CHAPTER 1 FINANCIAL LIABILITIES Debt Financing – increase shareholder’s equity NATURE OF LIABILITIES 1. Present Obligation 2. Past event 3. Transfer of an economic resources Obligation – Duty or responsibility that cannot be avoided Legal Obligation – Law 1. Accounts Payable 2. Withholding Taxes Payable 3. VAT Payable Constructive Obligation – Contracts Pattern of Past Practice Publish Policies Specific Current Statement NOTE* Must be explicit 1. Provision for Clean-up Cost NOTE* Mere Contract cannot create Liability, need all Categories to exist Present Obligation 1. 2. 3. 4. 5. Payment of Cash Transfer of Asset Provision of Service Replacement of an Obligation with another obligation Conversion of the Obligation to Equity (e.g. Convertible Bonds) Can be settle by condonation of creditor NOTE* No need to know the identity to have obligation IAS 32 - FINANCIAL LIABILITIES Contractual Obligation a. To deliver cash or transfer financial asset Accounts Payable Notes Payable Bonds Payable Mortgage Payable b. Exchange Financial Asset or Financial Liabilities to another entity under potentially unfavorable Conditions Contractual obligation c. Settled in equity instruments and non-derivative settled by own equity instruments d. Settled in equity instruments and derivate settled by financial assets for own equity instrument Initial Recognition - @ fair value or transaction price or amortized cost the transaction cost Subsequent Measurement = amortized cost NOTE* only when become party of contractual provisions ACCOUNTING FOR SPECIFIC FINANCIAL LIABILITES Accounts Payable Or trade Accounts Payable - open charge account basis (30-120 days) w/ no interest NOTE* Shall recognized accounts for goods in transit FOB shipping point Liability for Goods purchased under FOB destination Classified as A/P 1. 2. 3. 4. Received Invoice Goods in Transit (FOB shipping point) Debit Balance in Supplier’s Account Claims (Goods lost in transit – FOB shipping point) Not Classified as A/P 1. Goods in Transit (FOB destination) Deducted in A/P 1. Post-dated Check 2. Credit Memo for Goods returned Methods of Accounting for Cash Discounts Gross Method Periodic Inventory System Purchase and A/P @ gross invoice price Perpetual Inventory System Net Method Periodic Inventory System Purchase and A/P @ invoice price – cash discount Balance of Account – Finance Cost Upon purchase Purchases Freight in A/P Upon Payment on Discount Date Upon Payment after Discount Date @ year-end not yet paid but under discount period @ year-end discount lapse but not yet paid Upon Payment on Discount Date next year Gross Method xxx xxx xxx Purchase Freight in A/P Account Payable xxx Purchase Discount Cash Account Payable xxx Cash Allow. for Purchase Dis Purchase Discount xxx xxx xxx Net Method xxx xxx xxx Gross Price – purchase discount Account Payable xxx Cash xxx Account Payable xxx Purchase Discount Lost xxx Cash xxx xxx xxx Purchase Discount Loss xxx A/P xxx Account Payable xxx Purchase Discount Cash xxx xxx Accounts Payable Purchase Discount Payment of A/P Beg. Bal Debit Purchase or Purchase on Account NOTE* Net method > Gross Method, because of recognition of finance cost (Purchase Discount Loss) Notes Payable Note Bearing a Realistic Interest Rate Initial Measurement = @ fair value Long-term Notes – Principal and Interest are Payable Periodically Market rate = effective rate Due Date A Principal Due B Interest Due C Total Amount Due 1 End of the Year 1 End of the Year 2 End of the term/year of the Note 2 3 xxx Full amount x stated interest rate A1 + B1 xxx (Full amount of the note – Principal Due year 1) x stated interest rate (Full amount of the note – Principal Due Year 1 and 2) x stated interest rate A2 + B2 xxx A3 + B3 Long-term Notes – Principal Matures in Lump Sum, Interest is Payable Periodically - Lump sum meaning One payment Acquisition Payment Interest Accrued Long-term Notes – Principal and Interest are Payable Periodically Asset xxx N/P xxx Notes Payable xxx Cash xxx Long-term Notes – Principal Matures in Lump Sum, Interest is Payable Periodically Asset xxx N/P Notes Payable xxx Cash xxx Based on table Interest Expense xxx Cash xxx Interest Expense xxx Interest Payable xxx Only on maturity date Interest Expense xxx Cash xxx Interest Expense xxx Interest Payable xxx Note Bearing an Unrealistic Interest Rate 1. Market rate is NOT equal to stated rate 2. Fair Value is NOT equal to Face Value Total Future Cash Outflow = Principal + Interest PV of the Note = Total Future Cash Outflow x PV factor Same as A/R Acquisition Accrued or Year-end Interest Date Payment Short-Term Notes Stated Rate > Market Rate Asset xxx N/P xxx Premium on N/P xxx Interest Expense xxx Premium on N/P xxx Interest Payable xxx Same as A/R: may use amort table Premium on N/P xxx Interest Expense xxx Notes Payable xxx Interest Payable xxx Interest expense xxx Cash xxx Stated Rate < Market Rate Asset xxx Discount on N/P xxx Premium on N/P xxx Interest Expense xxx Interest Payable xxx Discount on N/P xxx Same as A/R: may use amort table Notes Payable Interest expense Cash xxx xxx xxx The Carrying Value of Notes Payable = Notes Payable + Premium + Interest Payable Long-Term Notes with Unrealistic Interest Rate - Bonds Payable Non-interest-Bearing Note Same concept in receivable Same computation of receivable with proper journal entry based on liabilities NOTE: If FV CANNOT be Determined o Measured @ Market rate Discounting the Notes To record Interest Short-term Non-Interest-Bearing Note Cash xxx Discount on N/P xxx N/P xxx Discount on N/P = face value x discount rate Cash = Face value – discount Interest Expense xxx Interest Payable xxx Discount Or Cash Proceed x effective interest rate Carrying Value Effective interest rate = Discount / Cash Proceed Or Effective Interest Rate = Discount / (1-Discount Rate) Notes Payable – Discount Long-term Note – Maturity Value is Payable in Lump-Sum SAME METHOD AS RECEIVABLE CASE 2 (AMORTIZE TABLE) ***Important NOTE*** PV factor = Cash price / face value of notes Long-term Note – Maturity Value is Payable in Installment SAME METHOD AS RECEIVABLE CASE 3 (AMORTIZE TABLE) ---- ---- ---- ---- ----- -------- ---- ---BONDS PAYABLE Bond Certificate of Indebtedness Sell All Bonds to Investment Firm o A.k.a. Underwriter o Then Resells to Public Or Corp Sell Themselves Bond Indenture o Contract Between Issuing Corporation Bondholder Type of Bonds 1. Term Bonds a. Maturity: Single Date 2. Serial Bonds a. Maturity: Mature in Installments 3. Serial Bonds & Unsecured Bonds a. Secured Bonds i. Protection to Investors in Form of Asset ii. Examples 1. Collateral Trust Bond a. Loan for Share of Stocks 2. Chattel Mortgage Bond a. Loan for Movable Property b. Unsecured Bonds i. A.k.a. Debentures ii. NOT Protected iii. Based on Credit Rating 4. Registered Bonds and Bearer (or Coupon) Bonds a. Registered Bonds i. Registered the Name of the Owner of Bonds in the Book b. Bearer Bonds i. Don’t Record the Name of the Owner ii. Issue w/ Coupon 5. Callable Bonds and Convertible Bonds a. Callable Bonds i. A.k.a. Redeemable Bonds ii. Buyback by the Issuing Company 1. Pay based on Call Provisions b. Convertible Bonds i. Loans for Bonds 1. Can be Exchange the Bonds for Shares 6. Zero-Interest Bonds a. A.k.a. Deep-Discount Bonds i. Issued Lower than FV ii. Who Pays the Interest? 1. The Issuing Company Issuance of Bonds Initially Recorded When o @ the Date of the Actual Issue of Bonds Interest Rate on Bonds o Contract Rate o Stated Rate o Nominal Rate Interest to Issue to Investors o Market rate o Yield Rate o Effective Interest Rate Interest rate to Sell Bonds o is Low If Corp Provide Certainty of Interest and Principal Payments Effective Rate > Stated Rate o Issue Price > Face Amount of Bonds o Discount Deduction to Bonds Example o Quoted Price is Lower than 100% Vice Versa o Premium Adjunct Account Addition to Face Value of Bonds o Quoted Price is Higher than 100% Measured @ Discounted Value or Equal to Net Proceeds Issue Price = FV of Bonds PV of Single Payment of Bonds xxx ADD: PV of Ordinary Annuity of Interest xxx Bond Price xxx Interest = Stated Rate x Bonds Or Bonds @ Quoted Price xxx ADD: Interest Payable xxx Cash Paid xxx Bond Price xxx LESS: Bond Face Value (xxx) Discount or (Premium) xxx Transaction Cost on Issue of Bonds If March 1, Bonds @ Face Value x Stated rate x 2/12 Jan - Feb Expenditures o Bond Issue Costs o Legal Fees o Printing and Engraving of Bonds Certificate o Taxes o Commissions and Similar Charges Issuance of Bonds Cash Bonds Payable Premium on B / P Premium on Bonds Payable Cash Payment of Expenditures xxx xxx xxx xxx xxx Carrying Value of Premium on Bonds Payable = Premium on CV - Expenditures CV of Bonds = Bonds Payable + CV of Premium or – CV of DIscount NOTE: Higher Effective Rate, the Lower the PV and Vise Versa ***Important Note*** How to Get the Effective Interest Rate? Trial and Error Using Different Interest Rate Step 1: Guess 2 rates that will Calculate the CV of the Bonds 1st rate = PV of Bonds that will be Higher than CV of Bonds 2nd Rate = PV of Bonds that will be Lower than CV of Bonds Step 2: Calculate each PV of Bonds PV of Single Payment of Bonds xxx ADD: PV of Ordinary Annuity of Interest xxx Bond Price xxx Interest = Stated Rate x Bonds Step 3: Y = (CV of Bonds – Bonds Price of Higher Rate) / (Bonds Price of Lower Rate – Bonds Price of Higher Rate) Step 4: (Higher Rate – Lower Rate) x Y Step 5: Effective Rate = Higher Rate – Y Premium and Discount Amortization Subsequent Measurement @ Amortized Cost o Initial Measurement – Principal Prepayments + Discount or – Premium Using Effective Interest Method NOTE: Period Interest Payment is NOT Equal to Comple Interest Expense over the Bond’s Life Amortization o Deduction from or Addition to Interest Expense Effective Interest Method Constant Interest Rate Unequal Interest Expense Interest Expense = Bonds Carrying amount @ Beg of Each Period x Effective Interest Rate When Issued @ Premium 1. Interest Expense Decreases Each Period 2. The Bigger the Gap Between Nominal and Effective Interest a. The More Premium on Amortization Increases each Period When Issued @ Discount 1. Interest Expense Increases Each Period 2. The Bigger the Gap Between Nominal and Effective Interest a. The More Discount on Amortization Increases each Period Retirement of Bonds @ Maturity Date Completely Amortized the Discount or Premium NO Gain or Loss Recorded as Payment of Debt as is Settle Before Maturity Redeeming the Bonds or Repurchasing it in Open Market Gain or Loss o Gain = CV of Bonds > Retirement Price o Loss = CV of Bonds < Retirement Price Procedure Before Retirement o Amort of Premium or Discount is Updated on CV of Bonds o Any Accrued Interest Must be Paid Example: Retirement on Oct 31, and Interest Payable on June 30 and Dec 31 Carrying Amount of Bonds xxx LESS: Amortized Premium (xxx) CV of Bonds @ Retirement Date xxx June Oct, Premium on Amort x 4/6 Retired @ Quoted Price + Accrued Interest Retirement Price xxx Bonds Face Value x Quoted Price ADD: Nominal Interest xxx June Oct, Face Value x Nominal Rate x 4/12, if stated Total Cash Paid xxx Retirement Price xxx LESS: CV of Bonds (xxx) Gain on Retirement of Bonds xxx Bond Refunding More Advantage if Company Replace the Bond with Lower Interest Rate Refunding o Replacement of Outstanding Bonds Payable with New Outstanding Means Unpaid or Due How it Works? Must be Recorded Separately o Retirement of Old Bonds With Gain or Loss o Acquisition of New Bonds Bonds With Equity Characteristics Issue Bonds for Creditors o Then Creditors Become Shareholders Dual Set of Righta Given to Creditors o Received Interest and Principal Payment o Purchase Ordinary Share and Appreciation of FV of Shares Attract More Investors Lower Rate and Higher Proceeds Bonds w/ Non-Detachable Share Warrants Issued Bonds with Share Warrant o Bondholder or Creditor has Right to acquire Ordinary Shares Residual Approach o Allocate the Issue Price of Bonds Between Debt or Bonds Equity or Warrant Residue o Amount Assigned to Equity Component Total Issue Price xxx Face Value x Quoted Price w/ Warrants LESS: Market Price of Bonds W/out Warrants (xxx) Face Value x Quoted Price w/out Warrants Price Assigned to Warrants xxx Or Total Issue Price xxx LESS: PV of Principal (xxx) LESS: PV of the Interest (xxx) Price Assigned to Warrants xxx ---- ---- ---- ---- ----- -------- ---- ---Convertible Bonds
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