Acctg24-Intermediate Accounting 2

Notes Payable and Debt Restructuring

Notes Payable

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

➢ Initial measurement of note payable (PFRS 9)

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

➢ Subsequent measurement of note payable (PFRS 9)

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

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

• An entity shall present a gain or loss on a note payable that is designated as at fair value
through profit or loss as follows:
a. The amount of change in the fair value that is attributable to changes in the credit risk of
the note payable shall be presented in other comprehensive income.
b. The remaining amount of change in the fair value of the note payable shall be presented in
profit or loss.

Initially – FV of notes @ 100,000

Subsequently – FV of the notes @ 80,000

Changes of FV -20,000
Gain on credit risk – OCI 5000
Gain on FV changes -P&L 15000
 • If presenting the change in fair value attributable to credit risk would create or enlarge an
accounting mismatch in profit or loss, an entity shall present all gains or losses on that liability
(including the effects of changes in the credit risk of that liability) in profit or loss.
• Amount recognized in other comprehensive income shall not be subsequently transferred to
profit or loss.
• Cumulative gain or loss in other comprehensive income may be transferred within equity
(retained earnings)
• Interest expense is measured using the stated or nominal rate.
Types of Notes issued Accounting Treatment Pro-forma journal entries
Issued solely for cash Present value is equal to cash Cash xx
proceeds. The difference Notes payable xx
between the cash proceeds and P/(D) on N/P xx
the face value of the notes is
accounted as discount or
premium.
Interest bearing note issued for The asset acquired is recorded Property xx
property at the purchase price Notes payable xx
Non-interest bearing note issued The property is recorded at cash Property xx
for property price. The cash price is Discount on NP xx
assumed to be the present value Notes payable xx
of the note issued. The
difference between the cash
price and face amount of the
note payable represents the
imputed interest.

If no cash price is available for

the property, the cost of the
property is equal to the present
value of future payments at the
prevailing market rate of interest.

Exercises

1. On March 01, Year 1, ABC Company issued a P90,000, 8% interest-bearing note payable from a
financial institution in exchange for cash. Interest and principal are payable after one year. How
much is the interest expense for Year 1?

Interest = 90,000 x 8%
= 7,200 x 10/12
= 6,000
2. DEF Company issued a 2-year, P100,000 face value note payable. Interest of 7% per annum is
deducted in advance. The effective interest rate for the discounted note is 7.8328%. The note was
 issued on January 01, Year 1. PV of 1 at 7% for 2 periods is 0.87 and PV of 1 at 7.8328% for 2
periods is 0.86. How much is the interest expense for Year 1?

Advance Interest (100,000 x 7% ) = 7,000x 2 = 14,000

Proceeds (100,000-14,000) 86,000
FV of N/P 100,000
Discount on N/P 14,000

PV of notes ( 86,000 x 7.8328%) = 6,736

3. GHI Company issued a 3-year, P150,000 face value noninterest-bearing note payable in exchange
for a new machinery on January 01, Year 1. The note is payable in three equal annual installments
every January 01, starting Year 1. No cash price of the machinery is available. The prevailing rate
for similar note is 12%. PV of 1 at 12% for 3 periods is 0.7118. PV of an ordinary annuity of 1 at
12% for 3 periods is 2.4018. PV of an annuity due at 12% for 3 period is 2.6900. How much is the
interest expense for Year 1?
How much is the carrying amount of the note payable as of December 31, Year 2?

PV of NP in advance (50,000 x 2.6900) 134,500

FV 150,000
Discount on NP 15,500

To compute for interest expense on Yr1

CA of NP 134,500
Less: Jan 1 Installment (50,000)
CA after Jan1 installment 84,500
x 12%
Interest expense 10,140

Journal Entries

Machinery 134,500
Discount on NP 15,500
Notes payable 150,000

Notes payable 50,000

Cash 50,0000

Interest expense 10,140

Discount on N/P 10,140
 4. JKL Company issued a 2-year, 10% interest-bearing, P100,000 face value note payable on
January 01, Year 1. JKL elected fair value option in measuring the note payable Transaction cost
paid by JKL to issue the note is P1,000. On December 31, Year 1, the fair value of the note is
P92,000. The P5,000 decline in fair value is associated with credit risk. How much is the loss from
change in fair value to be recognized in profit and loss?

Debt Restructuring

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

➢ Forms of debt restructuring

✓ A troubled debt restructuring may include, but is not necessarily limited to, one or a combination of
the following:
1. Asset swap – Transfer from the debtor to the creditor of receivables from third parties, real
estate, or other assets to satisfy fully or partially a debt (including a transfer resulting from
foreclosure or repossession).
2. Equity Swap – Issuance or granting of an equity interest to the creditor by the debtor to satisfy
fully or partially a debt unless the equity interest is granted pursuant to existing terms for
converting the debt into an equity interest.
3. Modification of terms – Modification of terms of a debt, such as one or a combination of:
a. Reduction (absolute or contingent) of the stated interest rate for the remaining original life
of the debt.
b. Extension of the maturity date or dates at a stated interest rate lower than the current
market rate for new debt with similar risk.
c. Reduction (absolute or contingent) of the face amount or maturity amount of the debt as
stated in the instrument or other agreement.
d. Reduction (absolute or contingent) of accrued interest.

➢ Accounting for asset swap (PFRS 9)

✓ Dation in payment/dacion en pago (R.A. 386, Art. 1245), whereby property is alienated to the
creditor in satisfaction of a debt in money is accounted as asset swap.
✓ The difference between the carrying amount of a financial liability (or part of a financial liability)
extinguished or transferred to another party and the consideration paid, including any non-cash
assets transferred or liabilities assumed, shall be recognized in profit or loss.
Total amount if Liability xx
Less: Carrying amount of property transferred and cash paid xx
Gain/loss on extinguishment of debt xx
 Under US GAAP
Fair value of property transferred xx
Less:Carrying amount of property transferred xx
Gain/loss on exchange xx

Total amount of liability xx

Less: Fair value of property transferred xx
Gain/loss on debt restructuring xx
➢ Accounting for equity swap (IFRIC 19)
✓ When equity instruments issued to a creditor to extinguish all or part of a financial liability are
recognized initially, an entity shall measure them at the fair value of the equity instruments issued,
unless that fair value cannot be reliably measured
✓ If the fair value of the equity instruments issued cannot be reliably measured then the equity
instruments shall be measured to reflect the fair value of the financial liability extinguished.
✓ Order of priority for measurement of equity instruments issued to extinguish a financial liability:
a. Fair value of equity instruments issued
FV of equity instrument 1,000,000
CA of liability 1,500,000
Gain on extinguishment of debt 500,000
b. Fair value of the financial liability extinguished
c. Carrying amount of the financial liability extinguished – no gain or loss on extinguishment of
debt
✓ If only part of the financial liability is extinguished, the entity shall assess whether some of the
consideration paid relates to a modification of the terms of the liability that remains outstanding. If
part of the consideration paid does relate to a modification of the terms of the remaining part of the
liability, the entity shall allocate the consideration paid between the part of the liability extinguished
and the part of the liability that remains outstanding

➢ Accounting for modification of terms (PFRS 9)

✓ A substantial modification of the terms of an existing financial liability or a part of it (whether or not
attributable to the financial difficulty of the debtor) shall be accounted for as an extinguishment of
the original financial liability and the recognition of a new financial liability.
✓ The terms are substantially different if the discounted present value of the cash flows under the
new terms, including any fees paid net of any fees received and discounted using the original
effective interest rate, is at least 10 percent different from the discounted present value of the
remaining cash flows of the original financial liability.
✓ If there is substantial modification, gain or loss on extinguishment is equals to the carrying amount
of the old liability minus the present value of the new liability, including net fees incurred.
✓ If there is no substantial modification of terms, gain or loss on extinguishment of debt is still
recognized in accordance with IAS Par B54.4.6.
✓ If an exchange of debt instruments or modification of terms is accounted for as an extinguishment,
any costs or fees incurred are recognized as part of the gain or loss on the extinguishment.
✓ If the exchange or modification is not accounted for as an extinguishment, any costs or fees
incurred adjust the carrying amount of the liability and are amortized over the remaining term of the
modified liability.
✓ Interest expense under the new liability is computed using effective interest method.
 ✓ The rate used to compute the present value of the new financial liability is the interest rate of the
old financial liability.

Illustration:
On January 1, 2021 an entity showed the following:
Note payable-due January 1,2021 – 14% 5,000,000
Accrued interest payable 700,000
The entity is granted by the creditor the following concession on January 1,2021:
a. The accrued interest of P700,000 is forgiven
b. The principal obligation is reduced to P4,000,000
c. The new interest rate is 10% payable every December 31
d. The new date of maturity is December 31,2024
e. The market rate of interest is 12% for similar liability
f. The entity paid P150,000 to the creditor as arrangement fee for the restructuring
The PV of 1 at 14% for 4 periods is 0.592 and the PV of an ordinary annuity of 1 at 14% for 4
periods is 2.914
The PV of 1 at 12% for 4 periods is .636 and the PV of an ordinary annuity of 1 at 12% for 4
periods is 3.037
To determine of there is substantial modification:
PV of principal (4,000,000 x .592) 2,368,000
PV of interest payments (400,000x2.914) 1,165,600
Present value of new liability 3,533,600

Note payable -old 5,000,000

Accrued interest 700,000
Carrying amount of old liability 5,700,000
PV of new note payable at 14% 3,533,600
Gain on modification 2,166,400
Arrangement fee ( 150,000)
Net gain on modification 2,016,400

2,016,400/5,700,000= 35%

To determine the fair value of the new liability

PV of principal (4,000,000x.636) 2,544,000

PV of interest (400,000x3.037) 1,214,000
PV of the new liability 3,758,800
Principal amount 4,000,000
Discount on new note payable 241,200
 To determine the gain or loss on extinguishment of debt
Note payable -old 5,000,000
Accrued interest 700,000
Carrying amount of old liability 5,700,000
PV of new note payable at 12% 3,758,800
Gain on extinguishment of debt 1,941,200
Arrangement fee ( 150,000)
Net gain on extinguishment 1,791,200

Journal entries

Note payable-old 5,000,000

Accrued interest payable 700,000
Discount on new note payable 241,200
Note payable-new 4,000,000
Gain on extinguishment of debt 1,791,200
Cash (arrangement fee) 150,000

December 31
Interest expense 400,000
Cash 400,000

Interest expense 51,056

Discount on notes payable 51,056

Int. paid Int expense D/Amort CA

Jan 1 3,758,800
Dec 31 400,000 451,056 51,056 3,809,856
Exercises

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