C H A P T E R

14
NON-CURRENT LIABI LITI ES
This IFRS Supplement provides expanded discussions of accounting guidance under
International Financial Reporting Standards (IFRS) for the topics in Intermediate
Accounting. The discussions are organized according to the chapters in Intermediate
Accounting (13
th
or 14
th
Editions) and therefore can be used to supplement the U.S.
GAAP requirements as presented in the textbook. Assignment material is provided for
each supplement chapter, which can be used to assess and reinforce student under-
standing of IFRS.
EFFECTIVE-INTEREST METHOD
As discussed earlier, by paying more or less at issuance, investors earn a rate different
than the coupon rate on the bond. Recall that the issuing company pays the contractual
interest rate over the term of the bonds but also must pay the face value at maturity.
If the bond is issued at a discount, the amount paid at maturity is more than the issue
amount. If issued at a premium, the company pays less at maturity relative to the issue
price.
The company records this adjustment to the cost as bond interest expense over the
life of the bonds through a process called amortization. Amortization of a discount
increases bond interest expense. Amortization of a premium decreases bond interest
expense.
The required procedure for amortization of a discount or premium is the effective-
interest method (also called present value amortization). Under the effective-interest
method, companies: [1]
1. Compute bond interest expense first by multiplying the carrying value (book value)
of the bonds at the beginning of the period by the effective-interest rate.
1
2. Determine the bond discount or premium amortization next by comparing the bond
interest expense with the interest (cash) to be paid.
Illustration 14-1 depicts graphically the computation of the amortization.
Amortization
Amount
Carrying Value
of Bonds at
Beginning of Period
Effective-
Interest
Rate

Bond Interest Expense
Face Amount
of
Bonds
Stated
Interest
Rate

Bond Interest Paid

==
ILLUSTRATION 14-1
Bond Discount and
Premium Amortization
Computation
1
The carrying value is the face amount minus any unamortized discount or plus any
unamortized premium. The term carrying value is synonymous with book value.
2
The issuance of bonds involves engraving and printing costs, legal and accounting fees,
commissions, promotion costs, and other similar charges. These costs should be recorded as
a reduction to the issue amount of the bond payable and then amortized into expense over
the life of the bond, through an adjustment to the effective-interest rate. [2] For example, if
the face value of the bond is $100,000 and issue costs are $1,000, then the bond payable (net
of the bond issue costs) is recorded at $99,000. Thus, the effective-interest rate will be higher,
based on the reduced carrying value.
Chapter 14 Non-Current Liabilities 141
U.S. GAAP
PERSPECTIVE
Under U.S. GAAP, companies
are permitted to use the
straight-line method of
amortization for bond
discount or premium,
provided that the amount
recorded is not materially
different than that resulting
from effective-interest
amortization. However, the
effective-interest method is
preferred and is generally
used.
The effective-interest method produces a periodic interest expense equal to a con-
stant percentage of the carrying value of the bonds.
2
142 IFRS Supplement
Bonds Issued at a Discount
To illustrate amortization of a discount under the effective-interest method, Evermaster
Corporation issued $100,000 of 8 percent term bonds on January 1, 2011, due on Janu-
ary 1, 2016, with interest payable each July 1 and January 1. Because the investors
required an effective-interest rate of 10 percent, they paid $92,278 for the $100,000 of
bonds, creating a $7,722 discount. Evermaster computes the $7,722 discount as follows.
3
The five-year amortization schedule appears in Illustration 14-3.
SCHEDULE OF BOND DISCOUNT AMORTIZATION
EFFECTIVE-INTEREST METHODSEMIANNUAL INTEREST PAYMENTS
5-YEAR, 8% BONDS SOLD TO YIELD 10%
Carrying
Cash Interest Discount Amount
Date Paid Expense Amortized of Bonds
1/1/11 $ 92,278
7/1/11 $ 4,000
a
$ 4,614
b
$ 614
c
92,892
d
1/1/12 4,000 4,645 645 93,537
7/1/12 4,000 4,677 677 94,214
1/1/13 4,000 4,711 711 94,925
7/1/13 4,000 4,746 746 95,671
1/1/14 4,000 4,783 783 96,454
7/1/14 4,000 4,823 823 97,277
1/1/15 4,000 4,864 864 98,141
7/1/15 4,000 4,907 907 99,048
1/1/16 4,000 4,952 952 100,000
$40,000 $47,722 $7,722
a
$4,000 $100,000 .08 6/12
c
$614 $4,614 $4,000
b
$4,614 $92,278 .10 6/12
d
$92,892 $92,278 $614
ILLUSTRATION 14-3
Bond Discount
Amortization Schedule
Maturity value of bonds payable $100,000
Present value of $100,000 due in 5 years at 10%, interest payable
semiannually ( Table 6-2); FV(PVF
10,5%
); ($100,000 .61391) $61,391
Present value of $4,000 interest payable semiannually for 5 years at
10% annually ( Table 6-4); R(PVF-OA
10,5%
); ($4,000 7.72173) 30,887
Proceeds from sale of bonds (92,278)
Discount on bonds payable $ 7,722
ILLUSTRATION 14-2
Computation of Discount
on Bonds Payable
3
Because companies pay interest semiannually, the interest rate used is 5% (10%
6

12
). The
number of periods is 10 (5 years 2).
Evermaster records the issuance of its bonds at a discount on January 1, 2011, as
follows.
Cash 92,278
Bonds Payable 92,278
It records the first interest payment on July 1, 2011, and amortization of the dis-
count as follows.
Bond Interest Expense 4,614
Bonds Payable 614
Cash 4,000
Maturity value of bonds payable $ 100,000
Present value of $100,000 due in 5 years at 6%, interest payable
semiannually (Table 6-2); FV(PVF
10,3%
); ($100,000 .74409) $74,409
Present value of $4,000 interest payable semiannually for 5 years at
6% annually (Table 6-4); R(PVF-OA
10,3%
); ($4,000 8.53020) 34,121
Proceeds from sale of bonds (108,530)
Premium on bonds payable $ 8,530
ILLUSTRATION 14-4
Computation of Premium
on Bonds Payable
Evermaster records the interest expense accrued at December 31, 2011 (year-end),
and amortization of the discount as follows.
Bond Interest Expense 4,645
Bond Interest Payable 4,000
Bonds Payable 645
Bonds Issued at a Premium
Now assume that for the bond issue described above, investors are willing to accept
an effective-interest rate of 6 percent. In that case, they would pay $108,530 or a pre-
mium of $8,530, computed as follows.
The five-year amortization schedule appears in Illustration 14-5.
SCHEDULE OF BOND PREMIUM AMORTIZATION
EFFECTIVE-INTEREST METHODSEMIANNUAL INTEREST PAYMENTS
5-YEAR, 8% BONDS SOLD TO YIELD 6%
Carrying
Cash Interest Premium Amount
Date Paid Expense Amortized of Bonds
1/1/11 $108,530
7/1/11 $ 4,000
a
$ 3,256
b
$ 744
c
107,786
d
1/1/12 4,000 3,234 766 107,020
7/1/12 4,000 3,211 789 106,231
1/1/13 4,000 3,187 813 105,418
7/1/13 4,000 3,162 838 104,580
1/1/14 4,000 3,137 863 103,717
7/1/14 4,000 3,112 888 102,829
1/1/15 4,000 3,085 915 101,914
7/1/15 4,000 3,057 943 100,971
1/1/16 4,000 3,029 971 100,000
$40,000 $31,470 $8,530
a
$4,000 $100,000 .08 6/12
c
$744 $4,000 $3,256
b
$3,256 $108,530 .06 6/12
d
$107,786 $108,530 $744
ILLUSTRATION 14-5
Bond Premium
Amortization Schedule
Evermaster records the issuance of its bonds at a premium on January 1, 2011, as
follows.
Cash 108,530
Bonds Payable 108,530
Evermaster records the first interest payment on July 1, 2011, and amortization of
the premium as follows.
Bond Interest Expense 3,256
Bonds Payable 744
Cash 4,000
Evermaster should amortize the discount or premium as an adjustment to interest
expense over the life of the bond in such a way as to result in a constant rate of interest
Chapter 14 Non-Current Liabilities 143
144 IFRS Supplement
Interest accrual ($4,000
2
6) $1,333.33
Premium amortized ($744
2
6) (248.00)
Interest expense (Jan.Feb.) $1,085.33
ILLUSTRATION 14-6
Computation of Interest
Expense
when applied to the carrying amount of debt outstanding at the beginning of any given
period.
4
Accruing Interest
In our previous examples, the interest payment dates and the date the financial statements
were issued were essentially the same. For example, when Evermaster sold bonds at a
premium, the two interest payment dates coincided with the financial reporting
dates. However, what happens if Evermaster prepares financial statements at the end
of February 2011? In this case, the company prorates the premium by the appropriate
number of months to arrive at the proper interest expense, as follows.
Extinguishment with Modification of Terms
Practically every day, the Wall Street Journal or the Financial Times runs a story about
some company in financial difficulty. Notable recent examples are Nakheel (ARE),
Parmalat (ITA), and General Motors (USA). In many of these situations, the creditor
may grant a borrower concessions with respect to settlement. The creditor offers these
concessions to ensure the highest possible collection on the loan. For example, a creditor
may offer one or a combination of the following modifications:
1. Reduction of the stated interest rate.
2. Extension of the maturity date of the face amount of the debt.
3. Reduction of the face amount of the debt.
4. Reduction or deferral of any accrued interest.
As with other extinguishments, when a creditor grants favorable concessions on
the terms of a loan, the debtor has an economic gain. Thus, the accounting for modifi-
cations is similar to that for other extinguishments. That is, the original obligation is
extinguished, the new payable is recorded at fair value, and a gain is recognized for
the difference in the fair value of the new obligation and the carrying value of the old
obligation.
5
To illustrate, assume that on December 31, 2010, Morgan National Bank enters into a
debt modification agreement with Resorts Development Company, which is experiencing
4
The issuer may call some bonds at a stated price after a certain date. This call feature gives
the issuing corporation the opportunity to reduce its bonded indebtedness or take advantage
of lower interest rates. Whether callable or not, a company must amortize any premium or
discount over the bonds life to maturity because early redemption (call of the bond) is not
a certainty.
5
An exception to the general rule is when the modification of terms is not substantial.
A substantial modification is defined as one in which the discounted cash flows under
the terms of the new debt (using the historical effective-interest rate) differ by at least
10 percent of the carrying value of the original debt. If a modification is not substantial,
the difference (gain) is deferred and amortized over the remaining life of the debt at the
(historical) effective-interest rate. [3] In the case of a non-substantial modification, in
essence, the new loan is a continuation of the old loan. Therefore, the debtor should record
interest at the historical effective-interest rate.
U.S. GAAP
PERSPECTIVE
Under U.S. GAAP, unamortized
bond issues costs are
reported as an asset and
amortized to expense over
the life of the bonds. IFRS
requires that the issue costs
reduce the carrying amount
of the bond, which increases
the effective-interest rate.
U.S. GAAP
PERSPECTIVE
U.S. GAAP uses the term
troubled debt restructurings
and has developed specific
guidelines related to that
category of loans. IFRS
generally assumes that all
restructurings be accounted
for as extinguishments of debt.
Chapter 14 Non-Current Liabilities 145
financial difficulties. The bank restructures a $10,500,000 loan receivable issued at par
(interest paid to date) by:
Reducing the principal obligation from $10,500,000 to $9,000,000;
Extending the maturity date from December 31, 2010, to December 31, 2014; and
Reducing the interest rate from the historical effective rate of 12 percent to 8 per-
cent. Given Resorts Developments financial distress, its market-based borrowing
rate is 15 percent.
IFRS requires the modification to be accounted for as an extinguishment of the old note
and issuance of the new note, measured at fair value. Illustration 14-7 shows the cal-
culation of the fair value of the modified note, using Resorts Developments market
discount rate of 15 percent.
Present value of restructured cash flows:
Present value of $9,000,000 due in 4 years at 15%,
interest payable annually ( Table 6-2); FV(PVF
4,15%
);
($9,000,000 .57175) $5,145,750
Present value of $720,000 interest payable annually
for 4 years at 15% ( Table 6-4); R(PVF-OA
4,15%
);
($720,000 2.85498) 2,055,586
Fair value of note $7,201,336
ILLUSTRATION 14-7
Fair Value of Restructured
Note
The gain on the modification is $3,298,664, which is the difference between the prior
carrying value ($10,500,000) and the fair value of the restructured note, as computed
in Illustration 14-23 ($7,201,336). Given this information, Resorts Development makes
the following entry to record the modification.
Note Payable (Old) 10,500,000
Gain on Extinguishment of Debt 3,298,664
Note Payable (New) 7,201,336
Illustration 14-8 shows the amortization schedule for the new note, following the
modification.
Date Cash Paid Interest Expense Amortization Carrying Value
12/31/2010 $7,201,336
12/31/2011 $720,000
a
$1,080,200
b
$360,200
c
7,561,536
d
12/31/2012 720000 1,134,230 414,230 7,975,767
12/31/2013 720000 1,196,365 476,365 8,452,132
12/31/2014 720000 1,267,820 547,868 9,000,000
a
$9,000,000 8%
b
$7,201,336 15%
c
$1,080,200 $720,000
d
$7,201,336 $360,200
ILLUSTRATION 14-8
Schedule of Interest and
Amortization after Debt
Modification
Resorts Development recognizes interest expense on this note using the effective rate
of 15 percent. Thus, on December 31, 2011 (date of first interest payment after restruc-
ture), Resorts Development makes the following entry.
December 31, 2011
Interest Expense 1,080,200
Note Payable 360,200
Cash 720,000
146 IFRS Supplement
1. What is the required method of amortizing discount and
premium on bonds payable? Explain the procedures.
2. Vodafone (GBR) recently issued debt. How should the
costs of issuing these bonds be accounted for?
QUESTIONS
3. What are the general rules for measuring and recognizing
gain or loss by a debt extinguishment with modification?
BRIEF EXERCISES
BE14-1 On January 1, 2011, JWS Corporation issued $600,000 of 7% bonds, due in 10 years. The bonds
were issued for $559,224, and pay interest each July 1 and January 1. Prepare the companys journal entries
for (a) the January 1 issuance, (b) the July 1 interest payment, and (c) the December 31 adjusting entry.
Assume an effective-interest rate of 8%.
BE14-2 Assume the bonds in BE14-1 were issued for $644,636 and the effective-interest rate is 6%. Prepare
the companys journal entries for (a) the January 1 issuance, (b) the July 1 interest payment, and (c) the
December 31 adjusting entry.
EXERCISES
E14-1 (Entries for Bond Transactions) Foreman Company issued $800,000 of 10%, 20-year bonds on
January 1, 2011, at 119.792 to yield 8%. Interest is payable semiannually on July 1 and January 1.
Instructions
Prepare the journal entries to record the following.
(a) The issuance of the bonds.
(b) The payment of interest and the related amortization on July 1, 2011.
(c) The accrual of interest and the related amortization on December 31, 2011.
Authoritative Literature References
[1] International Accounting Standard 39, Financial Instruments: Recognition and Measurement (London, U.K.:
International Accounting Standards Committee Foundation, 2003), par. 47.
[2] International Accounting Standard 39, Financial Instruments: Recognition and Measurement (London, U.K.:
International Accounting Standards Committee Foundation, 2003), par. 43.
[3] International Accounting Standard 39, Financial Instruments: Recognition and Measurement (London, U.K.:
International Accounting Standards Committee Foundation, 2003), par. AG62.
AUTHORITATIVE LITERATURE
Resorts Development makes a similar entry (except for different amounts for credits to
Note Payable and debits to Interest Expense) each year until maturity. At maturity,
Resorts Development makes the following entry.
December 31, 2014
Note Payable 9,000,000
Cash 9,000,000
In summary, following the modification, Resorts Development has extinguished the
old note with an effective rate of 12 percent and now has a new loan with a much
higher effective rate of 15 percent.
Chapter 14 Non-Current Liabilities 147
E14-2 (Entries for Bond Transactions) Assume the same information as in E14-1, except that the bonds
were issued at 84.95 to yield 12%.
Instructions
Prepare the journal entries to record the following. (Round to the nearest dollar.)
(a) The issuance of the bonds.
(b) The payment of interest and related amortization on July 1, 2011.
(c) The accrual of interest and the related amortization on December 31, 2011.
E14-3 (Settlement of Debt) Strickland Company owes $200,000 plus $18,000 of accrued interest to
Moran State Bank. The debt is a 10-year, 10% note. During 2010, Stricklands business deteriorated due
to a faltering regional economy. On December 31, 2010, Moran State Bank agrees to accept an old ma-
chine and cancel the entire debt. The machine has a cost of $390,000, accumulated depreciation of $221,000,
and a fair value of $180,000.
Instructions
(a) Prepare journal entries for Strickland Company to record this debt settlement.
(b) How should Strickland report the gain or loss on the disposition of machine and on restructuring
of debt in its 2010 income statement?
(c) Assume that, instead of transferring the machine, Strickland decides to grant 15,000 of its ordi-
nary shares ($10 par), which have a fair value of $180,000 in full settlement of the loan obligation.
Prepare the entries to record the transaction.
E14-4 (Loan Modification) On December 31, 2010, Sterling Bank enters into a debt restructuring agree-
ment with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure
a 12%, issued at par, 3,000,000 note receivable by the following modifications:
1. Reducing the principal obligation from 3,000,000 to 2,400,000.
2. Extending the maturity date from December 31, 2010, to January 1, 2014.
3. Reducing the interest rate from 12% to 10%. Barkleys market rate of interest is 15%.
Barkley pays interest at the end of each year. On January 1, 2014, Barkley Company pays 2,400,000 in
cash to Sterling Bank.
Instructions
(a) Can Barkley Company record a gain under the term modification mentioned above? Explain.
(b) Prepare the amortization schedule of the note for Barkley Company after the debt modification.
(c) Prepare the interest payment entry for Barkley Company on December 31, 2012.
(d) What entry should Barkley make on January 1, 2014?
E14-5 (Loan Modification) Use the same information as in E14-4 above except that Sterling Bank
reduced the principal to 1,900,000 rather than 2,400,000. On January 1, 2014, Barkley pays 1,900,000 in
cash to Sterling Bank for the principal.
Instructions
(a) Prepare the journal entries to record the loan modification for Barkley.
(b) Prepare the amortization schedule of the note for Barkley Company after the debt modification.
(c) Prepare the interest payment entries for Barkley Company on December 31 of 2011, 2012, and 2013.
(d) What entry should Barkley make on January 1, 2014?
USING YOUR JUDGMENT
Financial Reporting Problem
Marks and Spencer plc (M&S)
The financial statements of M&S can be accessed at the books companion website, www.wiley.com/
college/kiesoifrs.
Instructions
Refer to M&Ss financial statements and the accompanying notes to answer the following questions.
(a) What cash outflow obligations related to the repayment of long-term debt does M&S have over the
next 5 years?
(b) M&S indicates that it believes that it has the ability to meet business requirements in the foreseeable
future. Prepare an assessment of its liquidity, solvency, and financial flexibility using ratio analysis.
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148 IFRS Supplement
BRI DGE TO THE PROFESSI ON
Professional Research
Wie Company has been operating for just 2 years, producing specialty golf equipment for women golfers.
To date, the company has been able to finance its successful operations with investments from its princi-
pal owner, Michelle Wie, and cash flows from operations. However, current expansion plans will require
some borrowing to expand the companys production line.
As part of the expansion plan, Wie is contemplating a borrowing on a note payable or issuance of
bonds. In the past, the company has had little need for external borrowing so the management team has
a number of questions concerning the accounting for these new non-current liabilities. They have asked
you to conduct some research on this topic.
Instructions
Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/ ). When you have accessed
the documents, you can use the search tool in your Internet browser to respond to the following ques-
tions. (Provide paragraph citations.)
(a) With respect to a decision of issuing notes or bonds, management is aware of certain costs (e.g., print-
ing, marketing, selling) associated with a bond issue. How will these costs affect Wies reported earn-
ings in the year of issue and while the bonds are outstanding?
(b) If all goes well with the plant expansion, the financial performance of Wie Company could dramat-
ically improve. As a result, Wies market rate of interest (which is currently around 12%) could de-
cline. This raises the possibility of retiring or exchanging the debt, in order to get a lower borrowing
rate. How would such a debt extinguishment be accounted for?