt.
An entity applies the
bonds before maturity date:
following
procedures
when
it retires
the
(a)
The amortization
of premium
or discount must be
updated to determine the carrying amount of the bonds
at the date of retirement.
(b)
Any accrued interest on the retired bonds from the mast
recent interest payment date to the retirement date mus!
be recorded and paid.
The previous example will be used to illustrate the accountin:
procedures for the retirement of bonds before the maturity date.
Illustration of Retirement Before Maturity Date
The bonds have face value of 'P1,000,000 and bear annua
interest rate of 15%, with interest payable semi-annually every June 3!
and December 31. The bonds were sold at a price that yields 12%.
The
issuer retired these bonds
on October
31,
2025
@
102 plu:
accrued interest. The company prepared the entries every interest dat:
until June 30, 2025.
318
be8} CamScanner
CamScanner
Chapter5 —Financial Liabilities
Since
the last payment
of interest and amortization of premium
are made on June 3OQ, 2025, a proportionate interest expense should be
recorded from July 1 through October 31, 2025.
Bond Premium
Amortization
Table
Effective Interest Method
C
(A)
(B)
Effective
Nominal
Interest
Interest
Date
06/30/22
75,000
12/31/22
06/30/23
12/31/23
(A) — (B)
Previous (D)+{C)
6%
-”
-_
8,376
8.878
65,589
65,024
9411
_ 9,976
06/30/24
75,000
64,426
12/31/24
795,000
06/30/25
12/31/25
75,000
75,000
63,791 _
11,209
75,000
61,650
13,350
12/31/26
79,000
60,848
06/30/26
Bond Carrying
Value
66,122
75,000
75,000
(D)
Amortization
66,624
75,000
7
Premium
Previous (D)x |
PIM x 7.5%
01/01/22
(C)
1,110,401
1,102,025
1,093,147
|
_1,083,736
1,073,760
10,574
63,199
62,406
1,063,186
1,051,977
11,881
12,594
| _ 1,040,096
1,027,502
__
14,152
1,000,000
1,014,152
|
On October 31], 2025, the issuer should update the interest and
amortization of premium with the following entry.
2025
Oct.
31
41,604
Interest Expense
Premium. on Bonds Payable
Interest Payable
62,406 x 4/6 = 41,604
12,594 x4/6=
8,396
75,000 x 4/6 = 50,000
The
carrying
amount
of
the
bonds
8,396
20,000
on
October
31,
2025
is
P1,031,700, computed as follows:
Carrying amount on June 30, 2025
Less:
P1,040,096
amortized premium July 1 to October
31, 2025 (12,594 x 4/6)
Carrying amount, October 31, 2025
8,396
P1.031,700
The issuer shall pay P1,070,000 to retire the bonds.
Retirement price (1,000,000 x 102%)
Accrued interest from July 1 to Oct. 31
(1,000,000 x 15% x 4/12)
Total cash paid
P1,020,000
20,000
P1,070,000
319
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
The
of the
retirement
bonds
of P11,709
gain
a
in
results
computed as follows:
P1,020,000
1,031,700
Retirement price (1,000,000 x 102%)
,
Carrying amount of the bonds
The issuer shall record
31, 2025 as follows:
the retirement
700
ra
Gain on retirement of bonds
on October
of the bonds
1,000,000
31,700
Bonds Payable
Premium on Bonds Payable
50,000
Interest Payable
1,070,000
11,700
Cash
Gain on Retirement of Bonds
Notice that the gain or loss on the retirement of the debt is not
affected by the accrued interest,
separately as Interest Expense.
since the accrued
interest is recorded
Bond Refunding
Oftentimes, it is advantageous for the issuing corporation to
acquire the entire outstanding bond issue and replace it with a new
This replacement of an
bond issue bearing a lower interest rate.
outstanding bonds payable with a new one is called refunding. Under
IFRS 9 Financial Instruments, an exchange between existing borrower
and lender of debt instruments with substantially different terms shall
be accounted for as an extinguishment of the original financial liability
and the recognition of a new financial liability. The extinguishment is
recorded as a retirement, recognizing a gain or loss immediately.
issue is recorded as a separate borrowing transaction.
The
Bonds With Equity Characteristics
Corporations
issue
may
that
bonds
creditors
allow
shareholders by attaching share warrants to the bonds
conversion
has
feature in the bond
acquired
principal
indenture.
a dual set of rights:
payment
on
the
bonds
and
the
right
or including <«
case,
the investo!
to receive
interest anc
In either
the right
to becom:
to
purchase
ordinar
shares and participate in the potential appreciation of the market value
of the shares.
Usually,
bonds
of
this
nature
attract
generally result in a relatively lower interest rate
investors.
or higher
They
wt
proceed:
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
when
compared
with
other
bond
issues
with
such nights.
similar
risk but
without
Bonds with Non-Detachable Share Warrants Issued
When
gives
the
an entity issues bonds
bondholders
the
right
with share warrants
to
acquire
a specified
attached,
it
number
of
ordinary shares (common stock) at a given price within a specified time
period.
The issuer shall apply the residual approach to allocate the issue
price of the bonds with warrants attached between the debt (the bond)
and the equity (the warrant).
that
equity
represents
the
The residual approach uses the concept
residual
interest
in
the
assets
of the
corporation.
The issuer shall deduct the separately determined fair
value of the debt from the issue price. The residue is the amount
assigned to the equity component.
lustration of Bonds with Attached Warrants
10%,
On December 31, 2022, ABC Corporation issued 1,000
lO-year, P1,Q00 face value bonds with non-detachable
of its
share
warrants at i103. Kach bond carried two warrants, each warrant
entitling the holder for one share of ABC’s P20 par value ordinary share
at a specified option price of P25 per share. Immediately after issuance,
the bond without warrant sells at 97 and each ordinary share sells at
P75.
Total issue price (P1,000,000 x 103%)
Market price of bonds without warrants
97% x P1,000,000
Price assigned to warrants
The entry for the
share warrants 1s
issuance
of the
Cash
Discount on Bonds Payable
bonds
P1,030,000
970,000
P___ 60,000
with
non-detachable
1,030,000
30,000
Bonds Payable
Share Warrants Outstanding
1,000,000
60,000
The discount on bonds payable is the excess of the face value of
the bonds of P1,000,000 over the market price without the warrants,
P970,000.
ABC shall report the account Share Warrants Outstanding as
part of additional paid in capital in the equity section of the statement
of financial position.
321
be8} CamScanner
CamScanner
s
ie
it
il
ab
Li
l
ia
nc
na
Fi
5
r
e
t
p
a
Ch
When holders subsequently exercise the share warrants, Afc
Corporation shall cancel the warrants and issue the ordinary shares. |;
shall prepare this entry:
Cash
50,000
Share Warrants Outstanding
Ordinary Share Capital
Share Premium - Ordinary
1,000-x 2 x 25 = 50,000
1,000 x 2.x 20 = 40,000
60,000
40,000
70,000
An entity shall compute the market
price of the bonds without
the warrants if their fair value is not readily determinable. The bond
market price is computed by discounting the maturity value and
periodic interest at the market interest rate for similar debt instruments
without the equity component.
To illustrate, assume
bonds on bond
8% ten-year
that XYZ issued P5,000,000,
issue date at 105.
bond
P1,000
Each
carried two non-
entitles the holder to
Each warrant
detachable share warrants.
purchase one XYZ’s P200 par value ordinary share capital at P250 per
Similar instruments without any equity component are being
share.
traded at prices that yield 10%. Interest is payable annually.
The
as follows:
issue price of P5,250,000
(P5,000,000
x 1.05) is bifurcated
P5,250,000
Total issue price
Less:
Market value of the bonds without the
Watrants
Present value of the principal
P5,000,000 x 0.38554
P1,927,700
Present value of the interest
P400,000 x 6.14457
2,457,828
4,385,528
P_
Issue price assigned to the warrants
864,472
The issue of the bonds results in a discount of P614,472, which
is the excess of the face value of the bonds of P5,000,000 over the
computed market price of P4,385,928.
The
entry
to
record
the
issue
of
the
bonds
with
the
non-
detachable share warrants is as follows:
Cash
5,250,000
Discount on Bonds Payable
614,472
Bonds Payable
Share Warrants Outstanding
5, 000, 000
864,472
322
be8} CamScanner
CamScanner
Chapter 5 ~— Financial Liabilities
An entity shall apply the preceding principles and procedures for
bonds issued with detachable
share warrants.
Convertible
Another example of a
convertible bond.
Convertible
Bonds
compound financial instrument is a
bonds give their holders the right to
exchange their bond holdings into ordinary shares or other securities of
the issuing company within a specified period.
The issue price of the convertible bond is comprised of two
a financial liability (the bond liability) and an equity
components:
The issuer shall apply the
price.
instrument (the bond conversion privilege).
residual approach to bifurcate the total issue
Under the residual approach, the issuer of a bond convertible
into ordinary shares first determines the amount of the liability
component by measuring the fair value of a similar liability that does
not have
an
instrument
associated
represented
equity
by
the
component.
option
The
amount
to convert
the
of the
equity
instrument
into
ordinary shares is then determined by deducting the fair value of the
financial liability from the fair value of the compound
financial
instrument (the convertible bonds)..
To illustrate, assume that XYZ Corporation issued P5,000,000,
14% bonds at 105 on bond issue date.
into 5 XYZ
P100
par value
ordinary
Each P1,000 bond is convertible
shares.
feature, the bonds would have sold at 102.
Without
the conversion
The total issue price of the
bonds is allocated to the bond liability and the equity as follows:
Total proceeds (5,000,000 x 105%)
Market value of bonds without the conversion privilege
P5,250,000
5,100,000
(5,000,000 x 102%)
Paid in capital arising from bond conversion privilege
P__150,000
The entry to record the issuance of the convertible bonds is:
Cash
5,250,000
Bonds Payable
5,000,000
Premium on Bonds Payable
Share Premium - Bond Conversion Privilege
In circumstances
when
the bonds
100,000
150,000
are not readily quoted in the
market, its assumed market price without the equity component is the
present value of the future cash outflows, discounted at the market rate
of interest for similar instruments.
323
CamScanner
Chapter 5 — Financial Liabilities
To illustrate,
assume
l, 2022,
that on January
DEF
issued
1p.
for a total consideration of
year, P2,000,000 convertible bonds
P2,400,000. The bonds pay interest at 10% annually every December
31. Each P1,000 bond is convertible into four P100 par ordinary shares.
Similar instruments without the conversion feature would have sold to
yield
8%.
The issue price of P2,400,000 is bifurcated as follows:
Total issue price
Issue price assigned to bonds
2,000,000 x 0.46319
200,000 x 6.71009
Price assigned to conversion feature
P2,400,000
P
926,380
1,342,018
2,268,398
131,602
P
The entry to record the issuance is
2,400,000
Cash
Bonds Payable
Premium on Bonds Payable
Share Premium - Bond Conversion Privilege
Exercise of Bond
Assume
Conversion
that
before
2,000,000
268,398
131,602
Privilege
maturity
date
bonds,
of the
holders
of
P2,000,000 face value bonds exercised their conversion privilege when
Further assume that on this date,
each ordinary share sells for P130.
the balance of the premium on bonds payable is P30,000.
2
The conversion of bonds
is recorded
as follows:
Bonds Payable
Premium on Bonds Payable (30,000 x 2/5)
Share Premium - Bond Conversion
Privilege (150,000 x 2/5)
2,000,000
12,000
60,000
Ordinary Share Capital (2,000 x 5 x 100)
1,000,000
Share Premium — Ordinary
1,072,000
An enterprise recognizes no gain or loss on the conversion of
bonds into ordinary shares, because the conversion its based on the
original terms of the bonds.
The issuing corporation should pay the accrued interest on the
date it converts the bonds.
The expenditures incurred on the
conversion reduces the share premium, if any. The excess of the
expenditures over the related share premium shall be recorded as
expense in the period of conversion.
324
be8} CamScanner
CamScanner
Chapter 5 —- Financial Liabilities
Reurement of Convertible Bonds Prior to Maturity
An entity retiring the convertible bonds before
shall allocate the retirement price plus the transaction
maturity date
costs between
the lability settled and the bond conversion privilege cancelled. It shall
The company shall
apply the residual approach for this purpose.
compare
the retirement
price assigned
to the component
carrying value and treat the difference as follows:
with
its
(a)
the amount of gain or loss relating to the liability
component (the bonds) is recognized in profit or loss; and
(b)
the amount of gain or loss relating to the equity
component (the bond conversion privilege) is recognized
in equity.
To
illustrate,
assume
that
P1,000,000
of the
bonds
described
above were retired when the total unamortized premium was P40,000.
Further assume that interest payment and premium amortization have
been recorded properly.
The P1,000,000 bonds were retired at 105.
Without the conversion privilege, these bonds would have sold at this
date at 103.
The retirement price ts allocated as follows:
Total retirement price
P1,050,000
Retirement price on account of the liability
(1,000,000 x 103%)
Retirement price on account of equity portion
1,030,000
P
20,000
The gain or loss is computed as follows:
Face value of bonds retired
P1,000,000
Related unamortized premium
(P40,000 x 1M/5M)
Carrying value of bonds retired
8,000
P1,008,000
Retirement price on account of bond liability
Loss on retirement of bonds
1,030,000
P
22,000
The credit to equity (additional paid in capital) from unexercised
bond conversion privilege is computed as follows:
Carrying value of equity cancelled
(150,000 x 1M/5M)
Retirement price on account
privilege
P
of
30,000
conversion
Gain on cancellation — taken to equity (APIC)
20,000 _
P
10,000
325
be8} CamScanner
CamScanner
lities
Chapter 5 — Financial
the
records
entry
following
The
of the
retirement
cofvertilj,
bonds:
1,000,000
Bonds Payable
8,000
Premium on. Bonds Payable
22,000
Loss on Retirement of Bonds
30,000
1,050,000
Share Premium - Bond Conversion Privilege
Cash
Share Premium - Unexercised
Bond Conversion Privilege
10,000
Serial Bonds
Serial
bonds
mature
in
series
of installments.
Unlike
in term
bonds where the full amount of the principal is paid on maturity date,
the principal of serial bonds decreases after each installment payment.
Thus, both the nominal and effective interests decrease.
For a complete illustration of the issuance, premium
or discount
amortization, and retirement on maturity date of serial bonds, consider
the following:
January
P5,000,000,
1, 2022.
The
12% bonds
principal
were issued
is payable
in
on bond
senes
issue date,
of P1,000,000
annually, together with accrued interest on the outstanding bonds, each
December 31, starting December 31, 2022. The bonds were issued for
P5,.241,834,
a price that yields
10%.
Periodic interest due:
12/31/22
12/31/23
12/31/24
12/31/25
12/31/26
=
=
=
=
=
12% x
12% x
12%x
12% x
12% x
P5,000,000 = P 600,000
4,000,000= 480,000
3,000,000 = 360,000
2,000,000 = 240,000
1,000,000= 120,000
The issue price is computed as follows:
Due Date
12/31/22
12/31/23
12/31/24
12/31/25
12/31/26
_
Periodic
Total
Principal
Principal
Duce
1,000,000
Interest
Due
600,000
andInterest
Due
1,600,000
1,000,000
1,000,000
1,000,000
1,000,000
480,000
1,480,000
360,000
1,360,000
240,000
1,240,000
120,000
1,120,000
Total present value (issue price)
Present
Value
Factor at
10%
0.90909
0.82645
Present
value of
Principal
and Interest
1,454,544
1,223,146
0.75131
1,021,782
0.62092
695,430
0.68301
)
846,932
5,241,633 |
326
be8} CamScanner
CamScanner
Chapter 5 -Financial Liabilities
The amortization
presented below.
table
using
the
effective interest
method
is
Bond Premium Amortization Table
Effective Interest Method — Serial Bonds
an
(A)
(B)
(C)
Effective
Interest
Nominal
Date
Interest
Previous (D) —
(A) — (B)
1,000,000-(C)
_|
01/01/22
12/31/22
|12/31/23
-aatiae
12/31/25
12/31/26
600,000 _
480,000 _ 2
360,000
240,000
120,000
924,183
416, 602 _
310,262_
205,288_
101, 817
|
75,817
63,398
49,738
34,712
18,169*
|
end
Amortization |
(D)
om
Carrying value,
Premium
10% x
Previous
~
|
5,241,834
4,166,017
3,102,619
2,052, 881
1,018,169
a
*Adjusted; The difference is due to rounding off.
The following are the entries for 2022 and 2023:
2022
Jan. 1
Cash
0,241,834
Bonds Payable
5,000,000
Premium on Bonds Payable
Issuance of serial bonds.
241,834
Dec, 31 Interest Expense
524,183
Premium on Bonds Payable
Cash
Peniodic interest
73,817
600,000
31 Bonds Payabie
Cash
First instaliment on principal
1,000,000
1,000,000
2023
Dec, 31 Interest Expense
416,602
63,398
Premium on Bonds Payable
Cash
480,000
Periodic interest
1,000,000
31 Bonds Payable
Cash
1,000,000
Second installment on principal
327
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
The issuer shall prepare similar entries for years 2024
2026.
On
December
31,
after
2026,
recording
the
last
throug,
installmen
payment on the bond liability, both the bonds payable account and th,
related premium
shall have been brought to zero balances.
OPTION TO MEASURE A FINANCIAL LIABILITY
AT FAIR VALUE THROUGH PROFIT OR LOSS
An entity may, at initial recognition, irrevocably designate financial liability at fair value through profit or loss when doing so
results in a more relevant information because (a) it either eliminates or
significantly reduces a measurement or recognition inconsistency or (b}
a group of financial liabilities or financial assets and financial liabilities
is managed and the group’s performance is evaluated on a fair value
basis (par. 4.2.2, IFRS 9)
When an entity elects the fair value option through profit or loss,
it shall record as expense the transaction costs it incurs at the initial
recognition of the financial liability. If the liabilities’ fair value is not
readily determinable at the reporting date, an entity can approximate its
fair value by discounting the remaining future cash flows at the
reporting date using the market interest rate on that date. The entity
using the fair value measurement shall recognize the unrealized gain or
loss in profit-or loss.
TROUBLED-DEBT
RESTRUCTURING
During periods of depressed economic conditions, some debtors
experience difficulty in meeting their maturing obligations. For this
reason, the creditor may grant concession to the debtor that it woulc
not otherwise grant under normal conditions.
referred to as a troubled-debt restructuring.
This
concession
Is
An entity shall derecognize a financial liability (or a part of 4
financial liability) when, and only when, it is extinguished, 1.e., when
the obligation specified in the contract expires or is discharged 01
cancelled.
There are three forms of troubled-debt restructuring
Ds
Bi
3.
Asset swap
Equity swap
Modification of debt terms
328
be8} CamScanner
CamScanner
Chapter 5 ~— Financial Liabilities
settlement of Debt by Transfer of Assets (or Asset Swap
)
A transfer of non-cash assets (real estate,
assets) can be used to settle a debt obligation
restructuring.
The
fnancial liability (or
receivables or other
in a troubled debt
difference between the carrying amount of a
part of a financial liability) extinguished or
transferred to another party and the consideration paid (which is the
carrying value of the non-cash asset transferred) shall be recognized in
proit or loss.
Any
resulting
gain
or loss
does
not
necessarily
result
from the restructure of the debt only.
For a more meaningful financial
statement presentation, separate profit or loss accounts may be shown
for the gain or loss on the disposal of the asset and the gain on debt
restructuring. The difference between the fair value of the asset and its
carrying value is the gain or loss on disposal of the asset, while the
excess of the
carrying
value
of the debt at the date of restructure
over
the fair value of the asset is the gain on debt restructuring.
CV ofthe debt
>
FV
J
of the
i
asset
>
or
<
CV
of
the
asset
]
(Gain on debt restructuring) (Gain or loss on exchange of asset)
I
+
I
(Total amount taken to P and L)
Assume
the following information:
Manila
Bank loaned P10,000,000 to ABC Realty which was
invested in real estate development.
Due to economic downtrend in the
real estate business, the company had low sales and therefore, cannot
meet its loan obligations.
On
December
31, 2022,
the loan’s due date,
Manila Bank agrees to accept from ABC Realty a piece of land with fair
value of P9,000,000 in full settlement of the P10,000,000 principal and
one-year accrued interest at 12% (or P1,200,000). The land has a
carrying value, in ABC Realty’s books of P10,500,000, based on the cost
model.
ABC Realty records the transaction as follows:
Notes Payable - Manila Bank
Interest Payable
Loss on Disposal of Land
Gain on Debt Restructurinj g
10,000,000
1,200,000
1,500,000
200:0,000
2,20
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
I
Carrying value of debt settled
Fair market value of asset transferred
ane
2 VYY YO
—2,200,000
Gain on debt restructuring
9,000,000
Fair market value of land transferred
Carrying value of land transferred
10,500,000
Loss on disposal of land
1,900,000
Meanwhile, Manila Bank records the transaction as follows:
Land
9,000,000
Allowance for Uncollectible Accounts
2,200,000
10,000,000
Notes Recetwvable — ABC Realty
1,200,000
Interest Receivable
The land is recorded by the creditor at its fair value and the loss
is charged to Allowance for Uncollectible Accounts/Notes to reflect the
write off (this amount may also be charged
to a loss account,
Impairment Loss on Receivable, or Bad Debts Expense.
(For more
discussion of impairment of receivable, see Chapter 2 of this series.)
Settlement of Debt by Granting Equity Interest for Equity Swap)
A financially challenged entity may also settle its troubled debt
by issuing its equity instruments. IFRIC Interpretation 19 Extinguishing
Financial Liabilities with Equity Instruments provides guidance on how to
account for settlement of financial liability when the creditor accepts the
The equity
debtor company’s shares or other equity instruments.
instruments issued shall be measured at (in the order of priority)
(a)
the fair value
of the equity
instruments
(share
granted
capital issued;
(b)
Any
the fair value of the financial liability settled.
difference
between
the
fair
value
used
and
the
carrying
value of the financial liability settled is taken to profit or loss.
Assume that Manila Bank (in the preceding example) agreed to
accept ABC Realty’s 180,000 ordinary shares.
ABC Realty’s ordinary
share has a par value of P50 and a fair value of P60.
The
entries to record
this transaction
in the
books
Realty (debtor) and Manila Bank (creditor) are as follows:
of both
ABC
330
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
ABC Realty
Notes Payable ~ Manila Bank
Interest Payable
Gain on Debt Restructuring.
Ordinary Share Capital
Share Premium — Ordinary
10,000,000
1,200,000
~ 400,000
9, 000, 000
1,800,000
Carrying amount of the debt settled
Fair value of the shares issued (180,000 x 60)
Gain on debt restructuring
11,200,000
10,800,000
400,000
Fair value of the shares issued
10,800,000
Par value of the shares issued (180,000 x 50)
Additional paid-in capital
9,000,000
1,800,000
Manila Bank
Investment in ABC Realty Ordinary
Allowance for Bad Debts*
10,800,000
400,000
Notes Receivable —- ABC Realty
Interest Receivable
10,000,000
1,200,000
*may also be charged to an impairment loss account.
Fair value of ordinary shares received
Carrying amount of the receivable restructured
10,800,000
11,200,000
Impairment loss on receivables
Modification of
400,000
Terms
A troubled debt restructuring involving modification
may take the form of one or any combination of the following:
of terms
Reduction of stated interest rate
Reduction of the face amount of the debt
Reduction or condonation of accrued interest
Extension of the maturity date
Moratorium on the payment of interest and/or principal
The derecognition
debt terms
is covered
by
of a financial liability through modification of
3.3.2, IFRS
paragraph
9, which
states
that:
debt
of
r
lende
and
ower
borr
ing
exist
an
een
betw
ange
exch
“An
instruments with substantially different terms shall be accounted for as
an extinguishment
of the
original
liability
and
recognition
of a new
financial liability”.
331
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
The
terms
are substantially different
if the
presen
discounted
value of the cash flows under the new terms, including any fees paid
and 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 (par.
B3.3.6, IFRS 9).
Thus, in determining whether a modification
| qualify for derecognition, the debtor shall compare
amounts:
of the original obligation at the date
the carrying amount
(A)
of debt terms will
the following two
of the restructure; and
the
(B)
present
value
of the
net
cash
of the new
outflow
obligation, discounted using the original effective interest
rate of the old obligation.
If the difference between (A) and (B) is at least 10% of A, the
exchange qualifics as derecognition of the original financial liability and:
creation of a new financial liability.
In such a case, the difference
between
the carrying
amount
of the
old
debt
and
the initial
measurement basis of the new debt shall be taken to profit or loss.
Using the same data, assume that Manila
following modifications on December 31, 2022:
Reduction of
Condonation
Extension of
Reduction of
The
discounted
Bank
to the
agreed
principal from P10,000,000 to P7,000,000;
of accrued interest:
maturity date to December 31, 2026; and
interest rate from 12% to 8%.
amount
of the total future payments
new terms and the gain on debt restructuring are computed
under the
as follows:
Discounted amount of future payments under the new terms:
Present value of the new principal amount
(7,000,000 x 0.63552)
P4,448,640
Present value of the interest payments
(7,000,000 x 8%) x 3.03735)
1,700,916
P6,149,556
Total PV of future payments
|
Carrying amount of the debt restructured
(10,000,000 + 1,200,000)
11,200,000
P5,050,444
Difference
Because
the
difference
of
P5,050,444
is
more
than
10%
of
P11,200,000, the exchange transaction qualifies as derecognition of the
old
financial
liability
(P11,200,000)
and
creation
of
a
new
financial
332
be8} CamScanner
CamScanner
Chapter 5 — Nnanctal Liabilities
liability (P6,149,556). Assume in this example that the market rate of
interest at the date of restructuring was also 12%.
Based on the foregoing computations,
restructuring as follows:
ABC
Notes Payable-Manila Bank
Interest Payable
Restructured Notes Payable
Gain on Debt Restructuring
Realty records the
10,000,000
1,200,000.
6, 149,556
0,050,444
Alternatively, this transaction may also be recorded in a manner
that recognizes discount on the restructured notes, as follows:
Notes Payable-Manila Bank
10,000, 000
Interest Payable
1,200,000
Discount on Restructured Notes Payable
Restructured Notes Payable
Gain on Debt Restructuring
850,444
7,000,000
5,050,444
The discount on restructured notes payable represents the
difference between the total undiscounted future payments and its
present
value.
This
amount
is
amortized
periodically
until
maturity
using the effective interest method.
Face value of note
P7 ,000,000
6,149,556
P_
850,444
Present value of future payments (see above)
Discount on restructured notes payable
Hence,
Realty
for
the
after restructuring,
next
four
years
periodic
are
interest
recorded
as
payments
shown
by ABC
below:
(for
computations, please refer to the following table):
Discount Amortization Table
Effective Interest Method - Restructured Note
—_—_——
Date
12/31/22
12/31/23 |
|_ 12/31/24
| 12/31/25
_ 12/31/26
Interest
Payment
Carrying
Amount of
Interest | Amortization|
Expense | of Discount
Note
Zz
560,000 |
737,946 |
177,946
560,000
560,000
560,000
759,300|
783,216
809,982*
199,300—
223,216
249,982
|
6,149,556
6,327,502
6,526,802
6,750,018
7,000,000
‘Adjusted. The P20 difference is due to rounding off:
333
CamScanner
Chapter 5 — Financial Liabilities
12/31/23
737,946
Interest Expense
177,946
Restructured Notes Payable
560,000
Cash
12/31/24
12/31/25
759,300
Interest Expense
Restructured Notes Payable
199,300
Cash
560,000
Interest Expense
Restructured Notes Payable
783,216
223,216
560,000
Cash
12/31/26
809,982
Interest Expense
Restructured Notes Payable
249,982
Cash
560,000
In addition, the payment of principal is recorded in the usual
manner, which completely extinguishes the debt, as follows:
12/31/26
Restructured Notes Payable
Cash
7,000,000
7,000,000
If the restructuring on December 31, 2022 was recorded by
recognizing discount on restructured notes payable,
the periodic
interest and principal payments would, then, be recorded as follows:
12/31/23
Interest Expense
737,946
Cash
560,000
Discount on Restructured Notes Payable
177,946
12/31/24
Interest Expense
759,300
Cash
560,000
Discount on Restructured Notes Payable
199,300
12/31/25
Interest Expense
783,216
Cash
Discount on Restructured Notes Payable
12/31/26
Restructured Notes Payable
Interest Expense
Cash
260,000
223,216
7,000,000
809, 982
7,560,000
Discount on Restructured Notes Payable
249,982
If at the time of modification, ABC could have borrowed from a
financing institution with an interest rate of 15%, the present value o!
the modified debt is computed as follows:
334
be8} CamScanner
CamScanner
Chapter 5~ Financial Liabilities
Present value of the new principal amount
7,000,000 x 0.57175
Present value of the interest payments
(7,000,000 x 8%) x 2.85498
Total
Carrying value of the debt restructured
Gain on debt restructuring
P4,002,250
1,998,789
P5,601,039
11,200,000
P5,598,961
The new liability is initially recorded following the principle on
initial recognition, that is, at fair value (or present value based on
market rate at the date of initial recognition, which is the date of
restructuring).
If an exchange of debt instruments between the lender and the
borrower is not accounted for as an extinguishment (that is, the terms
are not substantially different), any costs or fees incurred adjust the
carrying amount of the liability and are amortized over the remaining
term of the modified lability (par. B3.3.6, IFRS 9).
In effect, if the difference between the carrying amount of the
original obligation at the date of restructuring and the discounted value
of the cash flow under the new terms is less than 10%, the exchange ts
not to be accounted for as an extinguishment.
Furthermore, any costs
or fees incurred adjust the carrying amount of the liability and are
amortized over the remaining term of the modified liability. In effect, a
new effective interest rate has to be computed.
Using the same data, assume that Manila
31, 2022 agreed to the following modifications:
Bank
on December
Reduction of principal from P10,000,000 to P9,500,000;
Condonation of accrued interest;
Extension of maturity date to December 31, 2026; and
The stated interest rate has been changed to 16%.
The discounted value of the cash flow under the new terms is:
P
Present value of principal (9,500,000 x 0.63552)
6,037,440
4,616,772
P10,654,212
11,200,000
Present value of interest (1,520,000 x 3.03735)
Total present value of the modified terms
Carrying amount of the original obligation
-
Difference
P__ 545,788
The difference is less than
10% of P11,200,000;
shall be recognized on the date of the restructuring.
thus, no gain
The modification of
terms is to be recorded as:
335
be8} CamScanner
CamScanner
Chapter 5 — Financiai Liabilities
10,000,000
Notes Payable
1,200,000
Interest Payable
9,500,000
Restructured Notes Payable
1,700,000
Premium on Restructured Notes Payable
The premium on restructured notes payable shall form part of
the amortized cost of the restructured liability. It shall be amortized to
interest expense over the terms of the modified obligation and the entity
shall compute a new effective interest rate. In the foregoing illustration,
the carrying amount of the restructured debt is P11,200,000.
Alternatively, the restructuring is recorded as follows:
Notes Payable
Interest Payable
10,000,000
1,200,000
a
Restructured Notes Payable
11,200,000
CLASSIFICATION AND PRESENTATION
ON THE FACE OF THE FINANCIAL STATEMENTS
An entity shall present current and non-current assets: and
current and non-current liabilities as separate classifications on. the
face of the financial statements, except when a presentation based on
liquidity provides information that is reliable and more relevant. When
that exception applies, all assets and labilities shall be presented in the
order of hquidity {par. 60, IAS 1 Presentation of Financial Statements}.
Using the guidance in IAS 1, an entity following the current,
non-current classifications for assets and liabilities shall classify each of
its financial liabilities as current based on any of the following critena:
(a)
(b)
it is expected to be settled in the entity’s normal
operating cycle;
it is held primarily for the purpose of being traded:
(c)
it is due
(dl)
reporting period; or
the entity does not have
to
be
settled
within
twelve
months
an unconditional
after
the
right to defer
settlement of the liability for at least twelve months
after
the reporting period.
Accounts
and
trade
notes
payable
are
classified
as
current
liabilities because they are related to the entity’s normal operating cycle.
The portion of long-term notes payable and bonds payable due within
twelve
months
from
the
reporting
date
shall
be
while the portion maturing beyond twelve months
non-current.
classified
as
current
shall be classified as
336
be8} CamScanner
CamScanner
Chapter 5 — Financiai Liabilities
within
twelye
months
from
the
date is generally classified as part of current liabilities.
if at the reporting date, the entity has the right to defer
of the obligation for a period of more than twelve months
date, the hability shall be classified as non-current based-on
-
maturing
——
reporting
However,
settlement
from such
liability
—_—_—
A long-term
item (d) above. The right to postpone the settlement of the obligation
may arise because of refinancing agreement entered into by the
enterprise. Refinancing takes the form of either extending the maturity
date or entering into a borrowing transaction with the same creditor,
proceeds of which will be used to settle the maturing obligation.
The currently maturing obligation shall be reported as noncurrent only if the agreement to refinance is completed on or before the
reporting date.
If the enterprise completes the agreement to refinance
after the reporting
period,
even
before
the issuance
of its financial
statements, it shall classify the maturing obligation as current, because
as of the end of the reporting date, the enterprise does not have the
right to defer the settlement of the hability.
Likewise, if an entity
expects, and has the discretion, to refinance or roll over an obligation
for more than twelve months after the reporting daté under an existing
loan facility, it classifies the obligation as non-current, even if it would
be due within a short penod.
Furthermore, when an entity breaches an undertaking under a
long-term loan agreement on or before the reporting date with the effect
that the liability becomes payable on demand, it shall classify the
liability as current, even if the lender has agreed, after the reporting
period and before the authorization of the financial statements for issue,
nol to demand payment as a consequence of the breach. The liability is
classified as current because, at the reporting date, the entity does not
have an unconditional nght to defer its settlement for at least twelve
months after that date,
However, the liability is classified as non-current if the lender
agreed at or before the reporting date to provide a grace period ending at
least twelve months from that date, within which the entity can rectify
the breach and during which the lender cannot demand
immediate
payment.
To illustrate the foregoing, assume the following independent
situations. After each situation, the disposition for the classification of
each item in the statement of financial position is presented.
The
Statement is dated December 31, 2022.
Case 1.
Dorina, ne. has P4 million of notes payable due June 15,
2023. At December 31, 2022, Dorina signed an agreement
to borrow up to P4 million to refinance the notes payable
on a two-year basis.
The financing agreement called for
337
be8} CamScanner
CamScanner
Chapter 5 -— Financial Liabilities
borrowings not to exceed
75% of the value of the collatera;
Dorina was providing. At the date of issue of the December
31, 2022 financial statements, the value of the collatera,
was P4.8 million and was
not expected
to fall below this
amount.
As of December 31, 2022, the reporting date, Dorina hag
the discretion to defer the settlement of a portion of the
maturing obligation for a period of more than twelve
months.
Thus,
of the
P4
million
notes
payable,
P3,600,000 (which is 75% of P4.8 million) shall be
classified as non-current while the remaining
shall be classified as current liabilities.
Case
2.
P400,000
Dorina, Inc. has P4 million of notes payable due June 15,
2023. At February 15, 2023, Dorina signed an agreement
to borrow up to P4 million to refinance the notes payable
on a long-term basis. The financing agreement called for
borrowings not to exceed 75% of the value of the collateral
Dorina was providing.
The value of the collateral was
P4,8 million and was not expected to fall below this
amount.
The financial statements are authorized for
issuance on March 5, 2023.
On the December
31, 2022
statement
of financial
position, the full amount of P4 million shall be classified
as current liabilities even if the enterprise signed an
agreement to refinance the maturing notes payable on a
long-term basis before the issuance of the 2022 financial
statements. Dorina should classify the full amount asa
current
liability because
as of December
31,
2022,
it has
no unconditional right yet to defer the settlement of the
P4 million. The refinancing of the P4 million is considered
as an event after the reporting period not requiring
adjustment in the financial statements.
This refinancing
after the reporting period, if
qualifies for disclosure in the
considered significant,
notes to the financial
statements.
Case
3.
In
October
2019,
Vivian
Corp.
acquired
a_
special
equipment from Carlo, Inc. by paying P1,000,000 down
and signing a note with a face value of P4,000,000 due
October 2022. Under the terms of the financing agreement,
Virian had the discretion to roll over the obligation for at
least fifteen months.
In October 2022,
management
decided to exercise its discretion to roll over the liability up
to October 31, 2024.
338
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
The
P4,000,000
December
31,
note
2022
is classified
as
non-current.
statement of financial position.
on
The
enterprise
already
exercised
its discretion as the
reporting date (December 31, 2022) to roll over the
obligation. The maturity date of the obligation has been
reset to October 31, 2024, which is 22 months away from
December 31, 2022, the reporting date.
Case 4.
In
October
2019,
Vivian
Corp.
acquired
equipment from
Carlo, inc. by paying P1,000,000 down and signing a note
with a face value of P4,000,000 due October 2022, The
existing loan agreement did not carry a provision to
_refinance.
In October 2022, Vivian was experiencing
financial difficulty and was unable to pay the maturing
obligation.
On February 1, 2023, Carlo had agreed not to
demand payment for at least 12 months as a consequence.
of the breach of payment on the principal of the loan. The
financial statements were authorized for tssue on March
S15: 2023.
The
P4,000,000
note
payable
shall
be
classified
on
Vivian’s December 31, 2022 statement of financial
position as current liabilities. It is classified as current,
because as of December 31, 2022, the entity had no
discretion yet to roll over the obligation for at least twelve
months after that date.
Case 5.
In October 2019, Vivian Corp. acquired equipment from
Cario, Inc. by paying P750,000 down and signing a note
with a face value of P4,000,000 due October 2022. The
existing loan agreement did not carry a provision to
refinance.
In October 2022, Vivian was experiencing
financial difficulty and was unable to pay the maturing
obligation.
On
December
31,
2022,
Carlo
signed
an
agreement.to provide Vivian a grace period of 15 months
from that date, during which pentod, Carlo will not demand
immediate payment in order to give Vivian the chance to
rectify
the
breach.
The financial
statements
were
authorized for issue on March 31, 2023.
In the December 31, 2022 statement of financial position
of Vivian, the P4,000,000 note payable shall be classified
as non-current, because Carlo had agreed not to demand
payment for 15 months from December 31, 2022. Thus,
under the new terms offered by the creditor, Vivian is
given a grace period of 15 months, within which the
creditor could not demand immediate payment.
339
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
Case
On October 1, 2019,
6.
Fortune
Corporation
balance
of the
Vilma Corporation acquired land fror,
by paying
and
down
P1,000,000
signing a note with a face value of P6,000,000 due in
installments of P1,000,000 pilus annual interest on the
principal
at
the
rate
of
10%,
the first
The
installment being dué on September 30, 2020.
existing loan agreement does not carry a provision to
refinance and further states that any fatlure to pay the
required installment and interest will make the full amount
of the loan due and demandabie. Further, the full amount
of the principal and accrued interest shall be subject to
Vilma
As of December 31, 2022,
interest of 10%.
in
behind
months
three
is already
Corporation
payment of the 2022 annual installment and interest.
the
The violation of the debt agreement makes the obligation
due and demandable. The remaining balance of the loan
principal amounting to P5,000,000 plus accrued interest
of P500,000 shall be subject to further interest of 10%,
Thus, the total amount of obligation related to this note
of P5,637,500 which is P5,500,000 + (P5,500,000 x 10%
x 3/12) shall be classified as current habilities.
If the following events occur between the end of the reporting
period and the date the financial statements are authorized for issue, an
entity shall disclose these events as non-adjusting events in the notes to
the financial statements (paragraph 76, JAS 1):
(a)
refinancing on a long-term basis;
(b)
rectification of a breach of long-term loan arrangement;
(c)
the granting by the lender of a period of grace to rectify a
breach of a long-term loan arrangement ending at least
twelve months after the reporting period.
Also, an entity shall describe in the notes to the financial
statements a liability that has been excluded from current liabilities as
a result of refinancing.
Interest
expense
recognized
on
financial
liabilities
shall
form
part of finance cost (or equivalent account) that requires separate line
presentation in the profit or loss section on the face of the statement of
comprehensive income.
340
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
DISCLOSURE
REQUIREMENTS
An entity shall disclose information that enables users of its
of financial
significance
the
evaluate
to
statements.
financial
instruments for its financial position and performance (par, 7, IFRS 7
Financial Instruments:
1,
Disclosures).
For each class of financial liability, an entity shall disclose
(a)
information about the extent and nature of the financial
instruments, including significant terms and conditions
that
may
affect
the
amount,
timing
and certainty
of
future cash flows;
(b)
the accounting policies and methods adopted, including
the criteria for recognition and the basis of measurement
applied.
When
financial
instruments
individually or as
exposure to either
cash flow interest
warrant disclosure
issued
by
an
entity,
either
a class, create a potentially significant
market risk, credit risk, liquidity risk, or
rate msk, the terms and conditions that
include
(a)
the principal, stated face, or other similar amount;
(b)
the date of maturity, expiry, or execution;
(c) early settlement options, including the period in which,
(d)
or date at which, the options can be exercised and the
exercise price ot range of prices;
options to convert the instrument into, or exchange it for,
another financial instrument or some other liability,
including
the
period
in which,
or date
at which,
the
options can be exercised and the conversion or exchange
ratio(s);
(e)
the amount and timing of scheduled future cash receipts
or payments of the: principal amount of the instrument,
including installment repayments and any sinking fund
or similar requirements;
(i
(g)
stated rate or amount of interest or other periodic return
on principal and timing of payments;
collateral pledged;
341
“
i
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
i
(h) in the case of an instrument
denominated in a currency
for which cash flows are
other than the entity’s
functional currency, the currency in which the payments
are required;
(i)
any condition of the instrument or an _ associated
covenant that, if contravened, would significantly alter
any of other terms (for example:
a maximum debt-toequity ratio in a bond covenant that, if contravened,
would make the full principal amount of the bond due
and payable immediately).
For each
class
of financial
liabilities,
such
as bonds,
notes,
about
and loans, an entity shall disclose information
exposure to interest rate nsk, including
|
its
(a) contractual repricing or maturity dates, whichever dates
are earlier; and
(b)
effective interest rates, when applicable.
For each class of financial liabilities, an entity shall disclose
the fair value of that class of financial liabilities in a way that
permits it to be compared with the corresponding
amount in the statement of financial position.
An
entity
shall
disclose
the
carrying
amount
carrying
of financial
assets pledged as collateral for liabilities, the carrying
amount
of financial
assets
pledged
as
collateral
for
contingent liabilities, and any material terms and conditions
relating to assets pledged as collateral.
if an entity has issued an instrument that contains both a
liability and an equity component and the instrument has
multiple embedded derivative features whose values are
interdependent
(such
as
aé callable
convertible
debt
instrument), it shall disclose the existence of those features
and the effective interest rate on the liability component
(excluding any
separately).
embedded
derivatives
that
are
accounted
for
An entity shall disclose material items of income, expense,
and gains and losses resulting from financial liabilities. For
this purpose, the disclosure shall include at least the total
interest
expense
(calculated
method) for financial
through profit or loss.
liabilities
using
that
the
effective
are
not
at
interest
fair
value
342
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
Q
With
fund
respect to any
or redemption
defaults of principal, interest, sinking
provision during the period on loans
payable recognized as at the reporting date, and any other
breaches
during the period of loan agreements when
those
breaches can permit the lender to demand payment (except
for breaches
terms
that are remedied, or in response to which the
of the loan
are renegotiated,
on or before the balance
sheet date), an entity shall disclose
:
(a) details of those breaches;
(b) the amount recognized as at the balance sheet date in
respect
of the
occurred;
(c) with
the
Sample Presentation
to
amounts
the default has
loans
financial
payable
on
which
the
breaches
and
respect
whether
loans
payable
disclosed
been
under
remedied
renegotiated
(b)
above,
or the terms
before
the
date
of
the
statements were authorized for issue.
in the Financial Statements
A portion of the comparative Consolidated Financial Statements
of NGO Corporation as of December 31, 2022, is presented below.
In millions of pesos
/
2021
2022
PHP
As Revised |
PHP
Current Liabilities
120
93]
Current portion of long-term debt
Short-term borrowings
50
627
Other financial liabilities
Accounts payable
Accrucd expenses and other habilities
547
5,101
5.360
425
4,950 |
8 504
Provisions
3,600
2,916
Non-current liabilities
18
9
Liabilities under pension plan __
Deferred tax liabilities
2022
2021,
437221
__ 3668
—_§,567
sd‘ 890
__—_3;244
Other payables
Provisions
17,472 |
5.43213
2
Financial liabilities
15,709
20
oe
Total non-current liabilities
__ 4543
|
1.012 |
3.234
21,208 ___17, 826
343
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
KEY TERMS
Amortized
cost.
The
USED
amount
IN THIS CHAPTER
at which
the
financial
asset
or financia]
liability
is measured
at initial
recognition
minus _ principal
repayments, plus or minus the cumulative amortization using the
effective interest method of any difference bctween that initial!
amount and the maturity amount,
and minus
any reduction
(directly or through the use of an allowance account) for impairment
or uncollectibility (paragraph 9, JAS 39).
Asset swap. A debt restructuring scheme where the debtor transfers its
non-cash assets (real estate, receivables, or other assets) to the
creditor to settle its obligation.
Accounts payable. Also called trade accounts payable.
These are
liabilities arising from the purchase of goods, materials, supplies, or
services on an open charge-account basis.
Bearer bond. Also called coupon
bond,
which
does
not require
registering the name of the owner. The periodic interest is paid to
whoever holds the bonds since each bond is accompanied by
coupons representing period interest payments covering the life of
the issue.
Bond certificates. These are evidences of indebtedness issued by a
company or gavernment agency guarantecing payment of a principal
al a specified future date plus periodic interest.
Bond discount. It is the difference between the face value and the sales
price when bonds are sold below their face value.
Bond
indenture.
It is a contract
between
the
issuing
entity
and
the
bondholders specifying the terms, mghts and obligations of the
contracting parties.
Bond issuance costs.
These are expenditures incurred by the issuer
for legal services, printing and engraving, taxes and underwriting in
connection with the sale of a bond.
It is the difference between the face value and the
Bond premium.
sales price when bonds are sold above their face value.
Bonds payable. A liability account initially recognized upon issuance of
bonds,
Callable bond. A kind of bond that gives the issuing company the right
to call or retire the debt before maturity date, usually specified on
the bond indenture.
Chattel mortgage bond. A bond
property like motor vehicles.
Collateral
trust
bond.
A bond
secured
secured
by
by
a lien
shares
against
movable
of stocks' or bonds
held by the issuing company as investments,
Compound financial instrument. A financial instrument
both a hability component and an equity component.
that contains
344
be8} CamScanner
CamScanner
Chap
5 ~t
Fie
nanc
r
ial Liabilities
Constructive obligation. An obligation that derives from an entity’s
actions where: (a) by an established pattern of past practice,
published policies or a sufficiently specific current statement, the
entity has indicated to other parties that it will accept certain
responsibilities; and (b) as a result, the entity has created a valid
expectation on the part of those other parties that it will discharge
those responsibilities (paragraph 10, JAS 37).
Convertible bond.
A financial instrument that pives the holder the
right to convert its bondholding into ordinary shares or other
securities of the issuing company within a specified period.
Current liability.
A liability that satisfies any of the following criteria:
(a) is expected to be settled in the normal course of the entity’s
operating cycle; (b) is due or expected to be settled within 12 months
after the reporting period; (c) is held primarily for the purpose of
being traded; and (d) the entity, as of the end of the reporting period,
does not have unconditional right to defer settlement for at least
twelve months after the reporting period (paragraph 69, IAS 1).
Debenture bond. Unsecured bond that is not protected by the pledge
of any specific asset and is generally issued based on the credit
rating of the company
since
this is backed
only by the issuer's
favorable credit standing.
Debt securities. Financial instruments
issued by a company that
typically have the following characteristics: (1) a maturity value, (2)
an interest rate (either fixed or variable) that specifies the periodic
interest payments, and (3) a maturity date,
Debt restructuring. The granting of a concession by the creditor to the
debtor that it would not otherwise grant under normal conditions.
The debt restructuring may take the form of an asset swap, equity
swap or a modification of terms.
This is the
Effective interest rate. Also called market rate or yield.
interest rate which investors are willing to accept on a bond at the
time of issue that depends on some factors such as the market
evaluation of the quality of the bond issue evidenced by the entity’s
financial strength, its earnings prospects, and specific provisions of
the bond issue.
Effective interest method. An amortization method that provides for
recognition of a constant interest rate based on the changing bond
carrying value.
Equity swap. A debt restructuring scheme where the debtor issues its
share capital to the creditor to settle its obligation.
The amount that will be paid on a bond at the maturity
Face value.
date; also called par value or maturity value.
Financial instrument. Any contract thai gives rise to a financial asset
of one entity and a financial liability or equity instrument of another
entity.
345
be8} CamScanner
CamScanner
Chapter
5 — Financial
Liabilities
Financial liability. A contractual obligation to deliver cash or another
financial asset to another entity or to exchange financial assets oy
financial liabilities with another entity under conditions that are
potentially unfavorable to the entity; also a contract that will or may
be settled in the entity’s own equity instruments and is either a nonfor which
derivative
the
entity
may
be
number of its own equity instruments
obliged
to
deliver a variable
or a derivative that will be
settled by cash or exchange of another financial asset for a fixed
number of the entity’s own equity instruments (paragraph 11, IAS
32).
Legal obligation. Obligation that derives from: {a) a contract (through
its explicit or implicit terms); (b) legislation; or (c) other operation of
law (paragraph 10, IAS 37).
Liability. A present obligation of an entity to transfer an economic
resource as a result of past events (New Conceptual Framework,
2018).
Nominal interest rate. Also termed as contract rate or stated rate.
This is the rate stated on the face of the bond that generally depends
on the financial condition and earnings of the issuing corporation.
Obligations which fail to meet any one of the
Non-current liabilities.
a company’s
liabilities;
current
as
for classification
criteria
obligations not expected to be paid within twelve months after the
reporting period, and obligations not expected to be settled within
the entity’s normal operating cycle and those not held mainly for
trading purposes and those in which the entity, as of the end of the
reporting period,
has
discretion
to refinance
or roll over for a period
of more than twelve months from that date.
Notes payable. Obligation evidenced by a promissory note to pay a
certain sum of money to the bearer at a designated future time. The
promissory notes may arise out of either a trade situation (purchase
of goods or services on credit) or the borrowing of money from a
bank, or other transactions.
a legal or constructive
An event that creates
event.
Obligating
obligation that results in an entity having no realistic alternative to
settling that obligation.
Obligation. A duty or responsibility that the entity has no practical
ability to avoid (New Conceptual Framework, 2018).
The average length of time necessary for an entity to
Operating cycle.
convert cash to inventory, inventory to receivables, and receivables
back to cash.
Probable
loss.
A contingent
loss
based
on
the
occurrence
event or events that are likely to occur.
Provision. A liability of uncertain timing or amount
37).
Real
estate
mortgage
bond.
A bond
secured
by
of a future
(paragraph
10, IAS
a lien against real
property (immovable property like land and buildings)
company.
of the issuing
|
346
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
registered bend.
of the issuing
Bond whose
corporation.
owner’s name is registered in the books
When sold, the original certificate is
cancelled and a.new certificate is issued and registered in the name
of the new bondholder.
restructuring.
It is a programme
that is planned
and controlled by
management,
and materially changes either (a) the scope of a
business undertaken by an entity; or (b) the manner in which the
business is conducted (paragraph 10, IAS 37).
gecured bond.
Bond
that provides security and protection to investors
in the form of specific assets of the issuer.
gerial bond. Itisa kind of bond that matures in installments,
term bond. It is a kind of bond that matures on a single date.
Zero interest bond. Also called deep-discount bond. This is issued at
a significantly lower amount than its face value.
The total interest
for the entire term of the bond
with the principal amount.
is payable on maturity date together
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
CHAPTER
SUMMARY
A liability is a present obligation of an entity to transfer an
economic resource as a result of past events. An obligation is a
duty or responsibility that the entity has no practical ability to
avoid. An economic resource is a right that has the potential to
produce economic benefits.
An entity’s obligation may arise from a legal obligation or a
A legal obligation derives from a
constructive obligation.
contract, legislation, or other operation of law.
A constructive
obligation derives from an enterprise’s actions whereby an
established pattern of past practice, published policies or a
sufficiently specific current statement,
the enterprise has
indicated
to
other
parties
that
it
will
accept.
certain
responsibilities; and as a result, the enterprise has created a
valid expectation on the part of those other parties that it will
discharge those responsibilities.
A financial liability is recognized when an entity becomes a party
to the contractual provisions of the financial instrument, that is
the entity becomes obligated to transfer an economic resource,
based on the terms of the financial instrument.
Financial liabilities are initially measured at fair value.
In the
case of financial liabilities that are to be subsequently measured
at amortized cost, transaction costs are considered in their
initial measurement.
Except for financial liabilities that are measured at fair value,
financial liabilities are subsequently measured at amortized cost,
being the discounted value of the future net cash flows that are
expected to be required to settle the obligation, using an imputed
interest rate.
Financial liabilities include accounts payable,
bonds payable.
notes payable and
Accounts payable arise from purchase of goods or services in the
normal course of business.
Accounts payable are initially
measured
at the transaction price,
considering
the cash
discounts offered by the supplier.
The purchase may be
recorded following either the gross method (discount is recorded
when taken) or the net method (discount is recorded when not
taken): Adjustments are made under both methods depending
on given circumstance at yearend.
348
-_
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
Notes
payable
promissory
are
note
or
financial
liabilities
accepted
time
evidenced
draft.
They
by
are
issued
initially
measured at transaction price, which is the amount of cas
h
received, the fair value of non-cash asset or Services. received, or
if such fair value is not reliably determinable at an amount
discounted based on imputed interest rate, which generally, is
the market rate at date of issue. Notes payable are measured at
amortized cost using the effective interest method.
Notes
are interest-bearing or non-interest bearing.
The
amortized cost of interest-bearing notes is the face plus accrued
interest.
amortized
cost
rate
at
considers
date
the
of
issuance,
balance
of
its
the
subsequent
discount
or
premium.
A bond
is a certificate
of long-term
indebtedness.
A bond
is
considered a public financial instrument, because it is required
to be registered with the Securities and Exchange Commission.
——
market
exe tsi
LL
the
o
from
If a note bears an interest rate significantly different
Bonds are of several types. Secured bonds have specific assets
of the issuer pledged or mortgaged as collateral. Unsecured. or
debenture bonds are not protected by specific assets of the
issuing corporation but backed only by the issuer’s strong credit
Term bonds are scheduled for maturity on one single
rating.
Serial bonds mature in series of installment payments.
date.
Bonds issued in the registered names and addresses of
bondholders are called registered bonds, while bonds whose
interest and principal are payable to whoever hold them are
called coupon bonds or bearer bonds. Convertible bonds can be
exchanged for a fixed or determimable number of ordinary shares
of the issuing corporation at the option of the bondholders.
Callable bonds
can be retired at a stated amount before maturi
date at the option of the issuing corporation.
Bonds
are
transaction
initially
costs
measured
incurred.
Any
at
issue
excess
price
and
of Issue price,
net
net
of
of
transaction costs, over the face value of the bonds is recorded as
premium on bonds payable and any excess is charged to
Over the life of the bonds, the
discount on bonds payable.
premium or discount is amortized and adjusted to interest
expense, using the effective interest method, thus measuring the
bonds at amortized cost. This measurement basis also requires
the accrual of interest at yearend, if applicable.
349
be8} CamScanner
CamScanner
5 r- Pinanctal Liahilities
Chapte
If bonds are retired before maturity date, the diflerence between
the updated carrying amount of the bonds and the retirement
Any
price is recorded as gain or loss on retirement of bonds.
from the most
accrued interest on the date of retirement
If bonds are
previous interest date is paid to the bondholders.
retired on maturity date, the carrying amount of the bonds is
of premium or
equal to the face value as the full amount
Thus, no gain or loss ig
discount shall have been amortized.
recognized upon retirement on matunity date.
debt
When
instruments
such
instruments contain an equity component,
financial
compound
be
to
considered
are
Examples are convertible bonds and bonds issued
instruments.
The issue price of such an instrument
with share warrants.
The
equity components.
shall be split into its debt and
bifurcation shall be made using the residual approach, the
market value of the debt without the equity characteristic shall
be the deemed
issue
price of the debt
the
component;
remainder
of the issue price (the residual amount) is the amount assigned
In a similar manner, the retirement
to the equity component.
price of a compound financial instrument shall be split into the
retirement price of the debt and the retirement price of the
‘The market price of the
equity following the residual approach.
Any gain or
debt shall be considered at the date of retirement.
loss on the retirement of the debt shall be taken to profit or loss.
Any gain or loss on the retirement of the equity component shall
remain in equity.
A
troubled
creditor
to
debt
the
restructuring
debtor,
that
is
a
it would
concession
not
granted
otherwise
grant,
by
the
under
normal circumstances.
Troubled debt restructuring takes the
form of any of the following:
asset swap,
equity swap or
modification of terms.
In asset swap, the creditor accepts noncash asscts of the debtor in settlement of the debtor’s troubled
obligation. Any difference between the carrying value of the debt
and the carrying value of the asset transferred shall be taken to
profit or loss.
When
equity shares are issued by the debtor to settle an overdue
obligation (equity swap), the transaction is measured at the fair
value of the equity instrument issued. If such fair value is not
reliably measurable, the fair value of the financial liability settled
shall be used.
Any
difference
between
the
fair value
used
and
the carrying value of the debt shall be taken to profit or loss.
350
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
When
the
modified,
terms
and
comparison
conditions
must
be
of
made
the
old
between
obligation
the
are
carrying
amount of the old obligation and the present value of the cash
outflows
of the
modified
obligation to determine
whether the
change in terms would qualify for derecognition of financial
liability. If the difference between the carrying value of the old
obligation at the date of restructure and the discounted present
value of the cash outflows of the modified obligation (discounted
at the historical interest rate) is at least 10% of the carrying
value of the original obligation, the terms are considered to be
substantially
different,
and
the transaction
is accounted
for as'
derecognition of the original obligation and recognition of a new
obligation. Any difference between the carrying value of the old
debt and the initial measurement
taken to profit or loss.
basis
of the modified debt is
Enterprises present assets and liabilities in the statement. of
financial position using current and non-current classification,
unless the management assesses that presentation based on
liquidity is more useful and relevant to the users. Entities
classifying assets and liabilities into current and non-current
shall present
a financial liability as current‘when it satisfies any
(a) it is expected to be settled in the
of the following criteria:
entity’s normal operating cycle; (b) it is held primarily for the
purpose of being traded; (c) it is due to be settled within twelve
months after the reporting period; or (d) ‘the entity does not have
an unconditional right to defer settlement of the liability for at
least twelve months alter the reporting period. All other labilities
not meeting any one of the criteria are classified as non-current.
The enterprise
shall present in its financial statements all the
required disclosures related to financial habilities.
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
QUESTIONS
DISCUSSION
What
lL.
are liabilities?
What
are the essential characteristics of
liabilities?
2.
What
are
financial
liabilities?
Give
examples
of
financia]
liabilities.
Which of the following are financial liabilities?
3.
Accounts payable
Notes payable
Unearned revenues
a.
b.
C.
Gift certificates outstanding
Income tax payable
Deferred tax liability
d.
e.
f.
g.
Provision for product warranties
h.
1,
jk,
1.
Bonds payable
Mortgage payable
Salaries payable
Share dividends distnbutable
Property dividends payable
A,
Discuss the initial recognition principle for financial liabilities.
5.
Discuss
the
methods
of accounting
for
cash
discounts
in the
books of the buyer of goods or services. How shall each of these
methods affect the measurement of the accounts payable at the
reporting date?
6.
How shall an entity account for interest-bearing notes? What is
their amortized cost at the reporting date?
7.
How
shall
an
entity
account
for
a non-interest-bearing
note?
What is its amortized cost at the reporting date?
8.
Discuss the accounting principles
bearing an unrealistic interest rate.
9.
What are bonds?
of bonds?
10.
and
procedures
for
notes
State the characteristics of the different types
How is a bond price calculated, given the prevailing market rate
of similar instruments? When is a bond issued at face value? At
less than face value? At more than face value?
352
CamScanner
Chapter 5 - Financial Liabilities
I.
What are bond issue costs?
the bond issue costs?
12.
How does the premium amortization
and the carrying value of the bond?
12.
How does the discount amortization affect the nominal interest
|
|
and the carrying value of the bond?
)3.
What
14,
Describe the accounting
with share warrants.
15.
What are convertible
convertible bonds?
16.
Discuss the accounting for the issuance of convertible bonds.
\7,
What
18.
When
would
a rnodification
of debt terms qualify as a
derecognition of the old financial liability and recognition of a
new financial liability?
19,
How does an entity present
statement of financial position?
20.
Give at least five (5) disclosures that are presented in the notes
are
detachable
share
How
should an entity account for
affect the nominal
warrants?
interest
Why. do corporations
issue bonds with detachable share warrants?
is a troubled
debt
entries involved in the issue of bonds
bonds?
Why
do
corporations
restructuring? What
issue
are the different
ways of restructuring a troubled debt? Describe each briefly.
its
financial
liabilities
in
its
to the financial statements relating to financial habilities.
353
be8} CamScanner
CamScanner
Chapter § — Financial Liabilities
PROBLEMS
Jefferson Corporation completed the following transactions
December 2022:
5-1.
Dec. 16
Purchased
P66,000,
merchandise
terms 2/10,
from
n/30;
FOB
jj,
Company.
Intel
shipping point,
Intel Company prepaid the freight of P1,400.
Corporation,
P72,000.
19
Received goods from Celeron
terms: 3/10, 2/15, n/30.
26
Paid the account with Intel Company in full.
31
Paid the account with Celeron Corporation in full.
REQUIRED:
(a)
(b)
Record the foregoing transactions tn the books of Jefferson
Corporation using the
(1) gross method of recording purchases.
(2) nei method of recording purchases.
Give
the necessary
adjustment
on December
31
assuming
that Jefferson uses the net method and assuming that the
account with Celeron is still unpaid on December 31.
Washington Company’s accounts payable on December 31, 2022
totaled P1,000,000 before any necessary year-end adjustments
relating to the following transactions and information:
e
On December 27, 2022, Washington wrote and issued
The issuance of the
checks to creditors totaling P350,000.
checks was recorded on January 3, 2023.
e
On December 28, 2022, Washington purchased and received
goods with invoice price of P150,000, terms 2/10, n/30.
Washington records purchases and accounts payable at net
amounts. The invoice was recorded and paid on January 3.
2023.
e
Goods
shipped
on
December
20,
2022
from
a vendor
to
Washington under terms F.O.B destination were received on
January 2, 2023.
The invoice cost was P65,000. The
purchase was recorded on January 2, 2023.
354
be8} CamScanner
CamScanner
Chapter 5 ~ Financial Liabilities
«
Goods costing P120,000 were purchased from NYC Tradin
g.
The goods were shipped on December 28, 2022, terms
shipping point.
On January 4, 2023,
the goods together with the invoice.
e
F.O.B.
Washington
received
The accounts payable general ledger balance of P1,000,000
is net of P80,000 debit balance in one supplier’s account
representing deposit on goods to be delivered in February
2023.
REQUIRED:
What amount
should Washington Company
accounts payable on December 31, 2022?
The
balance
in Adams
December 31, 2022 was
Company’s
P1,500,000
report
as
total
accounts payable
before considering
on
the
following:
e
Goods shipped FOB shipping point on December 20, 2022
from a vendor to Adams were lost 1n transit. Adams did not
record
the
invoice
cost of P240,000.
On January
6, 2023,
Adams filed a P240,000 claim against the common carrier.
e
On
December
27,
2022,
a
vendor
authorized
Adams
to
return, for full credit goods shipped and billed at P80,000 on
December 2, 2022. Adams shipped the returned goods on
December 27, 2022. A credit memo for P80,000 was received
and recorded by Adams on January 6, 2023.
should
Adams
Company
report
as
total accounts
payable on December 31, 2022?
4.
On May 1, 2022, the Madison Company purchased two new
company automobiles from Ford. Motors Corporation. The terms
of the sale called for Madison to pay P3,924,000 on Apmi 30,
2023.
Madison gave the seller a non-interest-bearing note for
iy, il
ell
amount
IMO
What
ay, tl,
REQUIRED:
this amount. At the date of purchase, the interest rate for shortterm loans of this type was 9%.
REQUIRED:
(a)
(b)
Give the journal entries
2022 and April 30, 2023.
on May
:
1, 2022,
December
31,
the
on
n
ow
sh
be
e
bl
ya
Pa
s
te
No
the
ld
ou
At what amount sh
355
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
31,
December
2022
statement
of
condition
of financial
Madison Company?
9-5.
On
1, 2022,
June
P3,000,000
10%.
Corporation
the Monroe
non-interest-bearing
with
note
its own
discounted
First
the
Bank
at
The note is due on May 31, 2023.
REQUIRED:
Give the journal
(a)
entries
on June
December 31,
J], 2022,
2022 and May 31, 2023.
Determine
31, 2022:
(b)
9-6.
the carrying
value
of the liability on December
On May 1, 2022, the Unison Company purchased a special type
of equipment from Taylor Corporation issuing a 9%, interest
bearing note for P8,000,000 due April 30,
established cash price for this equipment.
2023.
There
is no
REQUIRED:
Give
the entries
on May
1, 2022,
December
31,
2022
(year-end
adjustment), and April 30, 2023 and determine the carrying value
of the liability on December 31, 2022, assuming that
(a)
(b)
the market rate of interest for a note of this type is 5%,
the market rate of interest for a note of this type is 12%.
On April
1, 2022,
the KFC
Delivery Service issued a P9,000,000
non-interest-bearing note due March 31, 2025 for a piece of land
with a cash price of P6,949,800.
REQUIRED:
(a)
Determine the effective interest rate of this note.
(b)
Prepare a table of discount
the note.
(c)
Determine the interest expense for the year ended
December 31, 2022 and the carrying amount of the note at
December 31, 2022.
amortization
over the term of
356
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
(ei)
Prepare
the
necessary
entries for years
2025 relative to the foregoing,
at year-end, December 31.
:g,
2022
through
including any adjustments
On May 1, 2022, the JFC Company issued a 9% promissory note
with face value of P6,949,800, for a piece of land. The principal
and interest, compounded annually, are due on April 30; 2023.
REQUIRED:
(a)
Compute the interest expense for 2022, 2023, and 2024.
(b)
At what
amount
accrued
interest,
should
be
the notes payable, inclusive of
shown
on
December
31,
2023
statement of financtal position?
(c)
How will the Notes Payable and the Interest Payable be
shown on December 31, 2023 statement of financiai
position?
position?
{d)
5-9,
On
December
31, 2024
statement of financial
Prepare entries relating to the foregoing for years 2022
through 2025. (Prepare adjusting entries only at year-end,
December 31)
On April 1, 2022, the Wendy's Catering Service purchased three
units of baking equipment by issuing a four-year, non-interest
bearing, P3,200,000
note.
The note is payable in annual
installments of P800,000. The first installment is due on March
There was no equivalent cash
31, 2023.
equipment and the note had no ready market.
interest rate for a note of this type is 9%.
price for the
The prevailing
REQUIRED:
(a)
+10,
At what amount
2022?
should the note be recorded on April l,
(b)
Prepare an amortization table using the effective interest
method.
fe)
Prepare entries for years 2022 through 2026 relating to
the note, including any necessary adjustment at December
31 of each year.
On October 1, 2022, the Burgee’s Food Corporation purchased
three units
of baking
equipment
by issuing a four-year,
9%
357
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
promissory
note
with
face
value
The
of P2,591,760.
note
and
accrued interest are payable in equal amounts of P800,000 every
The penodic
September 30, starting September 30, 2023.
payment of P800,000 is to be applied first to interest, and the
remainder to the principal.
The accounting period of the company is the calendar year.
REQUIRED:
(a)
Prepare an amortization table over the term of the note.
(b)
Prepare entries for years 2022 through 2026 as a result of
the foregoing.
(c)
What amount relating to the note shall be presented as
current
liabilities and
mnon-current
labilities
on the
December 31, 2023 statement of financial position?
o-11.
Ruby Corp. is authorized to issue P5,000,000 of 5-year bonds
dated June 30, 2022 with a stated interest rate of 10%. Interest
on the bonds is payable semi-annually on June
30 and
December 31. The company uses the effective interest method of
amortization. The bonds were sold to yield (a) 8%; (b) 12%.
REQUIRED:
Complete the table that follows.
a)
8%
b)
Bond issue price
Nominal interest for 2022
Interest expense (Effective interest) for 2022
Premium /discount amortization in 2022
|
Bond carrying value at December 31, 2022
|
12%
Nominal] interest for 2023
Interest Expense for 2023
Premium /discount amortization in 2023
Bond carrying value at December 31, 2023
5-12.
On
March
1,
2022,
Fire
Company
issued
P4,000,000
of
10%
bonds to yield 8%. Interest is payable semiannually on February
28 and August 31. The bonds mature in 5 years. Fire Company
is a calendar-year corporation.
REQUIRED:
(a)
Determine the issue price of the bonds.
358
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
(b)
Prepare an amortization table for the first two years using
the effective-interest method.
(c)
Prepare journal entries to record bond-related transactions
at the following dates: March 1, 2022; August 31, 2022;
December 31, 2022; and February 28, 2023.
<.13.
On August 1, 2022, the Mercury Corporation issued P5,000,000
8% bonds dated March 1, 2022 and maturing on February 28,
2033, for a total consideration of P4,458,429 which includes
accrued
interest.
The
bonds
pay
interest
annually
every
February 28. The issue price provides a yield of 10%. Mercury
Corporation closes its books annually every December 31.
REQUIRED:
(a)
Prepare all entries in the books of Mercury Corporation for
2022 and 2023, including year-end adjustments.
(b)
How much is interest expense for 2022 and 2023?
(c)
At what amount should the bonds payable
be shown on
the statement of financial position on December 31,
and December 31, 2023?
§-14.
On July
10%,
1, 2022,
7-year
bonds
Metal
with
Corporation
issued
P5,000,000
detachable
share
warrants
at
2022
of its
108.
Each PJ],000 bond carried a detachable share warrant for the
purchase of 2 shares of P100 par value ordinary shares at P140
pershare. The market value of the bonds ex-warrants is 102.
REQUIRED:
5-15.
(a)
Prepare journal entry to record the issuance of bonds with
detachable warrants.
(b)
Prepare journal entry to record the exercise of warrants,
assuming that ail of the warrants were subsequently
exercised.
On March 1, 2022, Onyx issued P1,000,000 of its 10% nonconvertible bonds at 104, due February 28, 2029. Each P1,000
bond was issued with 30 non-detachable share warrants, each
of which entitles the holder to purchase for P40, one ordinary
share of Onyx, par value P25. If sold without the warrants, the
359
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
bonds
would
yield
12%.
The
interest
on
the
bonds
is payable
annually.
REQUIRED:
to the bonds
(a)
Determine the amount assigned
warrants on March 1, 2022.
(b)
Compute the interest expense for 2022.
and
to the
(c)
Compute the carrying value of the bonds on December 31,
2022.
(da)
Journalize the exercise of the warrants
assuming. that all
warrants were exercised on June 30, 2023.
0-16.
On July 1, 2022, the Celeron Company
issued 200,
10%,
P10,000 bonds at 101.
The holder of each bond is entitled to
convert the bond into 80, P100 par ordinary shares of Celeron
Company, at any time up to bond maturity.
When the bonds
were issued, the prevailing market rate for similar instruments
without the conversion option is 12%.
The bonds pay interest
annually at June 30 and mature on June 30, 2027.
On June 30, 2024, after receiving the annual interest, holders of
120 bonds exercised their conversion privilege.
Remaining
bonds were retired on matumty date. The Celeron Company
closes its books annually on June 30.
REQUIRED:
5-17.
(a)
Allocate the proceeds from bond issuance between the
bonds and the equity component (the bond conversion
privilege).
(b}
Prepare an amortization table using the effective interest
method over the term.of the bonds.
{c)
Prepare the entries
through 2025.
relating to the foregoing
during
|
2022
On January 2, 2022, the Lim Corporation issued P5,000,000
interest rate of 8%.
convertible bonds bearing an annual
Interest is payable annually every December 31 and the bonds
|
104,
|
mature
on
December
31,
2026.
The
bonds
were
sold
at
Each P5,000 bond is convertible into 40 ordinary shares of P100
360
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
par.
the
Without
sold to yield
conversion
privilege,
the
bonds
have
would
10%.
On December 31, 2024, after paying the periodic interest,
P1,000,000 of the bonds were converted into ordinary shares.
On December 31, 2025, after paying the periodic interest,
p2,000,000
interest
11%.
for
of the bonds
similar
bonds
were retired at 101.
without
Market
conversion
the
rate of
is
feature
REQUIRED:
(a)
Give the entry to record the issuance of the bonds.
(b)
Prepare
the
entry
to
record
the
periodic
interest
and
discount amortization on December 31, 2023.
9-18,
(c)
Prepare entries to record the periodic interest
conversion of bonds on December 31, 2024.
and
the
(d)
Prepare entries to record the periodic interest and
retirement of the borids on December 31, 2025.
the
(e)
Prepare the entries for the periodic interest
redemption of the bonds on December 31, 2026.
and
the
On December 1, 2022, the Emerald Corporation issued five-year,
for
bonds
12%
value
face
P5,000,000
non-convertible
10%. Interest is payable
a price that yields
P5,386,072,
semiannually on June
1 and December
1.
On August 1, 2025, the Emerald Corporation retired P3,000,000
The accounting
of the bonds at 105 plus accrued interest.
period for the Emerald Corporation is the calendar year.
REQUIRED:
Determine the following:
(a)
Carrying value of the bonds on December 31, 2023 |
(b)
Interest expense for the year ended December 31, 2023
(c)
Carrying value of the bonds retired on August 1, 2024
{d)
Gain or loss on redemption of the bonds on August 1, 2025
fe)
Carrying value of the bonds on December 31, 2025
(f
Interest expense for the years ended December 31, 2025
and 2026
361
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
5-19.
On January 2, 2022, Ohio Company issued P10 million of 12%,
bonds for P12,734,120 due December 31, 2028. Legal and other
costs of P50,000 were incurred in connection with the issue.
Interest on the bonds is payable annually each December 31.
Using a financial calculator, the effective interest rate on these
bonds was computed to be 8%, after considering the bond issue
cost of P50,000.
The bonds are callable at 110, and on December 31, 2025, after
paying the periodic interest, Ohio called P4,000,000 face amount
of the bonds and retired them.
REQUIRED:
5-20.
Determine the following:
(a)
Amortization of the premium for the year ended December
31, 2022
(b)
Carrying value of the bonds on December 31, 2025
(c)
Gain or loss on retirement of the bonds on December 31,
2025
(d)
Interest expense for the year ended December 31, 2026
(e)
Carrying value of the bonds on December 31, 2026
Jim Company issued P4,000,000 of 8 4%, S-year bonds on
March 1, 2022.
Interest payment dates are March 1 and
September 1. With a market interest rate of 9%, the bonds were
Jim Company retired all of the bonds on
sold for P3,926,000.
September 30, 2025 at 101 plus accrued mterest.
REQUIRED:
(a)
What
is the
amount
of interest
expense
and
discount
amortization that Jim will record on September
the first semi-annual interest payment date?
1, 2022,
(b)
What ts the carrying amount of the bonds on the December
31, 2023 statement of financial position, after all year-end
adjustments are made?
(c)
What amount of cash was paid for the retirement of bonds
and payment of accrued interest on September 30, 2025?
(d)
What is the gain or loss on retirement of bonds?
362
be8} CamScanner
CamScanner
Chapter 5 ~ Financial Liabilities
5-21.
Kim Company issued P10,000,000 bonds on bond issue date,
December 31, 2022. The bonds pay interest annually at 8% on
the outstanding bond balance.
The face value of the bonds is
payable in installments of P2,000,000 every December 31,
starting December 31, 2023. The bonds were sold at a price that
yields 12%,
REQUIRED:
(a)
Determine the issue price of the bonds on December 31,
2022.
(b)
Prepare an amortization table using the effective interest
method.
{c)
Prepare
entries in the books of Kim
Company for years
2023 through 2025 related to the bonds.
5-22.
On January 1, 2022, the Blue Sapphire Corporation issued
P8,000,000 bonds. The bonds pay interest annually at 12% on
the outstanding balance. The face value of the bonds is payable
in
installments
of P2,000,000
.December 31, 2022.
8%.
every
December
31,
starting
The bonds were sold at a price that yields
REQUIRED:
(a)
Determine
2022.
the issue price of the
(b)
Prepare an amortization table using the effective interest
method.
(c}
Prepare
the
entries
in
the
books
bonds on January
of the
Blue
1],
Sapphire
Corporation for years 2022 through 20285.
9-23.
For each
of the following independent
situations,
determine
the
gain on debt restructuring and give the entry in the books of the
debtor to record the debt restructuring.
a.
South Company has an overdue note payable to AB
Finance Company with face value of P900,000. Accrued
Because of financial
interest on the note is P90,000.
difficulty, South negotiates with AB Finance Company to
exchange a group of equipment costing P1,000,000 but
These pieces of
with carrying amount of P600,000.
equipment
had
a fair value
of P800,000
in the most
advantageous market.
363
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
Joy
Company
is unable
to meet
interest payments
on its
interest on
bankruptcy,
Accrued
P10,000,000 bonds payable.
In order to prevent
date is P900,000.
this
Joy
entered into an agreement to exchange
ordinary share for
P25
par value ordinary
the debt.
Joy is issuing 300,000,
Capshell
is
shares, which currently scll at P28 on this date.
experiencing
financial
difficulties
and
a
downward trend in its financial performance. The firm is
unable to service its debt and as a result, has missed
payment of the annual interest on its loan from Bank of
Manila. The principal amount of the loan is P10,000,000,
which is already due, with annual interest of 10% payable
annually.
Capshell management has negotiated a modification of its
The creditors agree to the
debt terms with its creditors.
following new terms:
e
e
*
e
Forgive the accrued interest.
Reduce
the principal
amount
of the loan to
P8,000,000.
Extend the payment of principal for two years.
Reduce the interest raie for the remaining two
years to 8%.
Capshell could issue debt with a term of two years ata
coupon rate of 12% based on its current credit rating,
In the latter part of 2022, Solid Company expenenced
severe financial pressure and was in default of meeting
interest and principal payments on notes of P3,000,000.
Accrued interest on this note at December 31,
P330,000 based on annual interest rate of 11%.
Solid obtained an acceptance
the note, as follows:
of a change
2022
in the terms of
e
e
Accrued interest on the note is forgiven.
Maturity date has been extended by five years.
e
Interest
rate
has
been
changed
to
is
12%,
which
1s
the prevailing rate at time
of restructuring.
Interest is payable annually on December 31.
364
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
For
each
of the
following
cases,
determine
the
amount
of the
notes payable reported as current and non-current at December
31, 2022.
Case
I!
Taft, Inc. has P3 million of notes payable due June 15, 2023.
At
December 31, 2022, Taft signed an agreement to borrow up to
P3 million to refinance the notes payable on a long-term basis.
The financing agreement called for borrowings not to exceed 80%
of the value of the collateral Taft was providing.
At the date of
issue of the December 31, 2022 financial statements, the value
of the collateral was
below this amount.
P3.6
million and was
not expected
to fall
Case 2
Taft, Inc. has P2 million of notes payable due June 15, 2023.
At
February 15, 2023, Taft signed an agreement to borrow up to P2
million to refinance the notes payable ona long-term basis. The
financing agreement called for borrowings not to exceed 80% of
the value of the collateral Taft was providing.
The value of the
collateral was P2.4 million and was not expected to fall below
this
amount.
The
issuance on Maren
financial
statements
are
authorized
for
5, 2023.
Case 3
In October
2020, Wilson
Corporation acquired land from
Woodrow, Inc. by paying P1,000,000 down and signing a note
with a maturity value of P6 million due October 31, 2022.
Wilson
has
twelve
months.
exercise
terms
the
Under
Situation A.
the discretion
its
In
the
financing
agreement,
to roll over the obligation for at least
2022,
October
discretion
of
to
extend
management
the
maturity
decides
to
of
its
date
obligation to December 31, 2023,
Under the terms of the financing agreement,
Situation B.
Wilson has the discretion to roll over the obligation for at least
In October 2022 management decides to
twelve months.
exercise its discretion to extend the maturity date of its
obligation to December 31, 2024.
Situation
provision
C.
to
The
existing
refinance.
experiencing financial
maturing obligation.
loan
In
agreement
October
does
2022,
not
carry
Wilson
a
was
difficulty and was unable to pay the
On February 1, 2023, Woodrow has
365
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
agreed not to demand payment for at least 12 months as a
consequence of the breach of payment on the principal of the
The financial statements were authorized for issue on
loan.
March 31, 2023.
The existing loan agreement does not carry a
Situation D.
Wilson was
2022,
In October
provision to refinance.
experiencing financial difficulty and was unable to pay the
On December 31, 2022, Woodrow signed
maturing obligation.
an agreement to provide Wilson a grace period of 15 months
from that date, during which period, Woodrow will not demand
immediate payment in order to give Wilson the chance to rectify
The financial statements were authorized for issue
the breach.
on March
9-20,
31, 2023.
14% note payable issued, October
30, 2023, P2,500,000
16%
balances
account
Included in Harding Company’s liability
December 31, 2022 were the following:
1, 2018,
maturing
at
September
note payable issued October 1, 2022 payable in six equal
semi-annual installments of P800,000 every April 1 and
October 1, beginning April 1, 2025, P4,800,000
Harding’s December
31, 2022
on March 31, 2023.
On March
financial
statements were issued
Harding consummated
10, 2023,
a non-cancelable agreement with the lender to refinance the 14%
note
P2,500,000
on
a long-term
basis,
on
readily
determinable
terms that have not yet been implemented.
REQUIRED:
On the December 31, 2022 statement of financial position, what
amount of the notes payable should Harding classify as current
liabilitiesP (Disregard any amount of accrued tmterest as of
December 31, 2022)
5-26.
At December 31, 2022, Roosevelt Corporation
owed notes
payable of P2,000,000 with a maturity of April 30, 2023.
These
notes did not arise from transactions in the normal course of
business.
On February 1, 2023, Roosevelt issued P4,000,000 of
ten-year bonds with the intention of using part of the bond
proceeds
me.
2023.
to
liquidate
the
P2,000,000
of
notes
payable.
2022 financial statements were issued on March 29,
be8} CamScanner
CamScanner
Ch
_5 — Financial
ities
REQUIRED:
How much of the P2,000,000 notes payable should be classified
as current liabilities in Roosevelt’s statement of financial position
at December 31, 2022?
367
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
MULTIPLE
MC1
QUESTIONS
Which of the following is an essential characteristic of a liability?
I,
I].
II.
IV.
a.
b.
C.
d.
MC2
CHOICE
It is a present obligation that requires settlement by
probable future transfer or use of cash, goods or services.
The liability must be an unavoidable obligation.
The transaction or other event creating the obligation
must have already occurred.
a_ specifically
to
settled
be
must
obligation
The
identifiable party.
I,
I,
II,
I,
I, UI, and IV
ll, and IV
IW, and IV
II, and II]
A company borrowed cash from a bank and issued to the bank a
bank
The
payable.
note
non-interest-bearing
short-term
discounted the note at 10% and remitted the proceeds to the
Which of the following statements is true?
company.
a.
The effective interest rate is equal
to the stated discount
rate of 10%.
b.
Cc.
d.
stated
the
than
effective interest rate is more
The
discount rate of 10%.
The effective interest rate is less than the stated discount
rate of 10%.
The effective interest rate cannot be determined from the
information given.
Which of the following shall generally be classified as current
even if they are due to be settled more than twelve months after
the end of the reporting period?
Roop
MC3
MC4
Bonds Payable
Trade Payables and Accrued Operating Expenses
Notes Payable to Bank
Deferred Revenues
On August 1, 2022, ABC Company borrowed cash
one-year interest-bearing note on which both the
interest are payable on August 1, 2023.
How
payable and the accrued interest be classified in
of financial position at December 31, 2022?
and signed a
principal and
will the note
the statement
368
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
Boop
Note Pavable
Current liability
MC6
Non-current liability
Current liability
Current lability
Current liability
Non-current liability
Not presented
Bonds maturing on a single date are called
aoop
MC9
Accrued Interest
Non-current liability
callable bonds.
debenture bonds.
serial bonds.
term bonds.
Bonds payable should be initially recognized at
issue
price
minus
transaction
A. 9
entity.
issue price.
MC7
ee
b.
MC8
Bonds
PSP
Se
by
the
recognized
on
issue price plus accrued interest.
face value.
expense
effective interest rate, considering the Issue
transaction costs.
nominal interest rate.
rate stated on the face of the bonds.
market rate of interest on the reporting date.
bearing
face value.
MC9
incurred
|
For accounting purposes, the interest
bonds payable should be based on the
a.
costs
an interest rate of 8%
were
price
issued above their
This implies that the market interest rate
at date of issue is equal to 8%.
at date of issue is higher than 8%.
at date of issue is lower than 8%.
at the reporting date is higher than 8%,
How should the issue price of bonds with non-detachable
warrants be accounted for?
a.
b.
and
share
The proceeds are fully assigned to bonds.
The proceeds shall be assigned first to the warrants, at
their market value and the remainder to the bonds.
369
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
The proceeds shall be assigned first to the bonds, at their
market value if sold without the warrants; then the
remainder of the issue price is assigned to the warrants
as part of equity.
The proceeds shall be allocated to the bonds and to the
warrants based on relative fair values.
MC10
Sun Corporation markets a 10-year bond issue dated January 1,
The bonds pay interest semi-annually on January 1 and
2022.
July 1. If these bonds are sold on August 1, 2022, how many
accrued
months
over how
many
must
interest
months
would
be
paid
discount
any
and
purchaser
the
by
on
the bonds be
amortized?
Amortization period
Months of accrued interest
of
aC
MC11
120 months
113 months
120 months
113months
7
7
1
1
Under the effective interest method
of amortizing bond premium
ao
on term bonds,
interest
interest
interest
interest
expense remains the same for each period.
rate varies from period to period.
expense increases each period.
expense decreases each period.
RosD
issued
proceeds from a bond
MC12:°The
warrants should be accounted for
MC13
b.
C.
d
detachable
alate
entirely as bonds payable.
entirely as shareholders’ equity.
partly as unearned revenue and partly as bonds payable.
partly as liability for the bonds payable and partly as
shareholders’ equity for the warrants.
Bond premium
position
a.
with
|
should be reported in the statement of financial
along with other
resulting from stock
as a deferred credit.
as a direct addition
as a deduction from
premium accounts
transactions.
such
as_
those
to the face amount of the bonds,
the face amount of the bonds.
370
be8} CamScanner
CamScanner
Chapter
44
-
How would
5 — Financial Liabilities
the carrying amount of the bonds be affected by the
amortization of each of the following?
a.
b.
C,
d.
Discount
No effect
Increase
Premium
No effect
No effect
Increase
Decrease
Decrease
Increase
(AICPA Adapted)
4ic15 Bonds with face value of P5.0 million carrying a stated interest
rate of 12% payable semiannually on March
were issued on July 1.
amounted to P5,200,000.
1 and September
1
The total proceeds from the issue
The best explanation for the excess
amount received over the face value is that
a
b.
c
d.
the bonds were sold at a premium.
the bonds bear an interest rate Jower than the market
rate of interest at the date of bond issuance.
the bonds were issued at face value plus accrued
interest.
the bonds were sold at a discount plus accrued interest.
MC16 An entity uses
the
calendar year
as its reporting period.
When
o Pp
ao
the interest payment dates of a bond issue are March 1 and
September 1, and the bond is issued on May 1, the amount of
interest expense during the year of issuance would be for
MC17
ten months.
eight months.
six months.
five months.
In theory, the proceeds from the sale of a bond will equal to the
a
b.
c,
d,
face amount of the bond.
present value of the principal amount due at the end of
the life of the bond plus the present value of the interest
payments made during the life of the bond.
face amount of the bond plus the present value of the
interest payments during the life of the bond.
sum of the face amount of the bond and the periodic
interest payments.
371
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
MC18
When
a.
b.
a corporation issues a callable bond,
this means
that the
investor may convert bonds held to cash at his or he,
option.
issuer may retire the bonds by paying a specified cal
price during a specified period.
issuer may retire the bonds by paying a specified market
price at the open market at any point in the life of the
bond.
|
issuer may convert the bonds to some form of equity
security during a specified period.
MC19
Under the effective interest method of bond discount or premium
amortization, the periodic interest expense is equal to the
a.
stated (nominal)
value of bonds.
D:
effective (yield) rate
value of the bonds.
C.
stated rate multiplied by the beginning-of-period carrying
amount of the bonds.
effective
rate
multiplied
by
the
beginning-of-period
carrying amount of the bonds.
d.
MC20
of interest
of
interest
multiplicd
multiplied
by
the face
by
the
face
ABC Company failed to amortize discount on outstanding 10What is the effect of the failure to record
year bonds payable.
amortization on interest expense, profit and bond carrying value,
respectively?
a.
b.
Understate, overstate, understate
Overstate, understate, overstate
C.
Understate, overstate, overstate
re
Mc21
rate
Overstate,
understate, understate
The market price of a bond issued at a premium
is the present
value of its principal amount at the effective rate of interest
a.
b.
plus the present value of all future interest payments
the effective rate of interest.
at
plus the present value of all future interest payments at
the stated rate of interest on the bond.
minus the present value of all future interest payments
at the effective rate of interest.
plus the total amount of all future interest payments.
372
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
Which
of
is
statements
following
the
regarding
imcorrect
troubled debt restructuring?
In
a modification
of terms,
when
the
total
discounted
—— a
a.
profit
or
loss
if the
discounted
present
value of the new terms is at least 10% different from the
carrying value of the old obligation.
Any difference between the ‘carrying value of the debt
settled
and
the
carrying
value
of the asset
——_——_
.
in
-
recognized
<<
cash flows under the new terms exceed the carrying
value of the debt, a gain on debt restructuring is
—
——_——_
MC22
transferred
shall be taken to profit or loss during the period of the
debt settlement.
In debt restructuring where shares of
are granted to settle an obligation,
carrying value of the debt settled over
shares issued shall be taken to profit
period of debt settlement.
In a modification of terms, the debtor
equity instruments
the excess of the
the fair value of the
or loss during the
recognizes interest
expense after the debt restructuring based on the interest
rate of the old debt.
MC23
The Hoover Company’s accounts payable balance at December
31, 2022 was P540,000 before the year-end adjustments relating
to the following information:
a,
Goods with an invoice cost of P30,000 were in transit from
the vendor to Hoover on December 31, 2022. The goods
were shipped FOB shipping point on December 29, 2022
and were received on January 3, 2023. Hoover recorded
the purchase when it received the invoice on January 3,
2023.
Goods with an invoice cost of P15,000, which were shipped
FOB shipping point on December 22, 2022, from a vendor
to Hoover, were lost in transit.
On January 4, 2023,
Hoever filed a P15,000 claim against the transportation
company. Hoover recorded the purchase when it received
the invoice on December 26, 2022,
Goods with an invoice cost of P9,000, which were shipped
FOB destination from a vendor to Hoover were received on
January 5, 2023. Hoover also received and recorded the
invoice on that date.
373
be8} CamScanner
CamScanner
Chapter 5 — Financial Liabilities
What amount should Hoover report as accounts payable on its
statement of financial position as of December 31, 2022?
a.
b.
Cc.
d.
MC24
MC25
P555,000
P564,000
P570,000
P585,000
The effective interest on a 12-month zero-interest-bearing
payable of P300,000, discounted at the bank at 10% is
a.
11.11%
b.
10.87%
Cc,
d.
10.00%
9.09%
On
January
1, 2022,
Las Vegas
Company
purchased a
specialized machinery with a cash equivalent price of P59,737.
Las Vegas signed a deferred payment contract that calls for
P10,000 down payment and a 3-year note for P49,737. The note
is payable in 3 equal annual payments of P20,000 beginning
December 31, 2022. The annual payment includes 10% interest.
How much is the (1) interest expense
December 31, 2022 and the (2) carrying
payable on December 31, 2022?
MC26
note
for the
amount
year ended
of the note
a.
b.
(1) Interest expense
P4,974
P4974
(2) Carrying amount
P34,711
P44,711
C.
P5,974
P34,711
d.
PS,974
P44,711
On January 1, 2022, the Dolce Corporation issued a three-year,
non-interest bearing note with face value of P3,000,000 for a
piece of land purchased from Jardine Corporation. The note is
payable in annual installments of P1,000,000 every December
31, starting on December 31, 2022. The land has an equivalent
cash price of P2,400,000, a price that provides the note an
effective interest rate of 12%,
How much is the interest expense for the year ending December
31, 2022?
a.
b.
Cc)
d.
P360,000
P288,000
P240,000
P168,000
374
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
MC27
Use
the
same
information
given
in MC26,
How
much
of the
Notes Payable, net of discount, should be reported as part of
current liabilities on December 31, 2022 statement of financial
position?
‘A.
b.
C;
d.
MC28
P1,000,000
P 890,560
P 805,120
P 797,440
Use the same information given in MC26. What is the balance of
the Discount on Notes Payable on December 31, 2022?
a.
b.
Ci
d.
MC29
P240,000
P3 12,000
P360,000
P432,Q000
The statement of financial
December 31, 2022 showed,
under its habilities section:
°>
position of Denver Company at
among others, the following items
10% mortgage bond due P500,000 annually
beginning October 1, 2023
«
12% convertible bonds, due on June 30, 2025
e
(Each P1,000 bond is convertible into 10, P100
par ordinary shares}
10% collateral trust bonds due on July 16, 2024
hoop
How much are Denver Company’s
serial bonds, respectively?
MC30
total
debenture
P2,000,000
1,500,000
3,000,000
bonds
and
P4,500,000 and P2,000,000
P1,500,000 and P2,000,000
P1,300,000 and P3,000,000
PO and P2,000,000
On January 1, 2022, Alabama, Inc. issued 10-year bonds with a
face amount of Pl million and a stated interest rate of 8%
payable annually on January 1. The bonds were priced to yield
10%. Present value factors are as follows:
Present value of P] for 10 periods
Present value of an ordinary annuity
,
of P] for 10 periods
~AtLB%
At 10%
0.46319
0.38554
6.71008
6.14457
375
CamScanner
Chapter 5 — Financial Liabilities
The total issue price (rounded to nearest P100) of the bonds was
a.
b.
Cc
d
MC31
P1,000,000.
P 980,000.
P 965,800.
P 877,100.
following information pertains to San
The
1, 2022,
issuance of bonds on July
— P10,000,000;
Face amount
rate — 8%;
Interest
Francisco Company's
payment
Term
— 10 years;
dates
— July
Stated
1] and
interest
January
1;
Effective yield — 12%.
4%
PV
PV
PV
PV
of
of
of
of
an ordinary annuity
an ordinary annuity
a single arnount of 1]
a single amount of |
of 1
of 1
for
for
for
for
10
20
8.11
13.59
0.68
0.46
10 penods
20 penods
penods
periods
8%
PV
PV
PV
PV
of
of
of
of
What
a,
hb.
Si
d.
MC32
an ordinary annuity
an ordinary annuity
a single amount of 1
a single amount of |]
should
of 1
of ]
for
for
7.36
11.47
0.56
0.31
12%
6.71
9.82
0.46
0.21
for 10 penods
for 20 penods
10 penods
20 penods
be the issue price for each
6%
P1,000
6.14
8.51
0:56
Q.31
bond?
P 659,60
P 768.80
P] 229.40
P1,340.40
On July 1, 2022, Florida Corporation issued at 97 plus accrued
The bonds are dated
interest, 2,000 of its 10%, P1,000 bonds.
Interest is payable
April 1, 2022 and mature on April 1, 2030.
semi-annually on April 1 and October 1.
From
a.
b.
cC.
d.
MC33
the bond
issuance,
Florida would
receive net cash of
P1,990,000.
P1,965,000.
P1,940,000.
P1,890,000.
On May 1, 2022, Manny Company issued P2 million, 20-year,
10% bonds for P2,120,000. Each P1,000 bond had a detachable
warrant eligible for the purchase of one share of Manny’s P50
par ordinary share for P60. Immediately after the bonds were
issued, Manny's securities had the following unit fair values:
376
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
10% Bond without warrant
Warrant
P1,040
20
Ordinary Share, P50 par
56
What amount should Manny
payable on May 1, 2022?
a.
b.
c.
d.
credit
to
premium
on
bonds
P120,000
P 80,000
P 40,000
PO
On December 31, 2021, the liability section of Texas Company’s
statement of financial position included bonds payable of P10
of
payable
on bonds
premium
wunamortized
million and
Further verification revealed that these bonds were
P180,000.
issued on December 31, 2019 and will become due on December
Interest
31, 2029,
December 31.
at
12%
is
payable
On April 1, 2022, Texas retired P4,000,000
plus accrued interest.
every
June
and
30
of these bonds at 97
How much was the total amount of cash paid for the retirement
of bonds on April 1, 2029?
a.
b.
Cc.
d.
P3,950,000
P4,000,000
P4,040,000
P4,180,000
MC35 In the statement of financial position of Magnolia,
December 31, 2021, the following accounts appear:
18% Bonds Payable, due January 1, 2023
Premium on Bonds
Payable
as
of
P1,000,000
70,000
Accrued Interest on Bonds Payable
Interest is payable semi-annually on January
January 1, 2022,
accrued interest.
Inc.
90,000
1 and July 1.
On
Magnolia, Inc. redeemed the bonds at 96 plus
How much is the gain (or loss) on the redemption of the bonds?
a
P 40,000
b. —- P_ (40,000)
Cc. — P 110,000
d. —-—- P(1 10,000)
377
be8} CamScanner
CamScanner
Chapter 5 -— Financial Liabilities
MC36
Michigan, Inc. issued P1 million, 12%, 20-year bonds at log
plus accrued interest on February 1, 2022. The bonds are dated
January 1, 2022 and pay interest semi-annually every June 3()
and December 31].
Transaction costs totaled P50,000.
How
interest on
much
accrued
the bends
shall
Michigan
collect
the
initial
California, Inc. had ouistanding 10%, Pl million face
convertible bonds maturing on December 31, 2024 on
value,
which
from the investor on February 1?
a.
b.
C.
d.
MC37
Use
P10,000
P20,000
P30,000
P50,000
the
same
information
given
in
carrying amount of the bonds on February
1, 2022?
P 950,000
P 970,000
P1,000,000
P1,020,000
a.
b.
Ci
d.
MC88&
is
what
MC36,
interest is paid on June 30 and December 31.
After
amortization
through
June
30,
2022,
balance in the bond discount account was
premium
from
bond
conversion
privilege
the
unamortized
P30,000.
had
a
The share
balance
of
On that date, all of these bonds were converted into
P50,000.
40,000 ordinary shares with P20 par value. At that time, each
share of California ordinary share capital sells for P23. California
incurred
expenses
of P10,000 in connection
with the conversion.
The conversion of the bonds to ordinary shares shall result to an
increase in share premium by
a.
b.
C.
d.
MC39
P160,000
P170,000
P1i80,000
P210,000
Recording the
Use the same information given in MC38._
conversion in accordance with current financial reporting
standards, California should record gain on conversion of
a.
b.
Ce
P60,000
P50,000
P40,000
d.
PO
378
be8} CamScanner
CamScanner
Chapter 5Fi
~ nancial Liabilittes
mc40
On
July
1, 2022,
Madison
Company
a.
b.
c.
d.
expense
for the
six months
for
ended
P61,973
P60,000
P51,644
P50,000
Use the same information given in MC4O0.
At what amount
should Madison report the bond liability on December 31, 2022?
a.
b.
C.
d.
MC42
P1,032,880
P1,000,000 face amount, 12% bonds, a price that yields 10%.
How much is the interest
December 31, 2022?
MC41
received
P1,024,524
P],031,236
P1,032,880
P}],041,236
On January
1, 2022,
London
Company
issued its 9% P2 million
bonds, which mature on January 1, 2028.
The bonds were
issued for P1,878,000 to yield 10% resulting in a bond discount
of P122,000.
Interest is payable annually on December 31.
What is the
2022?
a.
b.
Ci
d.
MC43
carrying
amount
of the bonds
on
December
31,
P1,885,800
P1,896,000
P1,896,780
P1,898,000
On January
1, 2022, when
the market rate for bond interest was
12%, Victoria Corporation issued P10 million face amount of
bonds with interest to be paid semi-annually at a 10% annual
rate every June 30 and December 31.
December
31,
P1,145,000.
2028
and
were
‘The bonds mature on
issued
at
a
discount
of
- How much is the increase in the carrying amount of the bond
hability from January 1 to June 30, 2022?
a.
b.
€.
d.
P 11,450
P 31,300
P 57,250
P696,667
379
a
.
i.
arm
be8} CamScanner
CamScanner
a
Chapter 5 — Financial Liabilities
MC44
Nevada, Inc. issued a P5,000,000, 10%, 10-year bonds on July |
1, 2022 for 113.6 when the effective interest rate was By, |
Interest is payable on June 30 and December 31.
How much interest expense should Nevada
loss for the year ended December 31, 2022?
a.
MC45
report
in profit
9;
P284,000
b.
P250,000
c
d
P227,200
P200,000
Fresh
Company
value
bond.
The
|
has
outstanding
bond
was
originally
interest. On June 30, 2021, the
outstanding bond was P2,100,000.
What
10-year,
7%,
amount of unamortized
P2,000,000: facg:
sold to yield
carrying
premium
6% annua}
amount
of the
on bond should Fresh
report in its June 30, 2022 statement of financial position?
a.
b.
Cc.
d,
MC46
On
P 86,000
P114,000
P126,000
P140,000
January
1, 2022,
Gell
Company
received
P1,032,880. for
P1,000,000 face amount, 12% bonds, a price that yields 10%.
Interest is payable semi-annually every June 30 and December
31.
Interest expense for the year ended
al.
b.
Cc.
d.
MC47
December 31, 2022 is
P123,946.
P120,000.
P103,288.
P102,870.
On December 31, 2021, Bell Co. issued P2,000,000, 8% senial
bonds, to be repaid in the amount of P400,000 each year.
Interest is payable annually
on December 31.
The bonds were issued to yield
10% a year.
The bond proceeds
were P1,902,800 based on the present values at December 3],
2021 of the five annual payments as follows:
380
CamScanner
Chapter 5 — Financial Liabilities
Due Date
12/31/22
Principal Due
400,000
12/31/23
12/31/24
12/31/25
12/31/26
Present Value at
_Interest Due
160,000
400,000
400,000
400,000
400,000
12/31/21
P 509,000
128,000
96,000
64,000
32,000
436,100
372,500
316,900
268,300
P1,902,800
In its December 31, 2022 statement of financial position, at what
amount should Bell report the carrying amount of the bonds?
a,
b.
C.
d.
MC48
P1,393,800
P1,491,000
P1,502,800
P1,533,080
On December 31, 2022, Columbia Company shows the following
data with respect to its matured obligation.
Notes Payable
Accrued Interest Payable
9,000,000
900,000
The company
is threatened with a court suit if it could not pay
its maturing
debt.
Accordingly,
the company
enters into an
agreement with the creditor for the transfer of a non-cash asset
in full settlement of the mortgage.
The agreement provides for
the transfer of real estate carried in the books of Columbia
P3,000,000.
The real estate has a current fair value
P4,500,000.
at
of
What total amount should Columbia recognize in profit or loss
for the year 2022 as a result of this transaction?
a.
b.
C.
d.
MC49
P
500,000
P1,000,000
P1,500,000
P2,500,000
On December 31, 2022, Guimaras Corporation is experiencing
extreme financial pressure and is in default in meeting interest
payment on its long-term note of P6,000,000 due on December
31, 2022.
The interest rate is 10% payable every December 31.
381
be8} CamScanner
CamScanner
Chapter 5 -— Financial Liabilities
Corporation
In an agreement with the creditor, Guimaras
obtained the following changes in the terms of the note:
e
e
e
The accrued interest of P600,000 on December 31, 2022 i,
forgiven.
The new interest rate is 12%, which approximates the
prevailing rate of interest for similar obligation at the time of
the restructuring.
The new date of matunty is December 31, 2027.
What is Guimaras Corporation’s gain on debt restructuring?
(Round of present value factors to three decimal points}
a.
b.
C.
d.
MCSO0
P1,032,.720
P 602,400
P
151,200
P O
On December 31, 2022. Guimary Corporation is experiencing
extreme financial pressure and is in default in meeting interest
payment
31, 2022.
on
its long-term
note
of P6,000,000
due
December
on
The interest rate is 10% payable every December 3].
Corporation
Guimary
the creditor,
with
agreement
In an
obtained the following changes in the terms of the note:
e
»
e
°
The accrued interest of
forgiven.
The principal is reduced
The new interest rate is
The new date of maturity
Ai the time of restructunng,
What
MCs]
is Guimary
a.
P1,979,180
b.
C:
d.
P],600,000
P1 223,020
PO
P600,000
on
December
31,
2022 is
by Pi,000,000.
12%.
is December
the market
31, 2027,
rate of interest was 10%.
Corporation's gain on debt restructuring?
Down Company has an overdue Notes Payable to City Bank of
P8,000,000.and recorded accrued interest of P640,000, based on
8% interest rate. (This rate of interest is presumed
market rate at the time of debt restructuring)
to be the
382
be8} CamScanner
CamScanner
Chapter 5 - Financial Liabilities
As a result of a settlement on December 31, 2022, City Bank
agreed to the following restructuring arrangement:
Reduced the principal obligation to P6,000,000.
Forgave the P640,000 accrued interest.
Extended the maturity date to December 31, 2024.
Annual
interest
of 10%
is to be paid on December
and 2024.
The
market
31, 2023
|
rate of interest for similar debt on December
31,
2022 is 8%.
What is Down Company’s gain on debt restructuring?
off present value factors to four decimal points)
MC52
el.
P2,640,000
b.
°;
d.
P2 426,220
P1,440,000
PO
(Round
|
Distress Corporation has an overdue Notes Payable to Country
Finance
with
face amount
of P10,000,000
and accrued interest
on December 31, 2022 of P1,000,000 based on 10% interest
Because of financial difficulty, Distress offered Country
rate.
to seitle the obligation by issuing 150,000 shares of its
Finance
ordinary share capital.
the market value on
accepted the offer.
Following
the
The par value of each share is P50 and
Country Finance
this date is P65.
interpretations
in
IFRIC
19
Extinguishing
Financial Liabilities with Equity Instruments, what amount
should Distress include in profit or loss for the year 2022 as a
result of the settlement of the obligation?
a.
PO
b.
P1,250,000
C.
P2,500,000
d.
P3,500,000
be8} CamScanner
CamScanner
Chapter 5 - Financtal Liabilities
Belo Company had a P4.0 M note payable due March 15, 202,
Belo Company expects, and has the discretion and intention »,
refinance the obligation for fifteen months from its due date
How should Belo classify
financial statements?
a.
b.
ap
MCS3
the
note
in
its
December
31,
202)
As a current liability with separate disclosure of the not
refinancing
As a non-current liability with separate disclosure of the
note refinancing
As a current liability with no separate disclosure required
As a non-current liability with no separate disclosure
required
384
be8} CamScanner
CamScanner