CHAPTER 5

FINANCIAL
LIABILITIES
PREPARED BY: FELECITAS C. TUAZON
 LECTURE CONTENTS
• Definition and Nature of Liabilities
• Financial Liabilities
• Accounting for Specific Financial Liabilities
• Bonds Payable
• Trouble-Debt Restructuring
• Classification and Presentation on the Face of the
Financial Statements
• Disclosure Requirements
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
 INTRODUCTION
For a number of years, debt financing has long been used to
increase the earnings of the shareholders Debts have helped
businesses to expand operations. One businessman says, “there is a
lot of risks involved; but if you’re successful, the benefits definitely
outweigh the risks.” The same businessman says, ”if you want your
business to be successful, monitoring and controlling liabilities is a
must.”
This chapter focuses on accounting for financial liabilities, which are
based on similar concepts in accounting for financial assets.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
DEFINITION AND
NATURE OF
LIABILITIES
DEFINITION AND NATURE OF LIABILITIES
• The IASB’s Conceptual Framework for Financial Reporting defines liability as
“present obligation of an enterprise arising from past event, the settlement of
which is expected to result in an outflow from the enterprise of resources
embodying economic benefits.” In the new Conceptual Framework to be released
soon by the International Accounting Standards Board (IASB),the definition of a
liability has been simplified into a “present obligation of an entity to transfer an
economic resource as a result of past event.” it can be inferred from the two
definitions that the phrase used in the old definition “outflow of resources
embodying economic benefits” is replaced by “transfer an economic resource”
which is more direct and simpler.
• From the definitions given, a liability possesses the following essential
characteristics:
1. present obligation;
2. past event; and
3. transfer of an economic resource.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
DEFINITION AND NATURE OF 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 acknowledged by an
enterprise because other parties are made to believe that it will carry out an
undertaking or certain action.
• It is clarified in the new Conceptual Framework that an obligation is a duty or
responsibility that the entity has no practical ability to avoid. Such obligation
is the result of an event called obligating event, which results in either a legal
obligation or a constructive obligation.
• A legal obligation is one that derives from a contract (through its explicit or
implicit terms), legislation, or other operation 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 operation of law.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
DEFINITION AND NATURE OF LIABILITIES
• A constructive obligation is one that 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 (paragraph 10, IAS 37, Provisions, Contingent Liabilities and
Contingent Assets). An example of a liability that is recognized as a constructive
obligation is provision for clean up costs where the enterprise has a widely
published policy of cleaning up all contamination that it causes.
• Liabilities arise only from past events or transactions. For example, the mere
signing of a purchase contract with a supplier does not give rise to a liability. The
liability will arise if the entity acquires legally or constructively the title to the goods
from the supplier. The past event in that case is the acceptance by the entity of the
goods delivered by the supplier. In a similar manner, the mere signing of an
employment contract with an employee does not give rise to a liability. The liability
for salaries shall be recognized when the employees render services to the entity.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
DEFINITION AND NATURE OF LIABILITIES
• The settlement of a present obligation involves the enterprise 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) transfer of other assets;
c) provision of services;
d) replacement of an obligation with another obligation; and
e) conversion of the obligation to equity.
• In some exceptional cases, an obligation is settled through 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.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
FINANCIAL
LIABILITIES
FINANCIAL LIABILITIES
• As defined in International Accounting Standards 32 Financial Instruments:
Presentation (now superseded by IFRS 9 Financial Instruments), a financial
liability is any liability that is a contractual obligation
a) to deliver cash or another financial asset to another entity, or
b) to exchange financial assets or financial liabilities to another entity
under conditions that are potentially unfavorable to the entity, or
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 pr a financial asset for a fixed number of the
entity’s own equity instruments.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
FINANCIAL LIABILITIES
• Based on the previous definition, a financial liability arises from a contract
to pay cash, or exchange financial asset or financial liability. Examples of
this nature are accounts payable, notes payable and bonds and mortgage
payable. Financial liabilities also include those contractual obligations that
will or may be settled by issuing equity instruments (e.g. convertible
bonds). However, rights, options and warrants issued by an entity on a
pro rata basis to its existing owners that impose on the entity to issue its
own share capital are not financial liabilities but are classified as equity.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
INITIAL RECOGNITION
• An entity shall recognize its financial liability when and only when it
becomes a party to the contractual provisions of the instrument; that is,
when the entity issues the financial instrument or acknowledges in
whatever form its obligation as a result of the contractual provisions of a
contract.
• A financial liability is initially recognized at fair value, which is the
transaction price. For financial liabilities that are measured at amortized
cost, the transactions costs directly attributable to the issuance of the
financial instrument is considered in the initial measurement.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
MEASUREMENT SUBSEQUENT TO INITIAL RECOGNITION
• Except for financial liabilities that are measured at fair value, financial
liabilities are subsequently measured at amortized cost.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ACCOUNTING FOR
SPECIFIC
FINANCIAL
LIABILITIES
ACCOUNTING FOR SPECIFIC FINANCIAL LIABILITIES
Accounts Payable
• Accounts payable or trade accounts payable are liabilities arising from the
purchase of goods, materials, supplies, or services on an open charge-account
basis. The credit time period generally varies (e.g. from 30 top 120 days)
without any interest being charged on the deferred payment. 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
supplied. Theoretically, however, an entity must recognize the accounts
payable when it acquired 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 transactions occurring near the end of one
reporting period and at the beginning of next reporting period. In most cases,
an entity acquires economic control over the goods purchased with the
transfer of the legal title, which depends on the terms of purchase.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ACCOUNTING FOR SPECIFIC FINANCIAL LIABILITIES
Accounts Payable
• A purchase made towards the end of the accounting period, where goods
are still in transit, should be recognized as a liability when the term of
shipment is FOB shipping point. Similarly, the liability is recognized upon
receipt of the goods when such are shipped FOB destination. The record
of goods received (inclusion in ending inventory) should be in agreement
with the recognition of accounts payable. Both the liability of the proper
reporting period.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
METHODS OF ACCOUNTING FOR CASH DISCOUNTS
• The agreement for the purchase of goods usually includes incentives for early
payment of the account; thus, cash discounts are offered. The purchase
transaction may be recorded using either the gross method or the net
method.
• Under the gross method and when the entity adopts the periodic inventory
system, the Purchases account and the Accounts Payable are recorded at the
gross invoice price. A cash discount taken on purchases is recorded upon
payment as a credit to Purchase Discounts. Any balance of Purchase Discounts
is reported in profit or loss as a deduction from gross purchases.
• When the entity uses the perpetual inventory system, the purchase
transaction is recorded in Inventory account and any cash discount taken is
credited to Inventory account, if the related goods are still unsold or to Cost
of Goods Sold account, if the related goods are still unsold or to Cost of Goods
Sold account, if the related goods have already been sold.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
METHODS OF ACCOUNTING FOR CASH DISCOUNTS
• Under the net method and when the entity adopts the periodic inventory
system, both Purchases and Accounts Payable are initially recorded at
invoice price less the cash discounts available. A cash discount not taken
is recorded as Purchase Discounts Lost, which is, reported in profit or loss
as part of finance cost.
• To illustrate, assume that ABC Corporation purchased merchandise from
DEF Company with an invoice price of P200,000; term: FOB shipping
points, 3/10; n/30.
• The purchase took place on November 2, 2019. DEF Company prepaid the
freight charges of P2,000. ABC paid the full account on November 10,
2019. assume further that ABC Corporation uses periodic inventory
system. Entries in the books of ABC Corporation to record the purchase
and payment under the gross and net methods are:
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
METHODS OF ACCOUNTING FOR CASH DISCOUNTS
Gross Method Net Method
November 2, 2019
Purchases 200,000 Purchases 194,000
Freight-in 2,000 Freight-in 2,000
Accounts Payable 202,000 Account Payable 196,000
November 10, 2019
Accounts Payable 202,000 Accounts Payable 196,000
Purchase Discount 6,000 Cash 196,000
Cash 196,000

• If the account is paid beyond the discount period, the journal entry for the payment
would be Gross Method Net Method
Accounts Payable 202,000 Accounts Payable 196,000
Cash 202,000 Purchase Discounts Lost 6,000
Cash 202,000
• Note that the 3% cash discount is based on the cost of goods purchased, excluding
the freight cost.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
METHODS OF ACCOUNTING FOR CASH DISCOUNTS
• If the payment is not made yet at the reporting date and the discount
period has already lapsed. An adjusting entry is required to be recorded
under the net method, as follows:
Purchase Discounts Lost 6,000
Accounts Payable 6,000
• This adjusting entry brings the accounts payable balance to P202,000. the
adjustment is made to reflect in the accounts the true amount of the
resources expected to be given up upon settlement of the obligation in
the subsequent period.
• Year-end adjustment is necessary under the gross method if the account
has not yet been paid at year-end but subsequently settled during the
subsequent reporting period within the discount period. The adjustment
is not necessarily made at year-end but us dated at the end of the year.
The adjusting entry is
Allowance for Purchase Discount xx
Purchase Discounts xx
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
METHODS OF ACCOUNTING FOR CASH DISCOUNTS
• This entry reduces the amortized cost of accounts payable to the amount
of cash that would be disbursed to settle the account in the subsequent
period. The adjustment also matches properly the purchase discounts
against the recorded purchases in the same reporting period. The account
Allowance for Purchase Discount is deducted from Accounts Payable in
the statement of financial position, while the Purchase Discounts account
reduces the recorded cost of Purchases that is shown in the statement of
comprehensive income. On the first day of the subsequent reporting
period, such an adjustment is reversed, so that the payment of account is
made in the usual manner, as follows:
Accounts Payable xx
Purchase Discounts xx
Cash xx
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
METHODS OF ACCOUNTING FOR CASH DISCOUNTS
• Between the two methods, the net method is more theoretically sound
because it results in separate recognition of finance cost that arises from
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 that an expense has been incurred
because of a credit related transaction. Under this method, any discount
lost is not accounted for separately and is absorbed by the cost of
purchases, thereby increasing operating cost.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
METHODS OF ACCOUNTING FOR CASH DISCOUNTS
Notes Payable
• A promissory note is a written promise 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.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
NOTE BEARING A REALISTIC INTEREST RATE
• Accounting for the issuance of interest-bearing note is relatively
straightforward. Since the note is interest bearing (and assuming that the stated
rate approximates thee prevailing market rate for similar obligations), the fair
value (and also the present value) of the note at the time of its issuance is equal
to its face value. The issuance of such a note is recorded as follows (assume an
issuance of note in settlement of an overdue trade account):
Accounts Payable xxx
Notes Payable xxx
• At maturity date, payment is made for the principal amount plus interest for the
entire term of the note, as follows:
Notes Payable xxx
Interest Expense xxx
Cash xx
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
NOTE BEARING A REALISTIC INTEREST RATE
• If the note is still outstanding at the end of the reporting period, an
accrued interest should be recorded for the period from the date of
issuance of the note to the end of the reporting period. Accrual of
interest is recorded as
Interest Expense xxx
Interest Payable xxx
• This adjusting entry may be reversed at the beginning of the new
accounting period so that the subsequent payment of the note and
interest may be recorded in the usual manner, debiting Notes Payable for
the principal and Interest Expense for the total interest paid.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
LONG-TERM NOTES – PRINCIPAL AND INTEREST ARE PAYABLE PERIODICALLY
• On March 31, 2018, the ABC Corporation issued a P3,000,000, 12%
promissory note for a machinery purchased. Equal principal amount of
P1,000,000 plus interest on the unpaid balance of the principal are
payable annually every March 31 starting March 31, 2019. Thus, the
following are the amounts to be paid during 2018 through 2021.

Due Date Principal Due Interest Due Total

March 31, 2019 1,000,000 3M x 12% = 360,000 1,360,000
March 31, 2020 1,000,000 2M x 12% = 240,000 1,240,000
March 31, 2021 1,000,000 1M x 12% = 120,000 1,120,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
LONG-TERM NOTES – PRINCIPAL AND INTEREST ARE PAYABLE
PERIODICALLY
• Assuming that the company reports o n a calendar year basis, the
following are the entries for years 2018 through 2021.
2018
Mar. 31 Machinery 3,000,000
Notes Payable 3,000,000
Dec. 31 Interest Expense 270,000
Interest Payable 270,000
360,000 x 9/12 = 270,000
2019
Mar. 31 Notes Payable 1,000,000
Interest Expense (360,000 x 3/12) 90,000
Interest Payable 270,000
Cash 1,360,000
Dec. 31 Interest Expense 180,000
Interest Payable 180,000
240,000 x 9/12 = 180,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
LONG-TERM NOTES – PRINCIPAL AND INTEREST ARE PAYABLE
PERIODICALLY
• Assuming that the company reports o n a calendar year basis, the
following are the entries for years 2018 through 2021. (continuation)
2020
Mar. 31 Notes Payable 1,000,000
Interest Expense (240,000 x 3/12) 60,000
Interest Payable 180,000
Cash 1,240,000
Dec. 31 Interest Expense 90,000
Interest Payable 90,000
120,000 x 9/12 = 90,000
2021
Mar. 31 Notes Payable 1,000,000
Interest Expense (120,000 x 3/12) 30,000
Interest Payable 90,000
Cash 1,120,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
LONG-TERM NOTES – PRINCIPAL AND INTEREST ARE PAYABLE
PERIODICALLY
• At the end of each reporting period, the amount of Interest Payable and
the portion of the Notes Payable that is due within the succeeding year
shall be classified as current liabilities.
• Thus, I the statement of financial position at December 31, 2018, 2019,
and 2020m the Notes Payable and Interest Payable shall be classified as
follows:

2018 2019 2020

Current Liabilities
Notes Payable P1,000,000 P1,000,000 P1,000,000
Interest Payable 270,000 180,000 90,000
Non-current Liabilities
Notes Payable P2,000,00 P1,000,000 0

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
LONG-TERM NOTES – PRINCIPAL MATURES IN LUMP SUM, INTEREST IS
PAYABLE PERIODICALLY
• Assume that on March 31, 2018, the MNO Corporation issued a three-
year, P4,000,000, 12% promissory note for a machinery purchased. The
interest on this note is payable annually on its anniversary date. The
company reports on a calendar year.
• The following are the entries for years 2018 through 2021.
2018
Mar. 31 Machinery 4,000,000
Notes Payable 4,000,000
Dec. 31 Interest Expense 360,000
Interest Payable 360,000
(4M x 12% x 9/12)
2019
Mar. 31 Interest Expense 120,000
Interest Payable 360,000
Cash 480,000
Dec. 31 Interest Expense 360,00
Interest Payable 360,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
LONG-TERM NOTES – PRINCIPAL MATURES IN LUMP SUM, INTEREST IS
PAYABLE PERIODICALLY
• The following are the entries for years 2018 through 2021. (continuation)
2020
Mar. 31 Interest Expense 120,000
Interest Payable 360,000
Cash 480,000
Dec. 31 Interest Expense 360,000
Interest Payable 360,000
2021
Mar. 31 Interest Expense 120,000
Interest Payable 360,000
Notes Payable 4,000,000
Cash 4,480,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
LONG-TERM NOTES – PRINCIPAL MATURES IN LUMP SUM, INTEREST IS
PAYABLE PERIODICALLY
• On December 31, 2018 and 2019, the Notes Payable is classified as non-
current liability. The balance of Interest Payable is classified as current
liability since the interest is payable periodically. On December 31, 2020,
both the Notes Payable and Interest Payable accounts are classified as
current liabilities since the promissory note matures three months from
the end of the reporting period.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
NOTE BEARING AN UNREALISTIC INTEREST RATE
• A note bears an unrealistic interest rate when any one or both of these
situations exist:
a) the interest rate appearing on the face of the note is significantly
different from the marketing rate of similar notes; and
b) the consideration received on account of the note issued has a fair
value that is significantly different from the face value of the note.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
NOTE BEARING AN UNREALISTIC INTEREST RATE
• In such case, 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 rate stated on the face of the note is higher than the market rate of
interest, the discounted amount is higher than the face 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.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
SHORT-TERM NOTE – STATED RATE OF NOTE IS MORE THAN THE
MARKET RATE
• To illustrate, assume that on May 1, 2019, Diana Corporation purchased
from Smith Company, a piece of special equipment by issuing a 14% one-
year note for P320,000. There is no equipment cash price for this
equipment, but the market rate of interest on similar notes is 8%.
• The present value (PV) of the future cash outflow to settle the obligation
is:
Principal P320,000
Stated interest (320,000 x 14% x 1 year) 44,000
Total future cash outflow P364,000
PV factor at 8% for 1 period 0.9259
Present value of the note P337,768

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
SHORT-TERM NOTE – STATED RATE OF NOTE IS MORE THAN THE
MARKET RATE
• The following are the entries in 2019 related to the note, assuming that
the company reports on a calendar year basis:
2019
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 11,853
Interest Payable (320,000 x 14% x 8/12) 29,867

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
SHORT-TERM NOTE – STATED RATE OF NOTE IS MORE THAN THE
MARKET RATE
• At December 31, 2019, the amortized cost of the Notes Payable is
computed as follows:
Notes Payable (at face value) P320,000
Premium on Notes Payable 5,915
Interest Payable 29,867
Total P355,782

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
SHORT-TERM NOTE – STATED RATE OF NOTE IS MORE THAN THE
MARKET RATE
• Assuming, no reversing entries were made at January 1, 2020, the
company shall prepare the following entries relating to the note.
2020
May 1 Premium on Notes Payable 5,915
Interest Expense 5,915
17,768 – 11,853
1 Notes Payable 320,000
Interest Payable 29,867
Interest Expense 14,933
Cash 364,800

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
SHORT-TERM NOTE – STATED RATE OF NOTE IS MORE THAN THE
MARKET RATE
• The computation of interest expense is based on the effective interest
rate of 8% and on the present value of the obligation. Thus, the interest
expense included in 2019 and 2020 statements of comprehensive income
are P18,014 and P9,018, respectively, computed as follows:
2019 interest expense
P337,768 x 8% x 8/12 = P18,014
2020 interest expense
P337,768 x 8% x 4/12 = P 9,018*
*(Difference in computation is due to rounding off of present value factor.)

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
SHORT-TERM NOTE – STATED RATE OF NOTE IS LESS THAN THE MARKET
RATE
• Assume instead that the note issued by Diana Corporation bears a 5%
interest rate, but the market rate of interest on similar notes on May 1,
2019 is 10%.
• The present value of the note on May 1, 2019 is computed as follows:
Face P320,000
Stated interest for one year
P320,000 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

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
SHORT-TERM NOTE – STATED RATE OF NOTE IS LESS THAN THE MARKET
RATE
• The following are the entries related to the notes, assuming that the
company reports on a calendar year basis.
2019
May 1 Equipment 305,458
Discount on Notes Payable 14,542
Notes Payable 320,000
Dec. 31 Interest Expense 20,364
Interest Payable 10,667
Discount on Notes Payable 9,697

Interest expense
305,458 x 10% x 8/12 = P20,364
Interest payable
320,000 x 5% x 8/12 = 10,667
Amortized discount P 9,697
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
SHORT-TERM NOTE – STATED RATE OF NOTE IS LESS THAN THE MARKET
RATE
• On December 31, 2019 statement of financial position, the liability on the
note is P325,822, computed as follows:
Notes Payable P320,000
Interest Payable 10,667
Discount on Notes Payable (14,542 – 9,697) ( 4,845)
Total P325,822
• Assuming, no reversing entries were made at January 1, 202, the
company shall prepare the following entries relating to the note.

2020
May 1 Interest Expense 4,845
Discount on Notes Payable 4,845
1 Notes Payable 320,000
Interest Payable 10,667
Interest Expense 5,333
Cash 336,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
SHORT-TERM NOTE – STATED RATE OF NOTE IS LESS THAN THE MARKET
RATE
• Interest expense included in 2019 and 2020 statement of comprehensive
income are P20,364 and P10,178, respectively, computed as follows:
2019 interest expense
P305,458 x 10% x 8/12 = P20,364
2020 interest expense
P305 x 10% x 4/12 = P10,178*
*Difference in computation is due to rounding off of to present value factor.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
LONG-TERM NOTES WITH UNREALISTIC INTEREST RATE
• The accounting for long-term notes with stated rate differing significantly
from the market rate shall be in accordance with the principles similar to
bonds payable that are issued at a discount or premium, discussed in the
section under Bonds Payable.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
NON-INTEREST BEARING NOTE
• Accounting for a non-interest-bearing note is slightly more complex and
applies the same principle for notes carrying an interest rate lower than
the market rate of interest. A non-interest-bearing note does not explicitly
state an interest rate on the face of the note. It does not mean, however,
that there is no interest imputed on the original obligation. A non-interest
bearing note is simply written in a form where the interest is imputed on
the face value of the note. Thus, the face value represents the present
value of the obligation plus the imputed interest for the term of the note.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
NON-INTEREST BEARING 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 reliability
determined, the note is initially measured based on the prevailing market rate of
interest for a 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 reporting date, the balance of discount on notes payable is deducted from the
face value of the note to arrive at the amortized cost of the note to be presented in
the statement of financial position. The balance of the discount represents interest
expense over the remaining term of the note
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ILLUSTRATIVE PROBLEM – SHORT TERM NON-INTEREST BEARING NOTE
• To illustrate, assume the following information: On October 1, 2019, ABC
Company purchased an equipment 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 rate of interest for
similar transactions at that time is 12%.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATIVE PROBLEM – SHORT TERM NON-INTEREST BEARING NOTE
• The cost of the equipment is P278,571, computed as follows:
Down payment P100,000
Present value of note (200,000 x 0.892857) 178,571
Total cost of equipment P278,571
• 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 P 21,429
• The transaction on October 1, 2019 is recorded as
Equipment 278,571
Discount on Note Payable 21,429
Cash 100,000
Notes Payable 200,000
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ILLUSTRATIVE PROBLEM – SHORT TERM NON-INTEREST BEARING NOTE
• On December 31, 2019, assuming that the company’s reporting period is
the calendar year, an adjusting entry is made as follows:
Interest Expense 5,357
Discount on Notes Payable 5,357
178,571 x 12% x 3/12
• On December 31, 2019, after making the necessary adjusting entries, the
balance of the Discount on Notes Payable is P16,072, which is P21,429
minus P5,357. This balance of the discount is deducted from the Notes
Payable account to arrive at the carrying amount of the note. Such
carrying amount is referred to as amortized cost. The December 31, 2019
statement of financial position of ABC Company shall therefore report
Notes Payable, net of discount, at P183,928 (P200,000 – P16,072).

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATIVE PROBLEM – SHORT TERM NON-INTEREST BEARING NOTE
• Upon payment of the note on October 1, 2020, the following journal entries are
made:
Interest Expense 16,072
Discount on Notes Payable 16,072
Notes Payable 200,000
Cash 200,000
• The first entry updates the amortization of the discount. The remaining balance of
the discount is recognized as interest expense during the year 2020. the second entry
records the payment of the obligation.
• Based on the preceding journal entries, ABC Company recognized interest expense of
P5,357 and P16,072, for years 2019 and 2020, respectively.
• A non-interest bearing note may also be issued for money borrowed form a bank or a
financing institution. The present value of such note is equal to the proceeds
received. The difference between the proceeds received and the face value of the
note issued is debited to Discount on Notes Payable.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ILLUSTRATIVE PROBLEM – SHORT TERM NON-INTEREST BEARING NOTE
• Assume that the XYZ Company discounted its own one-year P120,000,
non-interest bearing note on May 1, 2019 with Amihan Bank at a discount
rate of 12%. The proceeds received from this loan is P105,600, which is
equal to P120,000 less the discount of P14,400 (P120,00 x 12%).
• On May 1, 2019, XYZ Company records the transaction as follows:
Cash 105,600
Discount on Notes Payable 14,400
Notes Payable 120,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATIVE PROBLEM – SHORT TERM NON-INTEREST BEARING NOTE
• The interest rate imputed on the note on the previous slide is more than
12 %, as the effective interest is computed by dividing the initial discount
by the amount of the proceeds. The effective interest rate on the note
issued by XYZ is, therefore, 13.64%, which is P14,400 divided by P105,600.
Alternatively, such effective interest rate may also be computed by
dividing the discount rate of 12% by the proceeds expressed as
percentage of face value.
Face 100%
Discount rate 12%
Net proceeds 88%
• The effective interest rate 12%/88%, which is 13.64%. (the above
computation shall only be applicable for short-term notes.)

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATIVE PROBLEM – SHORT TERM NON-INTEREST BEARING NOTE
• If XYZ Company uses the calendar year as its reporting period, an
adjustment on December 31 is made as follows:
Interest Expense 9,600
Discount on Notes Payable 9,600
14,400 x 8/12 = 9,600
(or 105,600 x 13.64% x 8/12)
• In its December 31, 2019 statement of financial position, XYZ shall report
as part of its current liabilities Notes Payable with carrying amount of
P115,200, supported by ledger balances as follows:
Notes Payable P120,000
Discount on Notes Payable
(P14,400 – P9,600) 4,800
Amortized cost of Notes Payable P115,200
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ILLUSTRATIVE PROBLEM – SHORT TERM NON-INTEREST BEARING NOTE
• The computation of amortized cost at December 31, 2019 may also be
made as follows:
Amortized cost of Notes Payable, May 1, 2019 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 31,2019 P115,200

On May 1, 2020, the following entries shall be prepared by XYZ:

Interest Expense 4,800
Discount on Notes Payable 4,800
Notes Payable 120,000
Cash 120,000
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ILLUSTRATIVE PROBLEM – LONG-TERM NOTE – MATURITY VALUE IS
PAYABLE IN LUMP-SUM
• Assume that on March 31, 2018, the MNO Corporation issued a three-
year, P4,000,000, non-interest bearing promissory note for a machinery
purchased. The equivalent cash price of the machinery acquired is
P3,005,200. the company uses the calendar year as its accounting period.
• To determine the effective interest on this note, 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 II in the
Appendix (Present value of a Single Payment), on line 3, corresponding to
the number of period, the factor is under the column 10%. Thus, the
effective interest rate is 10%.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATIVE PROBLEM – LONG-TERM NOTE – MATURITY VALUE IS
PAYABLE IN LUMP-SUM
• The following table of amortization is prepared for the foregoing note.
(A) (B)
Discount Amortization Carrying Amount
Date Previous (B) x 10% Previous (B) + (A)
March 31, 2018 3,005,200
March 31, 2019 300,520 3,305,720
March 31, 2020 330,572 2,626,292
March 31, 2021 363,708* 4,000,000

*Adjusted. The difference is due to rounding off.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATIVE PROBLEM – LONG-TERM NOTE – MATURITY VALUE IS
PAYABLE IN LUMP-SUM
• The following are the entries related to the note from 2018 through 2021.
2018
Mar. 31 Machinery 3,005,200
Discount on Notes Payable 994,800
Notes Payable 4,000,000
Dec. 31 Interest Expense 225,390
Discount on Notes Payable 225,390
300,520 x 9/12
2019
Dec. 31 Interest Expense 323,059
Discount on Notes Payable 323,059
(300,520 x 3/12) +
(330,572 x 9/12)

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATIVE PROBLEM – LONG-TERM NOTE – MATURITY VALUE IS
PAYABLE IN LUMP-SUM
• The following are the entries related to the note from 2018 through 2021. (cont.)
2020
Dec. 31 Interest Expense 355,424
Discount on Notes Payable 355,424
(330,572 x 3/12) +
(330, 708 x 9/12)
2021
Mar. 31 Interest Expense
Notes Payable 90,927
Discount on Notes Payable 4,000,000
Cash 90,927
363,708 x 3/12 = 90,927 4,000,000

• In the given illustration, the amortization of discount on notes payable is made only at
year-end. Alternatively, amortization may be made every anniversary date of the note,
with appropriate adjustment at year-end to update the amortization.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATIVE PROBLEM – LONG-TERM NOTE, MATURITY VALUE IS
PAYABLE IN INSTALLMENTS
• Assume that on March 31, 2018, the MNO Corporation issued a three-year,
P3,000,000, non-interest bearing promissory note for a machinery purchased. The
note is payable in installments of P1,000,000 every March 31, starting March 31,
2019. The equivalent cash price of the machinery acquired is P2,401,800. Assume that
the company uses the calendar year as its accounting period.
• To determine the effective interest on this note, the present value factor is computed
by dividing the present value P2,401,800 by the periodic payment of P1,000,000.
Thus, the present value for three periods is 2.4018. Finding the appropriate interest
rate in Table IV in the Appendix (Present value of an Ordinary Annuity), on line 3,
corresponding to the number of period, the factor 2.4018 is under the column 12%.
Thus, the effective interest rate is 12%.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATIVE PROBLEM – LONG-TERM NOTE, MATURITY VALUE IS
PAYABLE IN INSTALLMENTS
• The following table shows the amortization of discount on the note payable.
Periodic Payment Applied to Balance of
Date Payment Interest Principal Principal, end
03/31/18 P2,401,800
03/31/19 P1,000,000 P288,216 P711,784 1,690,016
03/31/20 1,000,000 202,802 797,198 892,818
03/31/21 1,000,000 107,182* 892,818 -0-

*Adjusted. Difference is due to rounding off.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATIVE PROBLEM – LONG-TERM NOTE, MATURITY VALUE IS
PAYABLE IN INSTALLMENTS

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

• The following entries for years 2018 through 2021.
2018
Mar. 31 Machinery 2,401,800
Discount on Notes Payable 598,200
Notes Payable 3,000,000
Dec. 31 Interest Expense 216,162
Discount on Notes Payable 216,162

Robles & Empleo

288,216 x 9/12
2019
Mar. 31 Interest Expense 72,054
Discount on Notes Payable 72,054
288,216-216,162
2019
Mar. 31 Notes Payable 1,000,000
Cash 1,000,000
Dec. 31 Interest Expense 152,102
Discount on Notes Payable 152,102
202,802 x 9/12
ILLUSTRATIVE PROBLEM – LONG-TERM NOTE, MATURITY VALUE IS
PAYABLE IN INSTALLMENTS
• The following entries for years 2018 through 2021. (cont.)
2020
Mar. 31 Interest Expense 50,700
Discount on Notes Payable 50,700
202,802 – 152,102
31 Notes Payable 1,000,000
Cash 1,000,000
Dec. 31 Interest Expense 80,387
Discount on Notes Payable 80,387
107,182 x 9/12
2021
Mar. 31 Interest Expense 26,795
Discount on Notes Payable 26,795
107,182 - 80,387
31 Notes Payable 1,000,000
Cash 1,000,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATIVE PROBLEM – LONG-TERM NOTE, MATURITY VALUE IS
PAYABLE IN INSTALLMENTS
• On December 13, 2018, the Notes Payable and the related Discount on Notes Payable
have the following balances:
Total Current Non-Current
Notes Payable P3,000,000 P1,000,000 P2,000,000
Less: Discount in Notes Payable 382,038 72,054 309,984
Carrying Amount P2,617,962 P927,946* P1,690,016

*Portion classified as current liabilities = Principal due next year P711,784

+ interest from March 31, 2018 to Dec. 31, 2018 of P216,162 = P927,946

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
BONDS PAYABLE
BONDS PAYABLE
Nature of Bonds
• A bond is a certificate of indebtedness whereby the borrower agrees to
pay a sum of money at a specified future date plus periodic interest
payments at the stated rate. They are commonly issued in denominations
of P1,000, P5,000, or P10,000, referred to as face value or par value.
Normally, a corporation sells all of its bonds to an investment firm,
referred to as an underwriter, which resells the bonds to the investing
public. In some instances, bonds are sold directly to investors.
• The contract between the issuing corporation and the bondholder is
known as bond indenture. The bond indenture specifies the terms of the
bonds, rights and duties of both parties, restrictions on the issuing
corporation and all other important details affecting the contracting
parties.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
BONDS PAYABLE
Types of Bonds
• The more common types of bonds are term bonds, serial bonds, secured
bonds, unsecured bonds, registered bonds, bearer bonds, convertible
bonds and callable or redeemable bonds.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
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.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
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 held by the issuer as
investments; a chattel mortgage bond is secured by a lien against
movable property like motor vehicles.
• On other hand, unsecured bonds, frequently termed as debentures, are
not protected by the pledged of any specific asset of 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 a favorable interest rates.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
REGISTERED BONDS AND BEARER (OR COUPON) BONDS
• Registered bonds are bonds whose owners’ names are registered in the
books of the issuing corporation. When these bonds are sold, the transfer
agent cancels the original certificate surrendered by the seller, and a new
certificate is issued and registered in the name of the new bondholder.
Interest checks are mailed 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 as well
as preparing and mailing periodic interest checks

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
CALLABLE BONDS AND CONVERTIBLE BONDS
• Callable or redeemable bonds are those that 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 in accordance with the call provisions.
• Convertible bonds are those that give the bondholders the right to
exchange their bond holdings into a specified or predetermined number
of the issuing corporation’s shares of stock.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ZERO-INTEREST BONDS
• Zero-interest bonds, also known as deep-discount bonds, are issued at
significantly lower than their face value. Total interest on these bonds
during their entire term is paid together with the principal amount on
maturity date.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ISSUANCE OF BONDS
• An entity shall recognize financial liability in its statement of financial position
when, and only when, the entity 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.
• Bonds liabilities are initially recognized at their discounted value, which equals the
net proceeds from their issuance. The issue price of the bonds is the market price
of the bond, which varies with the safety of the investment and the prevailing
market rate of interest for similar instruments.
• The rate of interest stated on the face of the bond is termed as the contract rate,
stated rate or nominal rate of interest. 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 the risk factor increases, the company needs to offer a higher
interest rate in order to attract investors.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ISSUANCE OF BONDS
• The interest rate which investors are willing accept on a bond at the time of its
issue depends upon some factors such as the market evaluation of the quality
of the quality of the bond issue 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 agreement between the bond stated
rate of interest and the prevailing market rate of interest.
• 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 than the face value, the difference is referred to as a discount.
• Similarly, if the bond rate exceeds the market interest rate for comparable
instruments at the time of the issue, the price of the bonds will exceed the
face amount; that is, the bonds will be sold at a premium.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ISSUANCE OF BONDS
• When bonds are sold at face value, the entry is simply to debit cash and
credit bonds payable at the proceeds, which equals the face value.
The sale of bonds at a premium is recorded as
Cash (at the selling price) xx
Bonds Payable (at face value) xx
Premium on Bonds Payable (selling price – face value) xx

The sale of bonds at a distance is recorded as

Cash (at selling price) xx
Discount on Bonds Payable (face value – selling price) xx
Bonds Payable xx

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ISSUANCE OF BONDS
• 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 value of bonds payable.
• Bond prices are quoted in the market as a percentage of face value. For
example, a bond quoted at 97 ½ means that the market price is 97.5% of
face value; thus, the bond is trading at a discount. A quotation of 105
means that the market price is 105% of face value; thus, the bond is
trading at a premium.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ISSUANCE OF BONDS
• When bond quotations are not available, the market price can be
determined by discounting the maturity value of the bond and all interest
payments at the market rate of interest for similar debt on that date. Note
that the computation of bond price is similar to that of the investor’s
viewpoint. Thus, to reiterate the computation, assume the following
information:
On January 1, 2018, 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
value plus the present value of the periodic interest payment, both
discounted at the market rate of interest at the date the bons are issued.
For the purpose of computing the proceeds, the discount rate to be used is
6% (which is 12% x 6/12) since interest is payable semi-annually and the
number of periods CBET
to Department
be used is 10 (which is 5 years x 2).
of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ISSUANCE OF BONDS
• Thus, the proceeds from the issue of the P1,000,000 bonds described is computed as follows:
Present value of maturity value
Face value x PVF of P1 at 6% for 10 periods
1,000,000 x 0.558395 P 558,395
Present value of 10 interest payments
Interest per period x PVAF of P1
at 6% for 10 periods
Interest per period = P1.M x 7.5% = 75,000
75,000 x 7.36008 552,006
Bond Price P1,110,401
• Alternatively, the bond price may be computed as follows:
Difference in interest rates x Face value x PVAF
= Discount or Premium
Face value – Discount (or + Premium) = 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 + 110,401 = 1,110,401 bond price

CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ISSUANCE OF BONDS
• The issuance of the bonds on January 1, 2018 is recorded as follows:
Cash 1,110,401
Bonds Payable 1,000,000
Premium on Bonds Payable 110,401
• Assume, a reverse scenario regarding interest rates. On January 1, 2018, a
company issues a 5-year P1,000,000, 12% bonds. The effective interest
date for similar bonds is 15%. Interest on the bonds is payable semi-
annually on June 30 and December 31.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ISSUANCE OF BONDS
• The bond price is computed as follows:
Present value of maturity value
Face value x PVF of P1 at 7.5% for 10 periods
1,000,000 x 0.485194 P 485,194
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% = 60,000 411,845
Bond Price P 897,039
• Alternatively, the computation of bond price is made as follows:
Difference in interest rates x Face value x PVAF
= Discount or Premium
Face value – Discount (or + premium) = 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, 2018 is recorded as follows:
Cash 897,039
Discount on Bonds Payable 102,961
Bonds Payable 1,000,000
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ACCRUED INTEREST ON BONDS 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 interest date, the bondholder is usually required
to purchase the interest that has accrued from the most previous interest
date to the date of sale. This accrued interest is added to the issue price
of the bond to determine the total cash proceeds from the bond issuance.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ACCRUED INTEREST ON BONDS ISSUED
• Assume that 1,000 bonds of P1,000 face value, dated January 1, 2018 were
sold on March 1, 2018 at 112 plus accrued interest. The bonds pay interest
at 15% semi-annually on June 30 and December 31.
The issuance of bonds on March 1, 2018 is recorded as
Cash 1,145,000
Bonds Payable 1,000,000
Premium on Bonds Payable 120,000
Interest Payable 25,000
1,000,000 x .15 x 2/12 = 25,000
The payment of accrued interest on June 30 (the first periodic interest
payment) is then recorded as follows:
Interest Expense 50,000
Interest Payable 25,000
Cash 75,000
1,000,00 x .15 x 6/12
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ACCRUED INTEREST ON BONDS ISSUED
• Alternatively, on March 1, 2019, the accrued interest received may be
credited o Interest Expense account (instead of Interest Payable). This
nominal approach may appear to be more convenient since subsequent
transactions, such as payment of interest, will be recorded in the usual
manner without need for further adjustments. Payment of interest on
June 30 is, then, recorded as:
Interest Expense 75,000
Cash 75,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TRANSACTION COSTS ON ISSUE OF BONDS
• Bond issue costs are expenditures incurred by the issuing company for
legal fees, printing and engraving of bond certificates, taxes, commissions
and similar charges. When a financial liability is recognized initially, an
entity shall measure it at its fair value (issue price) and considering
transactions costs that are directly attributable to the issue of the
financial liability. This means that bond issue costs form part of the initial
carrying amount of the bond liability. In effect, the net proceeds are
reduced by incurrence of bond issue cost. The determination of the initial
amount of the premium or discount on bonds payable is based on the
difference between the face value and net proceeds.
• The incurrence of bond issue requires a re-computation of the yield or
effective interest rate on the bond issue.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TRANSACTION COSTS ON ISSUE OF BONDS
• To illustrate accounting for bond issue costs, assume that XYZ sells its
P1,000,000 face value, five year, 12% bonds on the bond date, January 1,
2018. The bonds were sold at 110. Bond issue costs of P15,000, consisting of
promotions, engraving, printing and underwriter’s commission, were
incurred and paid by the company.
• The entries for the issuance of the bonds and the payment of bond issue
costs are as follows:
Cash 1,100,000
Bonds Payable 1,000,000
Premium on Bonds Payable 100,000
Issue of bonds @ 110
Premium on Bonds Payable 15,000
Cash 15,000
Paid bond issue costs
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TRANSACTION COSTS ON ISSUE OF BONDS
• To illustrate accounting for bond issue costs, assume that XYZ sells its
P1,000,000 face value, five year, 12% bonds on the bond date, January 1,
2018. The bonds were sold at 110. Bond issue costs of P15,000, consisting of
promotions, engraving, printing and underwriter’s commission, were
incurred and paid by the company.
• The entries for the issuance of the bonds and the payment of bond issue
costs are as follows:
Cash 1,100,000
Bonds Payable 1,000,000
Premium on Bonds Payable 100,000
Issue of bonds @ 110
Premium on Bonds Payable 15,000
Cash 15,000
Paid bond issue costs
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TRANSACTION COSTS ON ISSUE OF BONDS
• After recording the payment of bond issue costs, the premium on bonds
payable is reduced to P85,000. The carrying amount og the liability on
issue date is, therefore, P1,085,000, which is the basis for the
computation of the bond yield.
• The bond yield is a rate lower than 12% because the bonds were sold at a
premium. Such yield may be computed on trial and error basis.
• If the yield is 10%, the proceeds should be approximately P1,075,815,
computed as follows:
Present value of maturity value
P1,000,000 x 0.62092 = P 620,920
Present value of periodic interest
P120,000 x3.79079 = 454,895
Total present value P1,075,815
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TRANSACTION COSTS ON ISSUE OF BONDS
• A principle in mathematics of investment indicates that the higher is the
yield, the lower is the present value, and the lower the yield, the higher
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 is 95% the proceeds should be approximately P1,095,995,
computed as follows:
Present value of maturity value
P1,000,000 x 0.63523 = P 635,230
Present value of periodic interest
P120,000 x 3.8971 = 460,765
Total present value P1,095,995

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TRANSACTION COSTS ON ISSUE OF BONDS
• 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 x
P1,095,95 – P1,075,815 (10% - 9.5%)

0.4552 x 0.5% = 0.23%

Approximate yield is 10% - 0.23% = 9.77%
• To check:
Using a discount rate of 9.77%

Present value of maturity value

P1,000,000 x 0.62745 = P 627,453
Present value of periodic interest
P120,000 x 3.81317 = 457,580
Total P1,085,033 CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TRANSACTION COSTS ON ISSUE OF BONDS
• Because the computed net proceeds above approximates P1,085,000, the
approximated yield on the bonds issued is 9.77%; thus, interest expense
during the term of the bond would be recorded based on such an
effective interest rate. The effective interest rate may also be computed
using a financial calculator or an Excel Worksheet.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
PREMIUM AND DISCOUNT AMORTIZATION
• Bonds are financial liabilities that are subsequently measured 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 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 not
represent the complete interest expense for the periods involved. In order to
reflect the total interest cost of the bonds, bond premium or discount should
be allocated over the life of the bonds using the effective interest method.
This allocation, called amortization, is a deduction from or addition to the
interest expense. The amortization of premium or discount results in a
gradual adjustment of the bond’s carrying amount toward the bond’s face
value and adjustment of the nominal interest to the effective interest.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
EFFECTIVE INTEREST METHOD
• Under the effective interest method, a constant interest rate based on the
beginning of period carrying amount of the bonds is recognized as
interest expense each period ., resulting in unequal recorded amounts of
interest expense. The effective interest method provides an increasing
premium or discount amortization each period.
• To obtain a period’s interest expense under this method. The bond’s
carrying amount at the beginning of each interest period is multiplied by
the effective interest rate. The difference between this amount and the
amount of interest paid or accrued (nominal interest rate x face value of
the bonds is the amount of discount or premium amortization.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Premium Situation
• Assume that a P1,000,00, 5-year, 15% bonds were issued on January 1,
2018 for P1,110,401, an issue price that provides a yield of 12%. Interest
on the bonds is payable semi-annually on June 30 and December 31.
• The table of bond premium amortization for the entire term of the bonds
is shown overleaf. The detailed computations are shown below:
A. Nominal interest = Face value x semi-annual stated interest rate
B. Effective interest = Bond carrying value, beg of period x semi-annual
market rate
C. Premium Amortization = (A) – (B)
D. Carrying value, end = Bond carrying value, beg of period – premium
amortization for the period
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Premium Situation
Bond Premium Amortization Table

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Effective Interest Method
(A) (B) (C) (D)
Nominal Effective Premium Bond Carrying
Interest Interest Amortization Value
Date P1M x 7.5% Previous (D) x 6% (A)-(B) Previous (D)-(C)
01/01/18 1,110,401
06/30/18 75,000 66,624 8,376 1,102,025

Robles & Empleo

12/31/18 75,000 66,122 8,878 1,093,147
06/30/19 75,000 65,589 9,411 1,083,736
12/31/19 75,000 65,024 9,976 1,073,760
06/30/20 75,000 64,426 10,574 1,063,186
12/31/20 75,000 63,791 11,209 1,051,977
06/30/21 75,000 63,199 11,881 1,040,096
12/31/21 75,000 62,406 12,594 1,027,502
06/30/22 75,000 61,650 13,350 1,014,152
12/31/22 75,000 60,848* 14,152 1,000,000
*The effective interest for the period ended December 31, 2022 has been adjusted.
The difference is due to rounding off.
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Premium Situation
• On maturity date, after appropriate amortization of premium for the
entire term is recorded, the bond’s carrying value will be equal to its face
value.
• It can be noted that amortization of premium tends to reduce both the
carrying value and the interest expense on the bond.
• The journal entries for the years 2018 and 2019 relating to this bond are
as follows (refer on the next slide):

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Premium Situation
2018
Jan. 1 Cash 1,110,401
Premium on Bonds Payable 110,401
Bonds Payable 1,000,000
Jun 30 Interest Expense 66,624
Premium on Bonds Payable 8,376
Cash 75,000
Dec. 31 Interest Expense 66,122
Premium on Bonds Payable 8,878
Cash 75,000
2019
Jun 30 Interest Expense 65,589
Premium on Bonds Payable 9,411
Cash 75,000
Dec. 31 Interest Expense 65,024
Premium on Bonds Payable 9,976
Cash 75,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Premium Situation
• Based on the foregoing table of amortization and journal entries for the
years 2018 and 2019, the statement of financial position on December 31,
2018 and December 31, 2019 would show bonds payable at carrying
amounts of P1,093,147 and P1,073,760, respectively, supported by ledger
balances as follows:

12/31/18 12/31/19
Bonds Payable P1,000,000 P1,000,000
Premium on Bonds Payable 93,147 73,760
Carrying amount P1,093,147 P1,073,760

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Premium Situation
• The profit or loss section of the statement of comprehensive income for
the years ended December 31, 2018 and 2019 will show interest expense
of P132,746 and P130,613, respectively, computed as follows:

2018 2019
January 1 to June 30 66,624 65,589
July 1 to December 31 66,122 65,024
Total interest expense 132,746 130,613

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Premium Situation
• Notice the following trends using the effective interest method when
bonds are sold at a premium:
1. Interest expense decreases each period, because the carrying value
also decreases as the premium is amortized/
2. The amount of premium amortization increases each period as the
difference between the nominal interest and the effective interest
becomes wider each period.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Premium Situation
• On maturity date, other than the entry for the payment of interest and
amortization of premium, an entry is also made for the payment of the
bonds at face value.
• On maturity date of the bonds (December 31, 2022), the issuer of these
bonds prepares the following entries:
Interest Expense 60,848
Premium on Bonds Payable 14,152
Cash 75,000
Payment of periodic interest
and amortization of premium
Bonds Payable 1,000,000
Cash 1,000,000
Payment on maturity date
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Discount Situation
• Assume that the P1,000,000 12% bonds were sold for P917,039. The
issuer incurred transaction costs (bond issue costs) of P20,000. The yield
on the net proceeds is computed at 15%.
• The table overleaf shows the amortization of bonds discount under the
effective interest method for the entire life of the bonds.
A. Nominal Interest = Face value x semi-annual stated interest rate
B. Effective Interest = Bond carrying value, beg of period x semi-annual
market rate
C. Discount amortization = (B) – (A)
D. Carrying value, end = Carrying value, beg of period + discount
amortization

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Discount Situation
Bond Discount Amortization Table

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

(A)
Effective(B)
Interest Method (C) (D)
Nominal Effective Discount Bond Carrying
Interest Interest Amortization Value
Date 6% x P1M Previous (D) x (B) – (A) Previous (D)+(C)
7.5%

01/01/18 897,039

Robles & Empleo

06/30/18 60,000 67,278 7,278 904,315
12/31/18 60,000 67,824 7,824 912,139
06/30/19 60,000 68,410 8,410 920,549
12/31/19 60,000 69,041 9,041 929,590
06/30/20 60,000 69,719 9,719 939,309
12/31/20 60,000 70,448 10,448 949,757
06/30/21 60,000 71,232 11,232 960,989
12/31/21 60,000 72,074 12,074 973,063
06/30/22 60,000 72,980 12,980 986,043
12/31/22 60,000 73,957* 13,958 1,000,000
*The effective interest for the period ending December 31, 2022 has been adjusted.
The difference is due to rounding off.
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Discount Situation
• The journal entries for the years 2018 and 2019 relating to this bond are as follows:
2018
Jan. 1 Cash 917,039
Discount on Bonds Payable 82,961
Bonds Payable 1,000,000
1 Discount on Bonds Payable 20,000
Cash 20,000
Jun. 30 Interest Expense 67,278
Discount on Bonds Payable 7,278
Cash 60,000
Dec. 31 Interest Expense 67,824
Discount on Bonds Payable 7,824
Cash 60,000
2019
Jun. 30 Interest Expense 68,410
Discount on Bonds Payable 8,410
Cash 60,000
Dec.31 Interest Expense 69,041
Discount on Bonds Payable 9,041
Cash 60,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Discount Situation
• Based on the foregoing table of amortization and journal entries for the
years 2018 and 2019, the statement of financial position on December 31,
2018 and December 31, 2019 would show bonds payable at carrying
amounts of P912,139 and P929,590, respectively, supported by ledger
balances as follows:

12/31/18 12/31/19
Bonds Payable P1,000,000 P1,000,000
Less: Discount on Bonds Payable 87,861 70,410
Carrying amount P 912,139 P 929,590

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Discount Situation
• The profit or loss section of the statements of comprehensive income for
the years ended December 31, 2018 and 2019 shall show interest
expense of P135,102 and P137,451, respectively, computed as follows:

2018 2019
January 1 to June 30 P 67,278 P 68,410
July 1 to December 31 67,824 69,041
Total interest expense P 135,102 P 137,451
• In contrast to the effect of premium amortization, discount amortization
increases the carrying value of the bonds, such that on maturity date, the
carrying value will equal the face value.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
ILLUSTRATION FOR EFFECTIVE INTEREST METHOD
Discount Situation
• Notice the following trends using the effective interest method when
bonds are sold at a discount:
1. Interest expense increases each period, because the carrying value
also increases as the discount is amortized.
2. The amount of the discount amortization increases each period as
the difference between the nominal interest and the effective
interest becomes wider.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
WHEN THE BOND YEAR DOES NOT COINCIDE WITH THE REPORTING
PERIOD
• If the bond year does not coincide with the reporting period, other than
the entries every interest payment date, an adjusting entry is made at
year-end to accrue interest and update the amortization of premium or
discount.
• To illustrate, let us reproduce a portion of the previous amortization table.
Assume instead that the bonds are dated March 1, 2018 and pay interest
semiannually every February 28 and August 31. The issuer uses the
calendar year as its reporting period.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
WHEN THE BOND YEAR DOES NOT COINCIDE WITH THE REPORTING
PERIOD
Bond Discount Amortization Table
Effective Interest Method
(A) (B) (C) (D)
Nominal Effective Discount Bond Carrying
Interest Interest Amortization Value
Date 6% x P1M 7.5% x Previous (D) (B) – (A) Previous (D)+(C)
03/01/18 897,039
08/31/18 60,000 67,278 7,278 904,315
02/28/19 60,000 67,824 7,824 912,139
08/31/19 60,000 68,410 8,410 920,549
02/28/20 60,000 69,041 9,041 929,590

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
WHEN THE BOND YEAR DOES NOT COINCIDE WITH THE REPORTING
PERIOD
• The journal 2018
entries for the years 2018 relating to this bond are as follows:
Jan. 1 Cash 917,039
Discount on Bonds Payable 82,961
Bonds Payable 1,000,000
Mar. 1 Discount on Bonds Payable 20,000
Cash 20,000
Aug. 31 Interest Expense 67,278
Discount on Bonds Payable 7,278
Cash 60,000
Dec. 31 Interest Expense 45,216
Discount on Bonds Payable 5,216
Interest Payable 40,000
67,824 x 4/6 = 45,216
7,824 x 4/6 = 5,216
1M x 12% x 4/12 = 40,000

• The previous 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
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
WHEN THE BOND YEAR DOES NOT COINCIDE WITH THE REPORTING
PERIOD
• The following are the entries for the year 2019:
2019
Jan. 1 Discount on Bonds Payable 5,216
Interest Payable 40,000
Interest Payable 45,216
Feb. 28 Interest Expense 67,824
Discount on Bonds Payable 7,824
Cash 60,000
Aug. 31 Interest Expense 68,410
Discount on Bonds Payable 8,410
Cash 60,000
Dec. 31 Interest Expense 46,027
Discount on Bonds Payable 6,027
Interest Payable 40,000
69,041 x 4/6 = 46,027
9,041 x 4/6 = 6,027

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
WHEN THE BOND YEAR DOES NOT COINCIDE WITH THE REPORTING
PERIOD
• The interest expense for the year 2018 is broken down as follows (refer to
the amortization table):
March 1 to August 31 P 67,278
September 1 to December 31 (67,824 x 4/6) 45,216
Total interest expense for 2018 P112,494
The interest expense for the year 2019 is computed as follows

January 1 to February 28 (67,824 – 45,216) P 22,608

March 1 to August 31 68,410
August 31 to December 31 (69,041 x 4/6) 46,027
Total interest expense for 2019 P137,045

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
WHEN THE BOND YEAR DOES NOT COINCIDE WITH THE REPORTING
PERIOD
• The carrying amount of the bonds at December 31, 2019 is computed as
follows (refer to the amortization table)
Carrying amount, August 31, 2019 P920,549
Add: Amortization of discount
from September 1 to December 31
(9,041 x 4/6) 6,027
Carrying amount, December 31,1 2019 P926,576

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
WHEN THE BOND YEAR DOES NOT COINCIDE WITH THE REPORTING
PERIOD
• The following ledger balances support the carrying amount computed at
December 31, 2019:
Bonds Payable P1,000,000
Less: Discount on Bonds Payable
(82,961 + 20,00 – 7,278 – 5,216 + 5,216
- 7,824 – 8,410 – 6,027) 73,422
Carrying amount, December 31, 2019 P 926,578*
*The difference of P2 is due to rounding off.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
RETIREMENT OF BONDS
• The issuing corporation may retire bonds at maturity date or before the
maturity date either by redeeming the bonds or repurchasing them in the
open market. If the bonds are retired at their maturity date, any premium
or discount will have been completely amortized. The retirement is
recorded as an ordinary payment of debt, and no gain or loss is
recognized upon retirement on maturity date. Hence, the entry for the
settlement of the bonds on maturity date is:
Bonds Payable xx
Cash xx
• The amount of cash paid to the bondholders equals the face value of the
bonds.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
RETIREMENT OF BONDS
• Meanwhile, when the bonds are retired prior to their maturity and the
retirement price is less than the carrying amount of the bonds, the entity
realizes a gain on the retirement. The carrying value is equal to the face
value of the bonds plus any unamortized premium or less any
unamortized discount on the date of retirement. Similarly, if the
retirement price is greater than the carrying value, a loss is incurred on
the retirement of the debt. Gain or loss on the retirement of bonds is
reported in profit or loss statement as an operating gain or loss.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
RETIREMENT OF BONDS
• When bonds are retired before maturity date, the following must be
observed:
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 most recent
interest payment date up to date of retirement must be recorded
and paid.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
RETIREMENT OF BONDS
• To illustrate the accounting procedures required for the retirement of
bonds prior to maturity, let us refer to the amortization table using the
effective interest method for the bonds exemplified on previously.
• To recall the information, the bonds have face value of P1,000,000 and
bear annual interest rate of 15% with interest payable semi-annually
every June 30 and December 31. The bonds were sold at a price that yield
12%.
• Assume that these bonds were retired by the issuer on October 31, 2021
@ 102 plus accrued interest. Assume further that the company prepared
appropriate entries every interest payment dates until June 30, 2021.
• Since the last payment of interest and amortization of premium are made
on July 30, 2021, a proportionate interest expense should be recorded
from July 1 through October 31, 2021.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
RETIREMENT OF BONDS
Bond Premium Amortization Table
Effective Interest Method
(A) (B) (C) (D)
Nominal Effective Premium Bond Carrying
Interest Interest Amortization Value
Date P1M x 7.5% Previous (D) x 6% (A)-(B) Previous (D)-(C)
01/01/18 1,110,401
06/30/18 75,000 66,624 8,376 1,102,025
12/31/18 75,000 66,122 8,878 1,093,147
06/30/19 75,000 65,589 9,411 1,083,736
12/31/19 75,000 65,024 9,976 1,073,760
06/30/20 75,000 64,426 10,574 1,063,186
12/31/20 75,000 63,791 11,209 1,051,977
06/30/21 75,000 63,199 11,881 1,040,096
12/31/21 75,000 62,406 12,594 1,027,502
06/30/22 75,000 61,650 13,350 1,014,152
12/31/22 75,000 60,848 14,152 1,000,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
RETIREMENT OF BONDS
• On October 31, 2021, the issuer should update the interest and
amortization of premium with the following entry.
2021
Oct. 31 Interest Expense 41,604
Premium on Bonds Payable 8,396
Interest Payable 50,000
62,406 x 4/6 = 41,604
12,594 x 4/6 = 8,396
75,000 x 4/6 = 50,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
RETIREMENT OF BONDS
• The carrying amount of the bonds on October 31, 2021 is P1,031,700,
computed as follows:
Carrying amount on June 30, 2021 P1,040,096
Less: amortized premium July 1 to October
31, 2021 (12,594 x 4/6) 8,396
Carrying amount, October 31, 2021 P1,031,700
• Upon retirement of the bonds, the amount to be paid by the issuer is
P1,070,000, computed as follows:

Retirement price (1,000,000 x 102%) P1,020,000

Accrued interest from July 1 to Oct. 31
(1,000,000 x 15% x 4/12) 50,000
Total cash paid P1,070,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
RETIREMENT OF BONDS
• The retirement of the bonds results in a gain of P11,700, computed as follows:
Retirement priced (1,000,000 x 102%) P1,020,000
Carrying amount of the bonds 1,031,700
Gain on retirement of bonds P 11,700
• To record the retirement of the bonds on October 31, 2021, the following entry is
made:

Bonds Payable 1,000,000

Premium on Bonds Payable 31,700
Interest Payable 50,000
Cash 1,070,000
Gainthe
• Notice that ongain
Retirement of Bonds
or loss on the retirement of debt is not affected by11,700
the accrued
interest, since the accrued interest is recorded separately as Interest Expense.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
BOND REFUNDING
• Oftentimes, it is advantageous for the issuing corporation to acquire the
entire outstanding bond issue and replace it with a new bond issue
bearing a lower interest rate. This replacement of an 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. The issue is recorded as a separate
borrowing transaction.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
BONDS WITH EQUITY CHARACTERISTICS
• Corporations may issue bonds that allow creditors to ultimately become
shareholders by either attaching share warrants to the bonds or including
a conversion feature in the bond indenture. In either case, the investor
has acquired a dual set of rights, namely: the right to receive interest and
principal payment on the bonds and the right to acquire ordinary shares
and participate in the potential appreciation of the market value of the
shares.
• Usually, the bonds of this nature are attractive to investors and will
generally result in either a relatively lower interest rate or greater
proceeds when compared with other bond issues with similar risk but
without such rights.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
BONDS WITH EQUITY CHARACTERISTICS
Bonds with Non-Detachable Share Warrants Issued
• When bonds are issued with share warrants attached, the bondholders
are given the right to acquire a specified number of ordinary shares
(common stock) of the issuing corporation at a given price within a
certain time period.
• When warrants are included in the issue of bond, the issue price shall be
allocated between the debt (the bond) and the equity (the warrants).
Based on the concept that equity represents residual interest in the
assets of the corporation, the equity component is assigned the residual
amount after deducing from the fair value of the compound instrument
(bond with warrant) as a whole the amount separately determined for
the liability component. This method of bifurcation is called the residual
approach.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
BONDS WITH EQUITY CHARACTERISTICS
Bonds with Non-Detachable Share Warrants Issued
• To illustrate, on December 31, 2018, ABC Corporation issued 1,000 of its 10%, 10-year,
P1,000 face value bonds with non-detachable share warrants at 103. Each bond carried
two detachable 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 (1,000,000 x 103%) P1,030,000
Market price of bonds without warrants
97% x P1,000,000 970,000
Price assigned to warrants P 60,000
• The entry for the issuance of the bonds with non-detachable share warrants described
above is
Cash 1,030,000
Discount on Bonds Payable 30,000
Bonds Payable 1,000,000
Share Warrants Outstanding 60,000
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
BONDS WITH EQUITY CHARACTERISTICS
Bonds with Non-Detachable Share Warrants Issued
• The discount on bonds payable recorded above is the excess of the face value of
the bonds of P1,000,000 over the market price without the warrants, P970,000.
• The account Share Warrants Outstanding is reported as part of additional paid
in capital in the equity section of the statement of financial position.
• When share warrants are subsequently exercised, the following entry will be
made:
Cash 50,000
Share Warrants Outstanding 60,000
Ordinary Share Capital 40,000
Share Premium – Ordinary 70,000
1,000 x 2 x 25 = 50,000
1,000 x 2 x 20 = 40,000
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
BONDS WITH EQUITY CHARACTERISTICS
Bonds with Non-Detachable Share Warrants Issued
• When the market price of the bonds without the warrants is not readily
determinable, it shall be computed by discounting the maturity value and
periodic interest at the market rate of interest for similar debt
instruments without the equity component.
• To illustrate, assume that P5,000,000, 8% ten-year bonds were issued on
bond issue date at 105. Each P1,000 bond carried two non-detachable
share warrants, each warrant entitling the holder to purchase one share
of the company’s P200 par value ordinary share capital at P250 per share.
Similar instruments without any equity component are being traded at
prices that yield 10%. Interest is payable annually.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
BONDS WITH EQUITY CHARACTERISTICS
Bonds with Non-Detachable Share Warrants Issued
• The issue price of 5,250,00 (P5,000,000 x 1.05) is bifurcated as follows:
Total issue price P5,250,000
Less: Market value of the bonds without the warrants
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
Issue price assigned to the warrants P 864,472
• The issue of the bonds results to 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 P4,385,528.
• 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 5,000,000
Share Warrants Outstanding 864,472
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
CONVERTIBLE BONDS
• Another example of a compound financial instrument is convertible bond.
Convertible bonds give the holders thereof the right to exchange their bondholding
into ordinary shares or other securities of the issuing company within a specified
period of time.
• The principle of splitting the issue price of a compound financial instrument to its
debt component and equity component is applied. The issue price of the convertible
component is comprised of two components: a financial liability (the bond liability)
and an equity instrument (the bond conversion privilege). The total issue price is
bifurcated using the residual approach.
• 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 associated equity component. The amount of
the equity instrument represented by the option to convert the 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).
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
CONVERTIBLE BONDS
• To illustrate, assume that XYZ Corporation issued P5,000,000, 14% bonds at
105 on bond issue date. Each P1,000 bond is convertible into 5 shares of
P100 par value ordinary shares. Without the conversion feature, the bonds
would have sold at 102. The total issue price of the bonds is then allocated to
bond liability and to equity as follows:
Total proceeds (5,000,000 x 105%) P5,250,000
Market value of bonds without the conversion privilege
(P5,000,000 x 102%) 5,100,000
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 100,000
Share Premium – Bond Conversion Privilege 150,000
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
CONVERTIBLE BONDS
• In circumstances when the bonds 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.
• To illustrate, assume that on January 1, 2018, DEF issued 10-year,
P2,000,000 convertible bonds for a total consideration of P2,400,000. The
bonds pay interest at 10% annually every December 31. Each P1,000 bond
is convertible into 4 shares of P100 par ordinary share. Similar
instruments without the conversion feature would have sold to yield 8%.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
CONVERTIBLE BONDS
• The issue price of P2,400,000 is bifurcated as follows:
Total issue price P2,400,000
Issue price assigned to bonds
2,000,000 x 0.46319 P 926,380
200,000 x 6.71009 1,342,018 2,268,398
Price assigned to conversion feature P 131,602
• The entry to record the issuance is
Cash 2,400,000
Bonds Payable 2,000,000
Premium on Bonds Payable 268,398
Share Premium – Bonds Conversion Privilege 131,602

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
CONVERTIBLE BONDS
Exercise of Bond Conversion Privilege
• Assume that before maturity date of the bonds, holders of P2,000,000
face value bonds exercised their conversion privilege when each ordinary
share sells for P130. Further assume that on this dater, the balance of
premium on bonds payable is P30,000
The conversion of bonds is recorded as follows:
Bonds Payable 2,000,000
Premium on Bonds Payable (30,000 x 2/5) 12,000
Share Premium – Bond Conversion
Privilege (150,000 x 2/5) 60,000
Ordinary Share Capital (2,000 x 5 x 100) 1,000,000
Share Premium – Ordinary 1,072,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
CONVERTIBLE BONDS
Exercise of Bond Conversion Privilege
• Note that no gain or loss is recognized upon conversion of bonds into
ordinary shares. This is because the conversion is accordance with the
original terms of the bonds.
• When conversion takes place between interest payment dates, any
accrued interest should be paid in cash. Expenditure incurred related to
conversion are recorded by reducing the additional paid-in capital (share
premium) pertaining to shares issued upon conversion. Any excess of
expenditures over the related share premium shall be recorded as
expense during the period of conversion.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
CONVERTIBLE BONDS
Retirement of Convertible Bonds Prior to Maturity
• When convertible bonds are retired before maturity date, the proceeds from the
retirement shall be allocated to the liability to be settled and the equity portion for
bond conversion privilege. The method used in allocating the consideration paid
and transaction costs to the separate components is consistent with that used in
the original allocation to the separate components of the proceeds received by the
entity when the convertible instrument was issued (residual approach).
• Once the allocation of the consideration is made, any resulting gain or loss is
treated in accordance with accounting principles applicable to the related
component as follows:
a) the amount of gain or loss relating to the liability component is recognized in
profit or loss; and
b) the amount of gain or loss relating to the equity component is recognized in
equity.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
CONVERTIBLE BONDS
Retirement of Convertible Bonds Prior to Maturity
• 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.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
CONVERTIBLE BONDS
Retirement of Convertible Bonds Prior to Maturity
• The retirement price is allocated as follows:
Total retirement price P1,050,000
Retirement price on account of the liability
(1,000,000 x 103%) 1,030,000
Retirement price on account of equity portion 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) 8,000
Carrying value of bonds retired P1,008,000
Retirement price on account of bond liability 1,030,000
Loss on retirement of bonds P 22,000
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
CONVERTIBLE BONDS
Retirement of Convertible Bonds Prior to Maturity
• The additional 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) P 30,000
Retirement price on account of conversion privilege 20,000
Gain on cancellation – taken to equity (APIC) P 10,000
• The following entry records the retirement of the convertible bonds:
Bonds Payable 1,000,000
Premium on Bonds Payable 8,000
Loss on Retirement of Bonds 22,000
Share Premium – Bond Conversion Privilege 30,000
Cash 1,050,000
Share Premium – Unexercised
Bond Conversion Privilege 10,000
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
SERIAL BONDS
• Serial bonds are bonds that mature in series of installments. The
amortization of premium or discount on serial bonds based on effective
interest method is computed by comparing the nominal interest and
effective interest. 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 interest and
effective interest decrease.
• For a complete illustration of the issuance, amortization premium or
discount, and retirement on maturity date of serial bonds, consider the
following: P5,000,000, 12% bonds were issued on bond issue date, January
1, 2018. The principal of the bonds is paid in series of P1,000,000 annually,
together with any accrued interest on the outstanding bonds, each
December 31, starting December 31, 2018. The bonds were issued for
P5,241,834, a price that yields 10%.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
SERIAL BONDS
• Periodic interest due:
12/31/18 = 12% x P5,000,000 = P 600,000
12/31/19 = 12% x 4,000,000 = 480,000
12/31/20 = 12% x 3,000,000 = 360,000
12/31/21 = 12% x 2,000,000 = 240,000
12/31/22 = 12% x 1,000,000 = 120,000
• The issue price is computed as follows:
Periodic Total Principal Present Value Present value
Principal Interest and Interest Factor at of Principal
Due Date Due Due Due 10% and Interest
12/31/18 1,000,000 600,000 1,600,000 0.90909 1,454,544
12/31/19 1,000,000 480,000 1,480,000 0.82645 1,223,146
12/31/20 1,000,000 360,000 1,360,000 0.75131 1,021,782
12/31/21 1,000,000 240,000 1,240,000 0.68301 846,932
12/31/22 1,000,000 120,000 1,120,000 0.62092 695,430
Total present value (issue price) 5,241,834

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
SERIAL BONDS
• The amortization table using the effective interest method is presented below.
Bond Premium Amortization Table
Effective Interest Method – Serial Bonds
(A) (B) (C) (D)
Effective Premium Carrying value, end
Nominal Interest 10% x Amortization Previous (D) –
Date Interest Previous (D) (A) – (B) 1,000,000 – (C)
01/01/18 5,241,834
12/31/18 600,000 524,183 75,817 4,166,017
12/31/19 480,000 416,602 63,398 3,102,619
12/31/20 360,000 310,262 49,738 2,052,881
12/31/21 240,000 205,288 34,712 1,018,169
12/31/22Difference is due
*Adjusted; 120,000
to rounding off. 101,817 18,169* 0

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
SERIAL BONDS
• The following are the entries for years 2018 and 2019:

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

2018
Jan. Cash 5,214,834
1 Bonds Payable 5,000,000
Premium on Bonds Payable 241,834
Issuance of serial bonds
Dec. Interest Expense 524,183
31 Premium on Bonds Payable 75,817

Robles & Empleo

Cash 600,000
Periodic Interest
31 Bonds Payable 1,000,000
Cash 1,000,000
First installment on principal
2019
Dec. Interest Expense 416,602
31 Premium on Bonds Payable 63,398
Cash 480,000
Periodic interest
31 Bonds Payable 1,000,000
Cash 100,000
Second installment on principal
SERIAL BONDS
• Similar entries shall be prepared for years 2020 through 2022. At
December 31, 2022, after recording the last installment payment on the
bond liability, both the bonds payable account and the related premium
shall have been brought to zero balances.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT
RESTRUCTURING
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 would not
otherwise grant under normal conditions. This is referred to as troubled
debt restructuring.
• An entity shall derecognize a financial liability (or a part of a financial
liability) from its statement of financial position when, and only when, it is
extinguished, i.e., when the obligation specified in the contract is
discharged or cancelled or expires.
A troubled debt restructuring involves one of three forms:
1. Asset swap
2. Equity swap
3. Modification of debt terms
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Settlement of Debt by Transfer of Assets (or Asset Swap)
• A transfer of non-cash assets (real estate, receivables or other assets) can be
used to settle a debt obligation in a troubled debt restructuring. 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
recognizing in profit or loss. Applying this principle does not necessarily
indicate that any resulting gain or loss results from the restructure of the debt
only. For a more meaningful financial statement presentation, separate profit
or loss accounts are shown for the gain or loss on the disposal of the asset and
the gain on debt restructure. 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.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Settlement of Debt by Transfer of Assets (or Asset Swap)

CV of the debt > FV of the asset > or < CV of the asset

(Gain on debt restructuring) (Gain or loss on exchange of asset)

+
(Total amount taken to P and L)

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Settlement of Debt by Transfer of Assets (or Asset Swap)
• 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 obligation. On December 31, 2019, the loan’s due date, Manila
Bank agrees to accept from ABC Realty 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,
based on the cost model, in ABC Realty’s books of P10,500,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Settlement of Debt by Transfer of Assets (or Asset Swap)
• ABC Realty records the transaction as follows:
Notes Payable – Manila Bank 10,000,000
Interest Payable 1,200,000
Loss on Disposal of Land 1,500,000
Land 10,500,000
Gain on Debt Restructuring 2,200,000

Carrying value of debt settled 11,200,000

Fair market value of asset transferred 9,000,000
Gain on debt restructuring 2,200,000

Fair market value of land transferred 9,000,000

Carrying value of land transferred 10,500,000
Loss on disposal of land 1,500,000
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Settlement of Debt by Transfer of Assets (or Asset Swap)
• Meanwhile, Manila Bank records the transaction as follows:
Land 9,000,000
Allowance Bad Debts 2,200,000
Notes Receivable – ABC Reality 10,000,000
Interest Receivable 1,200,000
• 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.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Settlement of Debt by Granting Equity Interest (or Equity Swap)
• The issuance of the debtor’s share capital can also be used to settle a
debt obligation in a troubled debt restructuring. 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 debtor company’s shares or other equity
instruments. The equity instruments issued shall be measured at (in order
of priority)
a) the fair value of the equity instruments granted (share capital
issued);
b) the fair value of the financial liability settled.
• Any difference between the fair value used and the carrying value of the
financial liability settled is taken to profit or loss.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Settlement of Debt by Granting Equity Interest (or Equity Swap)
• Assume that Manila Bank (in 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 of both ABC Realty
(debtor) and Manila Bank (creditor) are as follows: (Refer on the next two
slides)

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Settlement of Debt by Granting Equity Interest (or Equity Swap)
ABC Realty
Notes Payable – Manila Bank 10,000,000
Interest Payable 1,200,000
Gain on Debt Restructuring 400,000
Ordinary Share Capital 9,000,000
Share Premium – Ordinary 1,800,000
Carrying value of debt settled 11,200,000
Fair value of the shares issued (180,000 x 60) 10,800,000
Gain on debt restructuring 400,000

Fair value of the shares issued 10,800,000

Par value of the shares issued (180,00 x 50) 9,000,000
Additional paid-in capital 1,800,000
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Settlement of Debt by Granting Equity Interest (or Equity Swap)
Manila Bank
Investment in ABC Realty Ordinary 10,800,000
Allowance for Bad Debts* 400,000
Notes Receivable – ABC Realty 10,000,000
Interest Receivable 1,200,000
*may also be charged to an impairment loss account.

Fair value of ordinary shares received 10,800,000

Carrying amount of the receivable restructured 11,200,000
Impairment loss on receivables 400,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• A troubled debt restructuring involving modification of terms may take
the form of one or any combination of the following:
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

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• Derecognition of a financial liability through modification of debt terms is
covered by paragraph 3.3.2, IFRS 9, which states that: “An exchange
between an existing borrower and lender of debt instruments with
substantially different terms shall be accounted for as an extinguishment
of the original liability and 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 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, IFRS9).

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• Thus, in determining whether a modification of debt terms will qualify for
derecognition, the debtor shall compare the following two amounts:
A. the carrying amount of the original obligation at the date of the
restructure; and
B. the present value of the net cash outflow of the new 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
qualifies to be treated as derecognition of the original financial liability
and creation of the 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 taken to profit or loss.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• Using the same data, assume that Manila Bank agreed to the following
modifications on December 31, 2019:
Reduction of principal from P10,000,000 to P7,000,000;
Condonation of accrued interest;
Extension of maturity date to December 31, 2023; and
Reduction of interest rate from 12% to 8%

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• The discounted amount of the total future payments under the new
terms and the gain on debt restructuring are computed 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 3.0.3735 1,700,916
Total PV of future payments P6,149,556
Carrying amount of the debt restructured
(10,000,000 + 1,200,000) 11,200,000
Difference P5,050,444

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• Because the difference of P5,050,444 is more than 10% of P11,200,000,
the exchange transaction qualifies to be treated as derecognition of the
old financial liability (P11,200,000) and creation of a new financial liability
(P6,149,556). Assume in this example that the market rate of interest rate
at the date of restructuring was also 12%.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• Based on the foregoing computations, ABC Realty records the restructuring as
follows:
Notes Payable-Manila Bank 10,000,000
Interest Payable 1,200,000
Restructured Notes Payable 6,149,556
Gain on Debt Restructuring 5,050,444
• 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 850,444
Restructured Notes Payable 7,000,000
Gain on Debt Restructuring 5,050,444
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• The discount on restructured notes payable represents the difference
between the total undiscounted future payments and it present value.
This amount is amortized periodically until maturity using the effective
interest method.
Face value of note P7,000,000
Present value of future payments (see above) 6,149,556
Discount on restructured notes payable P 850,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• Hence, after restructuring, periodic interest payments by ABC Realty for the next four
years are recorded as shown below: (for computations, please refer to the following
table):
Discount Amortization Table
Effective Interest Method - Restructured Note
Interest Interest Amortization Carrying
Date Payment Expense of Discount Amount of Note
12/31/19 6,149,556
12/31/20 560,000 737,946 177,946 6,327,502
12/31/21 560,000 759,300 199,300 6,526,802
12/31/22 560,000 783,216 223,216 6,750,018
12/31/23 560,000 809,982* 249,982 7,000,000

*Adjusted. The P20 difference to rounding off

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
12/31/20 Interest Expense 737,946
Restructured Notes Payable 177,946
Cash 560,000
12/31/21 Interest Expense 759,300
Restructured Notes Payable 199,300
Cash 560,000
12/31/22 Interest Expense 783,216
Restructured Notes Payable 223,216
Cash 560,000
12/31/23 Interest Expense 809,982
Restructured Notes Payable 249,982
Cash 560,000

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

• In addition, the payment of principal is recorded in the usual manner,
which completely extinguishes the debt, as follows:
12/31/20 Interest Expense 737,946
Cash 560,000
Discount on Restructured Notes Payable 177,946

Robles & Empleo

12/31/21 Interest Expense 759,300
Cash 560,000
Discount on Restructured Notes Payable 199,300
12/31/22 Interest Expense 783,216
Cash 560,000
Discount on Restructured Notes Payable 223,216
12/31/23 Restructured Notes Payable 7,000,000
Interest Expense 809,982
Cash 7,560,000
Discount on Restructured Notes Payable 249,982
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• If at the time of modification, ABC could have borrowed from a financing
institution with an interest rate of 15%, the present value of the modified
debt is computed as follows:
Present value of the new principal amount
7,000,000 x 0.57175 P4,002,250
Present value of the interest payments
(7,000,000 x 8%) x 2.85498 1,598,789
Total P5,601,039
Carrying value of the debt restructured 11,200,000
Gain on debt restructuring P5,598,961

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• 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 liability (par. B3.3.6, IFRS 9).

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• 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 is 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 date, assume that Manila Bank on December 31, 2019 agreed
to the following modifications:
 Reduction of principal from P10,000,000 to P9,500,000;
 Condonation of accrued interest;
 Extension of maturity date to December 31, 2023; and
 The stated interest rate has been changed to 16%.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
TROUBLED-DEBT RESTRUCTURING
Modification of Terms
• The discounted value of the cash flow under the new terms is:
Present value of the principal (9,500,000 x 0.63552) P 6,037,440
Present value of interest (1,520,000 x 3.03735) 4,616,772
Total present value of the modified terms P10,654,212
Carrying amount of the original obligation 11,200,000
Difference P 545,788
• The difference is less than 10% of P11,200,00; thus, no gain shall be recognized
on the date of the restructuring. The modification of terms is to be recorded
as:
Notes Payable 10,000,000
Interest Payable 1,200,000
Restructured Notes Payable 9,500,000
Premium on Restructured Notes Payable 1,700,000
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
CLASSIFICATION AND
PRESENTATION ON THE
FACE OF THE FINANCIAL
STATEMENTS
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 liabilities shall be presented in the order of liquidity (par 60, IAS 1
Presentation of Financial Statements).
• Following therefore the given guidance in IAS 1, an entity following the current,
non-current classifications for assets and liabilities shall classify each of its
financial liabilities accordingly based on any of the following enumerated in IAS
1:
a) it is expected to be settled in the 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 after the reporting period.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
CLASSIFICATION AND PRESENTATION ON THE FACE OF THE FINANCIAL
STATEMENTS
• Based on the foregoing, accounts and trade notes payable are classified as
current liabilities, because of the application of the normal operating cycle
concept. Non-trade financial liabilities, on the other hand, shall be classified
as current based on whether they are expected to be settled. within twelve
months from the reporting date, regardless of the length of the normal
operating cycle.
• As discussed previously, a portion of long-term notes payable and bonds
payable shall be classified as current and another portion shall be classified as
non-current appropriately, based on expected date of settlement and
considering the criterion identified in item (d) in the foregoing enumerated
criteria.
• 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.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
DISCLOSURE
REQUIREMENTS
DISCLOSURE REQUIREMENTS
An entity shall disclose information that enables users of its financial
statements to evaluate the significance of financial instruments for its
financial position and performance (par. 7, IFRS 7 Financial Instruments:
Disclosures).
1. 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.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
DISCLOSURE REQUIREMENTS
2. When financial instruments issued by an entity, either individually or as a
class, create a potentially significant exposure to either market risk, credit
risk, liquidity risk, or cash flow interest rate risk, terms and conditions that
warrant disclosure include
a) the principle, stated face or other similar amount;
b) the date of maturity, expiry, or execution;
c) early settlement options, including the period in which, or date at which,
the options can be exercised and the exercise price or range of prices;
d) 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 amounts 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;
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
DISCLOSURE REQUIREMENTS
2. When financial instruments issued by an entity, either individually or as a class,
create a potentially significant exposure to either market risk, credit risk,
liquidity risk, or cash flow interest rate risk, terms and conditions that warrant
disclosure include
f) stated rate or amount of interest or other periodic return on principal and
timing of payments;
g) collateral pledged;
h) in the case of an instrument for which cash flows are denominated in a
currency 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-to-equity ratio in a bond covenant that, if contravened,
would make the full principle amount of the bond due and payable
immediately).
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
DISCLOSURE REQUIREMENTS
3. For each class of financial liabilities, such as bonds, notes, and loans, an
entity shall disclose information about its exposure to interest rate risk,
including
a) contractual repricing or maturity dates, whichever dates are earlier;
and
b) effective interest rates, when applicable.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
DISCLOSURE REQUIREMENTS
4. 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
carrying amount in the balance sheet.
5. An entity shall disclose the carrying amount 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.
6. 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 callable convertible debt instrument), it shall
disclose the existence of those features and the effective interest rate on the liability
component (excluding any embedded derivatives that are accounted for separately).
7. 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 using the effective interest method) for financial
liabilities that are not at fair value through profit or loss.

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo
DISCLOSURE REQUIREMENTS
8. With respect to any defaults of principal, interest, sinking fund or
redemption provision during the period on loans payable recognized as at
the balance sheet date, and any other breaches during the period of loan
agreements when those breaches can permit the lender to demand
payment (except for breaches that are remedied, or in response to which
the terms 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
loans payable on which the breaches occurred; and
c) with respect to amounts disclosed under the (b) above, whether the
default has been remedied or the terms of the loans payable
renegotiated before the date the financial statements were authorized
for issue.
CBET Department of Accountancy – Intermediate Accounting Series Volume 1
Robles & Empleo
 THANK YOU
STAY SAFE

CBET Department of Accountancy – Intermediate Accounting Series Volume 1

Robles & Empleo