CURRENT LIABILITIES,

PROVISIONS, AND
Financial CONTINGENCIES
reporting (IAS 37)
By Kebrysfaw G.
 CURRENT LIABILITIES
“What is a Liability?”

Liability is defined as present obligation of the company arising from past events, the
settlement of which is expected to result in an outflow from the company of resources,
embodying economic benefits.

Three essential Current liabilities are “obligations whose liquidation

is reasonably expected to require use of existing
characteristics:
resources properly classified as current assets, or
1. Present obligation. the creation of other current liabilities.”

2. Arises from past A current liability is reported if one of two conditions exists:
events.
1. Liability is expected to be settled within its normal operating cycle;
3. Results in an outflow or
of resources (cash,
2. Liability is expected to be settled within 12 months after the reporting
goods, services).
date.
CURRENT LIABILITIES

Typical Current Liabilities:

1. Accounts payable. 6. Customer advances and
deposits.
2. Notes payable.
7. Unearned revenues.
3. Current maturities of long-
term debt. 8. Sales and value-added
taxes payable.
4. Short-term obligations
expected to be refinanced. 9. Income taxes payable.

5. Dividends payable. 10. Employee-related liabilities.

 CURRENT LIABILITIES

Accounts Payable (trade accounts payable)

Balances owed to others for goods, supplies, or services
purchased on open account.
 Arises because of time lag between the receipt of services
or acquisition of title to assets and the payment for them.
 Terms of the sale (e.g., 2/10, n/30 or 1/10, E.O.M.) usually
state period of extended credit, commonly 30 to 60 days.
 These liabilities typically are noninterest-bearing and are
reported at their face amounts.
CURRENT LIABILITIES

Notes Payable
Written promises to pay a certain sum of money on a
specified future date.
 Arise from purchases, financing, or other transactions.
 Notes classified as short-term or long-term.
 Notes may be interest-bearing or zero-interest-bearing.
CURRENT LIABILITIES

Interest-Bearing Note Issued

Illustration: Castle National Bank agrees to lend €100,000 on March 1, 2015,
to Landscape Co. if Landscape signs a €100,000, 6 percent, four-month note.
Landscape records the cash received on March 1 as follows:

Cash 100,000
Notes Payable 100,000
Interest-Bearing Note Issued

If Landscape prepares financial statements semiannually, it makes the

following adjusting entry to recognize interest expense and interest payable
at June 30, 2015:

Interest calculation = (€100,000 x 6% x 4/12) = €2,000

Interest Expense 2,000

Interest Payable 2,000
Interest-Bearing Note Issued

At maturity (July 1, 2016), Landscape records payment of the note and

accrued interest as follows.

Notes Payable 100,000

Interest Payable 2,000
Cash 102,000
 CURRENT LIABILITIES
Zero-Interest-Bearing Note Issued
This note does not explicitly state an interest rate on the
face of a note. Interest is still charged, however. At
maturity, the borrower must pay back an amount greater
than the cash received at issuance date.
Illustration: On March 1, Landscape issues a €102,000, four-month, zero-interest-
bearing note to Castle National Bank. The present value of the note is €100,000.
Landscape records this transaction as follows.

Cash 100,000
Notes Payable 100,000
OR
Cash 100,000
Discount on Notes Payable 2,000
Notes Payable 102,000
Zero-Interest-Bearing Note Issued

If Landscape prepares financial statements semiannually, it makes the

following adjusting entry to recognize interest expense and the increase in
the note payable of €2,000 at June 30.

Interest Expense 2,000

Notes Payable/Discount on N/P 2,000

At maturity (July 1), Landscape must pay the note, as follows.

Notes Payable 102,000

Cash 102,000
CURRENT LIABILITIES

E13-2: (Accounts and Notes Payable) The following are selected

2015 transactions of Darby Corporation.

Sept. 1 - Purchased inventory from Orion Company on

account for $50,000. Darby records purchases gross and uses
a periodic inventory system.
Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in
payment of account.
Oct. 1 - Borrowed $75,000 from the Shore Bank by signing a
12-month, zero-interest-bearing $81,000 note.

Prepare journal entries for the selected transactions.

LO 1
CURRENT LIABILITIES

Sept. 1 - Purchased inventory from Orion Company on account for

$50,000. Darby records purchases gross and uses a periodic inventory
system.

Sept. 1 Purchases 50,000

Accounts Payable 50,000
CURRENT LIABILITIES

Oct. 1 - Issued a $50,000, 12-month, 8% note to Orion in payment of account.

Oct. 1 Accounts Payable 50,000

Notes Payable 50,000

Interest calculation = ($50,000 x 8% x 3/12) = $1,000

Dec. 31 Interest Expense 1,000

Interest Payable 1,000
CURRENT LIABILITIES

Oct. 1 - Borrowed $75,000 from the Shore Bank by signing a 12-month, zero-
interest-bearing $81,000 note.

Oct. 1 Cash 75,000

Notes Payable 75,000

Interest calculation = ($6,000 x 3/12) = $1,500

Dec. 31 Interest Expense 1,500

Notes Payable 1,500
 CURRENT LIABILITIES

Current Maturities of Long-Term Debt

Portion of bonds, mortgage notes, and other long-term
indebtedness that matures within the next fiscal year. It
categorizes this amount as current maturities of long-term debt
Exclude long-term debts maturing currently if they are to be:

1. Retired by assets accumulated that have not been shown as

current assets,

2. Refinanced, or retired from the proceeds of a new debt issue, or

3. Converted into ordinary shares.

 CURRENT LIABILITIES: Dividends
Payable
Amount owed by a corporation to its stockholders as a result of board
of directors’ authorization.
 Because companies always pay cash dividends within one year
of declaration (generally within three months), they classify
them as current liabilities.
 Undeclared dividends on cumulative preference shares not
recognized as a liability. Why? Because preferred dividends in
arrears are not an obligation until the board of directors
a u t h o r i z e s the payment.
 Dividends payable in the form of additional shares are not
recognized as a liability because such stock dividends do not
require future outlays of assets or services.
► Reported in equity because they represent retained
earnings in the process of transfer to paid-in capital.
 CURRENT LIABILITIES

Customer Advances and Deposits

Returnable cash deposits received from customers and
employees.
 To guarantee performance of a contract or service or
 As guarantees to cover payment of expected future
obligations.
Note: May be classified as current or non-current liabilities.
The classification of these items as current or noncurrent liabilities
depends on the time between the date of the deposit and the
termination of the relationship that required the deposit.
 CURRENT LIABILITIES: Unearned
Revenues
Payment received before providing goods or performing
services.
How do these companies account for unearned revenues ?
1. When a company receives an advance payment, it debits Cash, and
credits a current liability account identifying the source of the
unearned revenue.
2. When a company recognizes revenue, it debits the unearned
revenue account, and credits a revenue account.
CURRENT LIABILITIES

BE13-6: Sports Pro Magazine sold 12,000 annual subscriptions

on August 1, 2015, for €18 each. Prepare Sports Pro’s August 1,
2015, journal entry and the December 31, 2015, annual adjusting
entry.

Aug. 1 Cash 216,000

Unearned Revenue 216,000
(12,000 x €18)

Dec. 31 Unearned Revenue 90,000

Subscription Revenue 90,000
(€216,000 x 5/12 = €90,000)

LO 2
CURRENT LIABILITIES

Sales and Value-Added Taxes Payable

Consumption taxes are generally either

 a sales tax or
 a value-added tax (VAT).
Purpose is to generate revenue for the government.

The two systems use different methods to accomplish this objective.

Sales Taxes Payable

Illustration: Halo Supermarket sells loaves of bread to

consumers on a given day for €2,400. Assuming a sales tax
rate of 10 percent, Halo Supermarket makes the following entry
to record the sale.
Cash 2,640
Sales Revenue 2,400
Sales Taxes Payable 240
Value-Added Taxes Payable

Illustration: The VAT is collected every time a business

purchases products from another business in the product’s
supply chain. To illustrate,

1. Hill Farms Wheat Company grows wheat and sells it to

Sunshine Baking for €1,000. Hill Farms Wheat makes the
following entry to record the sale, assuming the VAT is 10
percent.

Cash 1,100
Sales Revenue 1,000
Value-Added Taxes Payable 100
Value-Added Taxes Payable

2. Sunshine Baking makes loaves of bread from this wheat and

sells it to Halo Supermarket for €2,000. Sunshine Baking
makes the following entry to record the sale, assuming the
VAT is 10 percent.

Cash 2,200
Sales Revenue 2,000
Value-Added Taxes Payable 200

Sunshine Baking then remits €100 to the government, not €200. The
reason: Sunshine Baking has already paid €100 to Hill Farms Wheat.
Value-Added Taxes Payable

3. Halo Supermarket sells the loaves of bread to consumers for

€2,400. Halo Supermarket makes the following entry to
record the sale, assuming the VAT is 10 percent.

Cash 2,640
Sales Revenue 2,400
Value-Added Taxes Payable 240

Halo Supermarket then sends only €40 to the tax authority as it

deducts the €200 VAT already paid to Sunshine Baking.
 CURRENT LIABILITIES

Income Tax Payable

Businesses must prepare an income tax return and compute the
income tax payable.
 Taxes payable are a current liability.
 Corporations must make periodic tax payments.
 Differences between taxable income and accounting income
sometimes occur. Because of these differences, the amount of
income taxes payable to the government in any given year may
differ substantially from income tax expense as reported on the
financial statements.
CURRENT LIABILITIES

Employee-Related Liabilities
Amounts owed to employees for salaries or wages are
reported as a current liability.

Current liabilities may include:

 Payroll deductions.
 Compensated absences.
 Bonuses.
 Employee-Related Liabilities
Payroll Deductions
To the extent that a company has not remitted the amounts
deducted to the proper authority at the end of the accounting
period, it should recognize them as current liabilities.
Taxes:
► Social Security Taxes
► Income Tax Withholding
Employee-Related Liabilities

Illustration: Assume a weekly payroll of $10,000 entirely subject to

Social Security taxes (8%), with income tax withholding of $1,320 and
union dues of $88 deducted. The company records the wages and
salaries paid and the employee payroll deductions as follows.

Wages and Salaries Expense 10,000

Withholding Taxes Payable 1,320
Social Security Taxes Payable 800
Union Dues Payable 88
Cash 7,792
Employee-Related Liabilities

Illustration: Assume a weekly payroll of $10,000 entirely

subject to Social Security taxes (8%), with income tax
withholding of $1,320 and union dues of $88 deducted.
The company records the employer payroll taxes as
follows.
Payroll Tax Expense 800
Social Security Taxes Payable 800

The employer must remit to the government its share of

Social Security tax along with the amount of Social
Security tax deducted from each employee’s gross
compensation.
 Employee-Related Liabilities

Compensated Absences
Paid absences for vacation, illness and maternity, paternity, and
jury leaves.
Companies should accrue a liability for the cost of
compensation for future absences if all of the following
conditions exist.
(a) The employer’s obligation relating to employees’ rights to
receive compensation for future absences is attributable to
employees’ services already rendered.
(b) The obligation relates to the rights that vest or accumulate.
(c) Payment of the compensation is probable.
(d) The amount can be reasonably estimated.
 Employee-Related Liabilities
Compensated Absences
The following considerations are relevant to the accounting for
compensated absences.
Vested rights - employer has an obligation to make payment to an
employee even after terminating his or her employment. Thus,
vested rights are not contingent on an employee’s future service.

Accumulated rights - employees can carry forward to future periods if

not used in the period in which earned.

Non-accumulating rights - do not carry forward; they lapse if not

used.
Companies should recognize the expense and related liability for
compensated absences in the year earned by employees.
Employee-Related Liabilities

Illustration: Amutron Inc. began operations on January 1, 2015. The

company employs 10 individuals and pays each €480 per week.
Employees earned 20 unused vacation weeks in 2015. In 2016, the
employees used the vacation weeks, but now they each earn €540
per week. Amutron accrues the accumulated vacation pay on
December 31, 2015, as follows.

Salaries and Wages Expense 9,600

Salaries and Wages Payable 9,600

In 2016, it records the payment of vacation pay as follows.

Salaries and Wages Payable 9,600

Salaries and Wages Expense 1,200
Cash 10,800
 Employee-Related Liabilities

Profit-Sharing and Bonus Plans

Payments to certain or all employees in addition to their regular
salaries or wages.
Frequently the bonus amount depends on the company’s yearly
profit.
A company may consider bonus payments to employees as
additional wages and should include them as a deduction in
determining the net income for the year.
 Bonuses paid are an operating expense.
 Unpaid bonuses should be reported as a current liability.
IAS 37 , PROVISION, CONTINGENT LIABILITY AND CONTINGENT
ASSET.
A PROVISION IS A LIABILITY OF UNCERTAIN TIMING OR AMOUNT.
Item Description Uncertainty Classifications

Trade Goods/services that: No uncertainty NOT A PROVISION

payables • have been received and
• have been invoiced/agreed
Accruals Goods/services that: Not a NOT A PROVISION
• have been received but significant
• have not been paid, invoiced or uncertainty
agreed
Warranty Obligation to repair defects for significant PROVISION (Provided
obligation Goods that were sold uncertainty that other conditions
are met)

Common Types of provision :

1. Lawsuits 4. Environmental 7. Profit Bonus

2. Warranties 5. Onerous contracts 4. Severance pay

3. Consideration payable 6. Restructuring

IAS 37 , PROVISION, CONTINGENT LIABILITY AND CONTINGENT
ASSET.
When to Recognize a Provision ?

An entity has a present Probable transfer/outflow Measure the out

obligation Of economic benefit come reliably

> 50%
Legal Constructive obligation
obligation

Are all the conditions met? No

s
ye

Recognize provision Disclose Contingent liability

if
the outflow is possible

Noting if the outflow is Remote

 How to measure a Provision ?

Bets estimate of the expenditure to settle the

obligation

judgment

Expected value Most likely out come

(Weighted average
value)

several (multiple) possible outcome Single obligation

Present value
 Provisions Measurement

Basic Best estimate of required expenditure (the amount entity would

principle rationally pay to settle)
Excludes expected disposal of assets

Portfolio Large populations

• expected value (probability- Single obligation
vs single • most likely outcome may be best estimate
weighting of all possible outcomes)
obligations • mid-point of range
• other outcomes should also be considered

Risks and uncertainties must be taken into account

Risks &
• risk adjustments may increase liability
uncertain
ty • risk adjustments should not be duplicated

Discount to PV if time value material, using rate that:

Time • is pre-tax
value
• reflects risks specific to liability (either adjust cash flows or adjust discount rate).
IAS 37 , PROVISION, CONTINGENT LIABILITY AND CONTINGENT
ASSET.
• Entity A has manufactured and delivered a custom-designed ship and has a warranty obligation to repair any
faults in the next 12 months
• management estimates the following two possible outcomes, their associated probability and cost:
o no faults: 20% probability, zero cost
o normal faults: 80% probability, cost CU10,000.
What is the accounting treatment in accordance with IAS 37 (ignoring the time
value)?
A provision of CU10,000 is an appropriate 'best estimate' since the most likely
outcome is CU10,000.

• Entity B has manufactured and delivered a custom-designed ship and has a warranty
obligation to repair any faults in the next 12 months
• management estimates the following three possible outcomes, their associated probability
and cost:
o no faults: 25% probability, zero cost
o normal faults: 40% probability, cost CU10,000
o major faults: 35% probability, cost CU100,000.

What is the accounting treatment in accordance with IAS 37 (ignoring the time value)?
a provision of CU39,000 (being: CU10,000*40%+ CU100,000*35%) is an appropriate 'best estimate'.
 Common Types of Provisions

Warranty Provisions
Promise made by a seller to a buyer to make good on a
deficiency of quantity, quality, or performance in a product.

If it is probable that customers will make warranty claims and a

company can reasonably estimate the costs involved, the
company must record an expense.

13-39
 Warranty Provisions

Companies often provide one of two types of warranties to

customers:

Assurance-Type Warranty
A quality guarantee that the good or service is free from
defects at the point of sale.
 Obligations should be expensed in the period the
goods are provided or services performed (in other
words, at the point of sale).
 Company should record a warranty liability.

13-40
 Assurance-Type Warranty

Facts: Denson Machinery Company begins production of a new

machine in July 2015 and sells 100 of these machines for $5,000
cash by year-end. Each machine is under warranty for one year.
Denson estimates, based on past experience with similar
machines, that the warranty cost will average $200 per unit.
Further, as a result of parts replacements and services performed
in compliance with machinery warranties, it incurs $4,000 in
warranty costs in 2015 and $16,000 in 2016.

Question: What are the journal entries for the sale and the
related warranty costs for 2015 and 2016?

13-41
 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

1. To recognize sales of machines and accrual of warranty

liability:

July–December 2015

Cash 500,000
Warranty Expense 20,000
Warranty Liability 20,000
Sales Revenue 500,000

13-42
 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

2. To record payment for warranties incurred:

July–December 2015

Warranty Liability 4,000

Cash, Inventory, Accrued Payroll 4,000

The December 31, 2015, statement of financial position reports

Warranty Liability as a current liability of $16,000. The income statement
for 2015 reports Warranty Expense of $20,000.

13-43
 Assurance-Type Warranty

Solution: For the sale of the machines and related warranty

costs in 2015 the entry is as follows.

3. To record payment for warranty costs incurred in 2016

related to 2015 machinery sales:

January 1–December 31, 2016

Warranty Liability 16,000

Cash, Inventory, Accrued Payroll 16,000

At the end of 2016, no warranty liability is reported for the machinery

sold in 2015.

13-44
 Warranty Provisions

Companies often provide one of two types of warranties to

customers:

Service-Type Warranty
An extended warranty on the product at an additional cost.
 Usually recorded in an Unearned Warranty Revenue
account.
 Recognize revenue on a straight-line basis over the period
the service-type warranty is in effect.

13-45
 Service-Type Warranty

Facts: You purchase an automobile from Hamlin Auto for €30,000

on January 2, 2014. Hamlin estimates the assurance-type
warranty costs on the automobile to be €700 (Hamlin will pay for
repairs for the first 36,000 miles or three years, whichever comes
first). You also purchase for €900 a service-type warranty for an
additional three years or 36,000 miles. Hamlin incurs warranty
costs related to the assurance-type warranty of €500 in 2014 and
€200 in 2015. Hamlin records revenue on the service-type
warranty on a straight-line basis.

Question: What entries should Hamlin make in 2014 and 2017?

13-46
 Service-Type Warranty

Solution:

1. To record the sale of the automobile and related

warranties:

January 2, 2014

Cash (€30,000 + €900) 30,900

Warranty Expense 700
Warranty Liability 700
Unearned Warranty Revenue 900
Sales Revenue 30,000

13-47
 Service-Type Warranty

Solution:

2. To record warranty costs incurred in 2014:

January 2–December 31, 2014

Warranty Liability 500

Cash, Inventory, Accrued Payroll 500

13-48
 Service-Type Warranty

Solution:

3. To record revenue recognized in 2017 on the service-

type warranty:

January 1–December 31, 2017

Unearned Warranty Revenue (€900 ÷ 3) 300

Warranty Revenue 300

13-49
 Common Types of Provisions
Onerous Contract Provisions
“The unavoidable costs of meeting the obligations exceed the
economic benefits expected to be received.”
An example of an onerous contract is a loss recognized on
unfavorable non cancelable commitments relate to inventory items.

The expected costs should reflect the least net cost of exiting from
the contract, which is the lower of

1. the cost of fulfilling the contract, or

2. the compensation or penalties arising from failure to fulfill the

contract.

13-50
 Onerous Contract Provisions

Illustration: Sumart Sports operates profitably in a factory that

it has leased and on which it pays monthly rentals. Sumart
decides to relocate its operations to another facility. However,
the lease on the old facility continues for the next three years.
Unfortunately, Sumart cannot cancel the lease nor will it be able
to sublet the factory to another party. The expected costs to
satisfy this onerous contract are €200,000. In this case, Sumart
makes the following entry.

Loss on Lease Contract 200,000

Lease Contract Liability 200,000

13-51
 Onerous Contract Provisions

Assume the same facts as above for the Sumart example and
the expected costs to fulfill the contract are €200,000. However,
Sumart can cancel the lease by paying a penalty of €175,000. In
this case, Sumart should record the liability as follows.

Loss on Lease Contract 175,000

Lease Contract Liability 175,000

13-52
 Common Types of Provisions

Self-Insurance
Self-insurance is not insurance, but risk assumption.
There is little theoretical justification for the establishment of
a liability based on a hypothetical charge to insurance
expense.

Conditions for accrual stated in IFRS are not satisfied prior to

the occurrence of the event.

13-53
 Contingent liability

A contingent liability is:

1. a POSSIBLE obligation that 1. a PRESENT obligation 1. a PRESENT
arises from past events AND that arises from obligation that
2. its existence will be confirmed only by past events BUT arises from past
the occurrence/non‑occurrence of 2. is not recognised events BUT
uncertain future events not wholly because it is not 2. is not recognised
within the control of the entity probable that an because the amount
outflow of economic of the obligation
benefits will be required cannot be reliably
measured

OR OR

An entity should not recognise a contingent liability

Disclosure only (unless possibility of outflow is remote)
 Provisions and contingent
liabilities
Decision tree
Present obligation
No Possible No
as a result of
obligation
an obligating event

Yes Yes
No Yes
Probable Remote
outflow
No
Yes
No (rare)
Reliable estimate

Yes
Provision DISCLOSE DO NOTHING
 Contingent assets
1. possible asset that arises from past events and
2. whose existence will be confirmed only by the occurrence or non-occurrence of uncertain future
events not wholly within the entity’s control

How likely is realisation of income?

Not probable? probable but not

virtually certain?
virtually certain?

Recognise
Do nothing Disclose
under
only applicable
IFRS

Contingent asset
Actual asset
Intermediate Financial Accounting
Accounting for long term Liability

Part Two

By Kibrysfaw Tutor
 Reasons for Issuance of Long-term Debt
Borrowing, which results in a long-term liability, is one of the choices available to companies
seeking to obtain financial resources..
1. Debt financing may be the only available source of funds. Many small- and medium sized
companies may appear too risky to investors to attract equity (i.e., capital stock) investments.
2.Debt financing may have a lower cost. Historically, since debt has a lesser investment risk than
stock, it usually has offered a relatively lower rate of return.
3.Debt financing offers an income tax advantage. Interest payments to debt holders are deductible
by a corporation as interest expense for income tax purposes, whereas dividend payments on
equity securities are not.
4.The voting privilege is not shared. Corporate stockholders may not wish to share ownership. Thus,
by issuing debt, which does not provide voting rights, ownership interests are not diluted.
5.Debt financing offers the opportunity for leverage. The term leverage (or trading on the equity)
refers to a company’s use of borrowed funds. By investing these funds, the company expects to
earn a return greater than the interest it will pay for their use and thereby benefit the
stockholders. Earnings in excess of interest charges (net of the applicable income tax reduction)
increase earnings per share.
 Bonds Payable
Non-current liabilities (long-term debt) consist of an expected
outflow of resources arising from present obligations that are not
payable
Examples:within a year
Bonds payable, or the
Long-term notesoperating cycle
payable, Mortgages of the
payable, company,
Pension
liabilities, is
whichever lease Liability
longer.
, Bond contract known as a bond indenture.


 Represents a promise to pay sum of money at designated

maturity date, plus periodic interest at a specified rate on
the maturity amount (face value).
 Paper certificate, typically a €1,000 face value.
 Interest payments usually made semiannually.
 Types and Ratings of Bonds
Common types found in practice:
 Secured and Unsecured (debenture) bonds.
 Term, Serial, and Callable bonds.
 Convertible, Commodity-Backed, Deep-Discount bonds.
 Registered and Bearer (Coupon) bonds.
 Income and Revenue bonds.
Corporate bond
listing.

Company Price as a % Creditworthin

Name Interest rate of parInterest rate based on price ess
paid as a % of
 Valuation of Bonds Payable
Selling price of a bond issue is set by the
supply and demand of buyers and sellers,
relative risk,
market conditions, and state of the economy.
 Investment community values a bond at the present value of its
expected future cash flows, which consist of (1) interest and (2)
Interest Rate
principal.
 Stated, coupon, or nominal rate = Rate written in the terms of the
bond indenture.
► Bond issuer sets this rate & Stated as a percentage of bond
face value (par).
 Market rate or effective yield = Rate that provides an acceptable
return commensurate with the issuer’s risk.
 Valuation of Bonds Payable
How do you calculate the amount of interest that is actually paid to the
bondholder (Stated rate x Face Value of the bond)
each period?

How do you calculate the amount of interest that is actually recorded

(Market rate x Carrying Value of the
as interest expense by the issuer of the bonds? bond)
Recognize financial Assume Stated Rate of 8%
liability when, and only
when, the entity becomes Market Interest Bonds Sold At
a party to the contractual
provisions of the 6% Premium
instrument (ie trade date)
 Initially all liabilities 8% Par Value
shall be recognized
at fair value 10% Discount
 In Subsquent years,
fiancial liablites
 Bonds Issued at Par
Illustration: Santos Company issues R$100,000 in bonds dated January
1, 2015, due in five years with 9 percent interest payable annually on
fJanuary
the bond = the
1. At PV (Principal) + PV
time of issue, the(interest)
market rate
PV (P) =for such bonds
Annual is 9 =
coupon
percent. Principal PMT=100,000*0.
PV 09= 9,000
(I)=
given principal (Face PV (P) = 100,000
( 1+i)n
value) = $100,000 64,993
stated (coupon (PV
1.09)
(I) =
5
9,000 (1-
rate) = 0.09 (1/1.09) 5
) =
the bond = 64,993 + 35,007 = 100,000
Market (eff rate) 35, 007
= 0.09 0.09
 Bonds Issued at Par

Issuer Investor
Journal entry on date of issue, Journal entry on date of
Jan.Cash
1, 2015. 100,000 Debt investment
purchase, Jan. 1, 2015.
Bonds payable 100,000
100,000 cash
Journal entry to record accrued Journal entry to record accrued
100,000
interest at Dec.
Interest 31, 2015.
expense interest at Dec.
Interest 31, 2015.
Receivable
9,000 9,000
JournalInterest
entry to payable
record first payment JournalInterest
entry toincome
record first
on 9,000
Jan. 1, payable
2016. 9,000 on Jan. 1, 2016.
payment
Interest 9,000 cash
Cash 9,000 9,000
 Bonds Issued at a Discount
Illustration: Assuming now that Santos issues R$100,000 in bonds,
due in five years with 9 percent interest payable annually at year-
fend.
the bond
At the=time
PV (Principal) + PV
of issue, the (interest)
market rate for such bonds is 11
PV (P)
PV =
percent. (I)100,000
= 9,000
59,345(1-(1/1.11)5) = 33,263
0.11
( 1.11) 5
Price of the bond = 59,345 +
33263 = 92,608
 Bonds Issued at a Discount
Issuer . Investor
Journal entry on date of Journal entry on date of
issue,
Cash Jan. 1, 2015.92,608 Acquisition
Debt , Jan. 1, 2015.
investment
Bonds payable 92,608
92,608
Journal entry to record accrued Cash
Journal entry to record accrued
interest at Dec. 31, 2015. 92,608
Interest expense ($92,608 x 11%) interest at Dec. 31, 2015.
Debt Investment
10,187 1,187
Interest Receivable
Interest payable
9,000
9,000
Journal entry to record first Interest
Journal Income
entry ($92,608
to record first x
Bonds payable
payment Jan. 1, 2016.
onpayable
Interest 9,000 11%)
Cash
payment 10,187
on Jan. 1, 2016.
9,000
1,187
Cash Interest Receivable 9,000
 Bonds Issued at a Discount
When bonds sell at less than face value:
 Investors demand a rate of interest higher than stated rate.
 Usually occurs because investors can earn a higher rate on
alternative investments of equal risk.
 Cannot change stated rate so investors refuse to pay face value for
the bonds.
 Investors receive interest at the stated rate computed on the face
 Bond issued at a discount - amount paid at maturity is more than
value, but they actually earn at an effective rate because they paid
thethan
less issueface
amount.
value for the bonds.
 Bonds issued at a premium - company pays less at maturity relative
to the issue price.
 Adjustment to the cost is recorded as bond interest expense over
the life of the bonds through a process called amortization.
 Required procedure for amortization is the effective-interest method
 Effective-Interest Method
Effective-interest method produces a periodic interest expense equal
to a constant percentage of the carrying value of the bonds.
 Bonds Issued at a Premium [Term Bonds]
Illustration: Evermaster Corporation issued €100,000 of 8% term bonds
on January 1, 2015, due on January 1, 2020, with interest payable each
July 1 and January 1. Investors require angiven principal (Face
effective-interest ratevalue)
of 6%.
Calculate the bond = $100,000
Annual coupon = proceeds.
stated (coupon rate)
PMT=100,000*0.08= 8,000/2 =
= 0.08/2 = 0.04
4,000
PV PV
(P) (I)
= 100,000
= 4,000 (1-(1/1.03)10) = 34,121 Market (eff rate) =
= 74,409 0.03 0.06/2 = 0.03
( 1.03)
Price of the bond =
10

74409+34121 = 108,530
 Effective-Interest Method

ISSUER Investor
Journal entry on date of issue, Journal entry on date of
Cash
Jan. 1, 2015. 108,530 Acquisition
Debt investment, Jan. 1, 2015.
108,530
Bonds payable
Cash
108,530
108,530
 Effective-Interest Method

Journal entry to record first payment and amortization of the

premium on July 1, 2015.
ISSUER Investor
Interest expense 3,256 Cash 4,000
Bonds payable 744
Cash 4,000 Interest income 3,256
 Effective-Interest Method
Accrued Interest
What happens if Evermaster prepares financial statements at the end of
February 2015? In this case, the company prorates the premium by the
appropriate number of months to arrive at the proper interest expense,
as follows.

ISSUER
Investor
Evermaster records this
accrual
Interest as follows
expense 1,085.33
. Interest Receivable 1,333,333
Bonds payable 248.00 Interest income 1,085.33
Interest payable 1,333.33 Debt investment 248.00
 Effective-Interest Method
Bonds Issued between Interest Dates
 Bond investors will pay the seller the interest accrued from the last
interest payment date to the date of issue.
 On the next semiannual interest payment date, bond investors will
receive the full six months’ interest payment.
 Effective-Interest Method
Bonds Issued at Par
Illustration: Assume Evermaster issued its five-year bonds, dated
January 1, 2015, on May 1, 2015, at par (€100,000). Evermaster records
the issuance of the bonds between interest dates as follows.
ISSUER Investor
Cash 100,000 Debt investment
Bonds payable 100,000
100,000
00,000 x .08 x 4/12) = €2,667 Cash x .08 x 4/12) = €2,667
(€100,000
100,000

Cash 2,667
Interest expense Interest income
2,667 2,667
Long-term Notes Payable

Accounting is Similar to Bonds

 A note is valued at the present value of its future interest
and principal cash flows.
 Company amortizes any discount or premium over the
life of the note.
 Notes Issued at Face Value

BE14-9: Coldwell, Inc. issued a €100,000, 4-year, 10% note at

face value to Flint Hills Bank on January 1, 2015, and received
€100,000 cash. The note requires annual interest payments each
December 31. Prepare Coldwell’s journal entries to record (a) the
issuance of the note and (b) the December 31 interest payment.

(a) Cash 100,000

Notes payable 100,000

(b) Interest expense 10,000

Cash 10,000
(€100,000 x 10% = €10,000)
 Notes Not Issued at Face Value

Zero-Interest-Bearing Notes
Issuing company records the difference between the face
amount and the present value (cash received) as
 a discount and
 amortizes that amount to interest expense over the life
of the note.
 Zero-Interest-Bearing Notes

Illustration: Turtle Cove Company issued the three-year,

$10,000, zero-interest-bearing note to Jeremiah Company. The
implicit rate that equated the total cash to be paid ($10,000 at
maturity) to the present value of the future cash flows ($7,721.80
cash proceeds at date of issuance) was 9 percent.

ILLUSTRATION 14-14
Time Diagram for Zero-Interest Note
 Zero-Interest-Bearing Notes

Illustration: Turtle Cove Company issued the three-year,

$10,000, zero-interest-bearing note to Jeremiah Company. The
implicit rate that equated the total cash to be paid ($10,000 at
maturity) to the present value of the future cash flows ($7,721.80
cash proceeds at date of issuance) was 9 percent.

Turtle Cove records issuance of the note as follows.

Cash 7,721.80
Notes Payable 7,721.80
 Zero-Interest-Bearing Notes

ILLUSTRATION 14-15
Schedule of Note
Discount Amortization
 Zero-Interest-Bearing Notes
ILLUSTRATION 14-15
Schedule of Note
Discount Amortization

Turtle Cove records interest expense for year 1 as follows.

Interest Expense ($7,721.80 x 9%) 694.96

Notes Payable 694.96
 Interest-Bearing Notes

Illustration: Marie Co. issued for cash a €10,000, three-year

note bearing interest at 10 percent to Morgan Corp. The market
rate of interest for a note of similar risk is 12 percent. In this case,
because the effective rate of interest (12%) is greater than the
stated rate (10%), the present value of the note is less than the
face value. That is, the note is exchanged at a discount.

ILLUSTRATION 7-16
Computation of
Present Value—
Effective Rate
Different from
Stated Rate
 Interest-Bearing Notes

Illustration: Marie Co. issued for cash a €10,000, three-year

note bearing interest at 10 percent to Morgan Corp. The market
rate of interest for a note of similar risk is 12 percent. In this case,
because the effective rate of interest (12%) is greater than the
stated rate (10%), the present value of the note is less than the
face value. That is, the note is exchanged at a discount.

Marie Co. records the issuance of the note as follows.

Cash 9,520
Notes Payable 9,520
 Interest-Bearing Notes

ILLUSTRATION 14-16
Schedule of Note
Discount Amortization
 Interest-Bearing Notes
ILLUSTRATION 14-16
Schedule of Note
Discount Amortization

Marie Co. records the following entry at the end of year 1.

Interest Expense 1,142

Notes Payable 142
Cash 1,000
 Accounting for Serial Bonds

At the beginning of 2006; a company issued $500,000 of

ten-year, 10% serial bonds, to be repaid in the amount of
$50,000 each year. The bond issue costs were $25,000.
Assume that interest payments are made annually and
that the bonds are issued to yield:
Case 1 9% p.a.
Case 2 11% p.a.
 Accounting for Serial Bonds
Case 1: Bonds are issued to yield 9%
a. Proceeds of bond issue = PV (I) + PV (P)
A B A+B A+B (1+i)-n
Interest Principal Total Discount Present
End of Due Due Amount Due Factor (9%) value
2006 50,000 50,000 100,000 0.917 91,700
2007 45,000 50,000 95,000 0.842 79,990
2008 40,000 50,000 90,000 0.772 69,480
2009 35,000 50,000 85,000 0.708 60,180
2010 30,000 50,000 80,000 0.650 52,000
2011 25,000 50,000 75,000 0.596 44,700
2012 20,000 50,000 70,000 0.547 38,290
2013 15,000 50,000 65,000 0.502 32,630
2014 10,000 50,000 60,000 0.460 27,600
2015 5,000 50,000 55,000 0.422 23,210
Totals 275,000 500,000 775,000 519,780
Proceeds of Serial Bond issue @ 9% yield 519,780
 Accounting for Serial Bonds
b. Premium on bond issue
Total proceeds……………………………………$519,780
Face value……………………………………………500,000
Premium…………………………………………......19,780

c. Journal entry for the issuance of the serial bonds

Cash……………………………………519,780
Bonds payable…………………………………….519,780

d. Premium amortization table for the serial bonds using the

interest method
 Accounting for Serial Bonds
d. Premium amortization table for the serial bonds using the interest method
B C D A
Year Interest Interest Premium Bond Carrying
Expense Payment Amortization Premium Bal. Amount
(9%*CV) (10%*FV) (C-B) (BB-D)
Issue - - - 19,780 519,780
2006 46,780 50,000 3,220 16,560 466,560
2007 41,990 45,000 3,010 13,550 413,550
2008 37,220 40,000 2,780 10,770 360,770
2009 32,469 35,000 2,531 8,239 308,239
2010 27,742 25,000 2,258 5,981 255,981
2011 23,038 20,000 1,962 4,019 204,019
2012 18,362 15,000 1,638 2,381 152,381
2013 13,714 10,000 1,286 1,095 101,095
2014 9,099 5,000 901 194* 50,194
2015 4,517 483* - -

*Rounding up difference
 Accounting for Serial Bonds
Journal entry to record the retirement of the first serial bond and
the payment of the first interest for 1996:
Bonds payable……………………….53, 220
Bond Interest Expense…………….46,780
Cash 100,000
Case 2: Bonds are issued to Yield 11%
a. Proceeds of bond issue = PV (I) + PV (P)
 Accounting for Serial Bonds
A B A+B (1+i)-n A+B (1+i)-n
Interest Principal Total Amount Discount Present
End of Due Due Due factor (11%) value
1996 50,000 50,000 100,000 0.901 90,100
1997 45,000 50,000 95,000 0.812 77,140
1998 40,000 50,000 90,000 0.731 65,790
1999 35,000 50,000 85,000 0.659 56,015
2000 30,000 50,000 80,000 0.593 47,440
2001 25,000 50,000 75,000 0.535 40,125
2002 20,000 50,000 70,000 0.482 33,740
2003 15,000 50,000 65,000 0.434 28,210
2004 10,000 50,000 60,000 0.391 23,460
2005 5,000 50,000 55,000 0.352 19,360
Totals 275,000 500,000 775,000 481,380
Proceeds of Serial Bond issue @ 11% yield 481,380
 Accounting for Serial Bonds

b. Discount on bond issue

Face value……………………………………………500,000
Total proceeds……………………………………$481,380
Discount ………………………………………….......18,620
c. Journal entry to record the issuance of the bonds
Cash ………………………………………….481,380
Bonds Payable…………………………………..481,380

d. Discount amortization table using the interest method

 Accounting for Serial Bonds
Year Carrying Interest Interest Discount Bond Cumulative
Amount Expense Payment Amortization Discount Principal
(11%) (10%) Balance Payment
Issue 481,380 - - - 18,620 -
1996 434,332 52,952 50,000 2,952 15,668 50,000
1997 387,109 47,777 45,000 2,777 12,891 100,000
1998 339,691 42,582 40,000 2,582 10,309 150,000
1999 292,057 37,366 35,000 2,366 7,943 200,000
2000 244,183 32,126 25,000 2,126 5,817 250,000
2001 196,043 26,860 20,000 1,860 3,957 300,000
2002 147,608 21,565 15,000 1,565 2,392 350,000
2003 98,845 16,237 10,000 1,237 1,155 400,000
2004 49,718 10,873 5,000 873 282* 450,000
2005 - 5,469 496* - 500,000

*Rounding up difference
e. Journal entry to record the retirement of the first serial bond and the
payment of the first interest for 1996:
Bonds payable [50000-2952]……47048
Bond Interest Expense…………..52,952
Cash………………………………… 100,000
 Intermediate Financial Accounting
Accounting for long term Investment (Investment in
Financial instruments )

IFRS 9

Part one (Debt investment)

 Long term Investment (Investing in
Financial Asset Financial Assets)
Cash.

Equity investment of another company (e.g., ordinary or preference

shares).
Debit investment -Contractual right to receive cash from another
Recognition
party (e.g., loans, receivables, and bonds).
Recognize a financial asset or financial liability when, and only when,
the entity becomes a party to the contractual provisions of the
instrument (ie trade date)
Initial Meseuremnt of
Fianacial assets
Initially all financial asset shall be recognized at fair value.
Except for trade receivables
 ACCOUNTING FOR FINANCIAL ASSETS
Subsequent Meseuremnt of
Fianacial assets
 subsequent measurement model for financial assets
depends on their model/classification
IFRS requires that companies measure their financial assets based on two criteria:
 Company’s business model for managing its financial assets; and
 Contractual cash flow characteristics of the financial asset.

Equity investments are generally recorded and reported at fair value.

 Business Other
Business
model = hold business
model= hold
to collect and model
to collect
sell
Cash flows are
solely payments of Amortised cost FVTPL
FVOCI*
principal and
interest (SPPI)

Other types of
FVTPL FVTPL FVTPL
cash flows

Only debt investments such as receivables, loans, and bond investments

that meet the two criteria above are recorded at amortized cost. All other
debt investments are recorded and reported at fair value.
 DEBT INVESTMENTS
Debt investments are characterized by contractual payments on
specified dates of
 principal and
 interest on the principal amount outstanding.
Companies measure debt investments at
 amortized cost or
 fair value.
Illustration: XYZ Company purchased $500,000 of 10% bonds of
ABC co. on January 1, 2020. The bonds mature January 1,2022 and
yield 12%; interest is payable each July 1 and January 1. Robinson
records
Pv the investment as follows:
(p) = 25,000 * (1- 482,675
500,000 (1/1.06^4)/0.06)
 Investor (XYZ) Issuer (ABC)
Debt investment Cash 482675
482675 Bond payable
Cash Interest 482675
482675 Cas received revenue Discount
Date (paid) (Expense) amortization Carrying amount
1/1/2020 482675
7/1/2020 $25,000.00 28960.5 $3,960.50 $486,636
1/1/2021 $25,000.00 29198.13 $4,198.13 $490,834
29450.017
7/1/2021
records the$25,000.00
receipt/payment8of the first
$4,450.02
semiannual $495,284
interest payment on 29717.018
July 1, 2020
Investor
1/1/2022 $25,000.00 (XYZ) 87 $4,717.02 Investor (XYZ)
$500,000
Cash 25,000 Interest expense
Interest revenue 28960.5
28,960.5 Cash
Assume that XYZ sells its investment March 30,2021 for 92 2/3 plus Accrued interest
Interest
Cas received revenue Discount
Date (paid) (Expense) amortization Carrying amount
1/1/2020 482675
7/1/2020 $25,000.00 28960.5 $3,960.50 $486,636
1/1/2021 $25,000.00 29198.13 $4,198.13 $490,834
29450.017
7/1/2021 $25,000.00 8 $4,450.02 $495,284
Debt investment
29717.018
(4,450*3/6)= 2,225
1/1/2022 $25,000.00 87 $4,717.02 $500,000
Interest revenue
Selling price of bond (exclusive of accrued interest)
2,225
500,000*0.9275
Less book value = 463,750
( carrying value) of the bond March
30,2021 = 2,225+490,834= 493,059
Loss from sales of bond =463,750-
493059 =29,309
 Selling price of bond (exclusive of accrued interest)
500,000*0.9275 = 463,750
Less book value ( carrying value) of the bond March
30,2021 = 2,225+490,834= 493,059
Loss from sales of bond =463,750-
493059 =29,309
Investor Issuer

Cash (463,750+12,500) Bond payable

loss476,250
on sales of Debt 493,059
Interest expense
investment 29,309
Debt investment 12,500
Cash
493,059
Interest revenue 493,059
Gain from exting. of bond
12,500 29,309
 Debt Investments—Fair Value
Illustration: XYZ Company purchased $500,000 of 10% bonds of ABC
co. on January 1, 2020. The bonds mature January 1,2022 and yield
12%; interest is payable each July 1 and January 1 . Robinson records
the investmentEntries are the same as those for amortized cost.
as follows:
020

Investor (XYZ) Issuer (ABC)

Jan. 1,2

Debt investment Cash 482675

482675 Bond payable
Cash 482675
482675
Investor (XYZ) Investor (XYZ)
020

Cash 25,000 Interest expense

July 1,2

Interest revenue 28960.5

28,960.5 Cash
Debt investment 25,000
 Cash received Interest revenue Discount Carrying
Date (paid) (Expense) amortization amount
1/1/2020 482675
7/1/2020 $25,000.00 28960.5 $3,960.50 $486,636
1/1/2021 $25,000.00 29198.13 $4,198.13 $490,834
7/1/2021 $25,000.00 29450.0178 $4,450.02 $495,284
1/1/2022 $25,000.00 29717.01887 $4,717.02 $500,000
Its determined that, due to a decrease in interest rates, the fair value
of the debt investment increased to $502, 321 at December 31,
2020
Fair value at December 31,2020.
502,321
Amortization cost December 31,2020
490,384
Fair Value Adjustment holding
Unrealized 11,937 gain or loss
11,937
Unrealized Holding Gain or Loss—Income
11,937
 Cash received Interest revenue Discount Carrying
Date (paid) (Expense) amortization amount
1/1/2020 482675
7/1/2020 $25,000.00 28960.5 $3,960.50 $486,636
1/1/2021 $25,000.00 29198.13 $4,198.13 $490,834
7/1/2021 $25,000.00 29450.0178 $4,450.02 $495,284
1/1/2022 $25,000.00 29717.01887 $4,717.02 $500,000
At December 31, 2021, assume that the fair value of the debt
investment is $495,000.
Investment Amortized cost FV
Unrealized gain(Loss)
ABC Bond 500,000 495,000
- 5,000
Previous period FV adjustment
Unrealized
- 11,937Holding Gain or Loss—Income
16,937
Fair value Adjustment
Fair Value Adjustment 16,937
(16,937)
 Intermediate Financial Accounting
Accounting for long term Investment (Investment
in Financial Instrument)

IFRS 9

Part Two ( Equity Investment )

 EQUITY INVESTMENTS
Equity investment represents ownership of ordinary, preference, or
other capital shares.
 Cost includes price of the security.(FV)
 Broker’s commissions and fees are recorded as expense.

The degree to which one corporation (investor) acquires an interest in

the common stock of another corporation (investee) generally
determines the accounting treatment for the investment subsequent
to acquisition.
EQUITY INVESTMENTS
 EQUITY INVESTMENTS (Holdings of Less Than 20%)
Under IFRS, the presumption is that equity investments are held-for-
trading.
General accounting and reporting rule:
 Investments valued at fair value.
 Record unrealized gains and losses in net income .
Illustration: November 3, 2015, Tewedaje company purchased
ordinary shares of Four companies, each investment representing
Investments
less Tewdajeshares
than a 20 percent interest. These records these investments as follows:
are held-for-trading.
Cost
ordinary shares of X Equity Investments
$520,000
$1,680,000
ordinary shares of y
$360,000 Cash 1,680,000
ordinary
Total shares of z
 Equity Investments—Trading (Income)
On December 6, 2015, Republic receives a cash dividend of $9,250 on
its Cash
investment in the ordinary shares of Y
9,250
Dividend Revenue
Equity investment portfolio
9,250 December 31,2015
Investments carrying value fair
value
ordinary shares of X unrealized gain/ loss
$520,000
$560,000 $40,000
ordinary shares of y $360,000
$340,00 $(20,000)
ordinary
Total shares
portfolio of z $480,000
$1,680,000
$500,000
$1,750,000 $20,000
$70,000
ordinary
Previous shares
period of Kadjustment balance
FV $320,000
$350,000 $30,000
 Equity Investments—Trading (Income)
Total portfolio $1,680,000 $1,750,000
$70,000
Previous period FV adjustment balance
0
Fair value
Fair Valueadjustment
Adjustment 70,000
Unrealized
$70,000 Holding Gain or Loss—Income 70,000
On February 6 , 2016, Tewedaje sold all of its X ordinary shares,
receiving
Net$560,000.
proceeds from sales $560,000
Cost of Ordinary share sold $520,000
Gain From sales of Share 40,000
Cash 560,000
Equity Investments 520,000
Gain on Sale of Equity Investment 40,000
 Equity Investments—Trading (Income)
In addition, assume that on February 10, 2016, Tewedaje purchased
$450,000 of L’s company ordinary shares (30,000 shares $15 per
share), plus brokerage commissions of $3,500. Tewedaje’s equity
investment portfolio as of December
Equity 31, 2016.
investment portfolio
December 31,2016
Investments carrying value fair value
ordinary shares of L unrealized gain/ loss
$450,000
$470,000 $20,000
ordinary shares of y $360,000 $325,00
$(35,000)
ordinary
Total shares of z
portfolio $480,000
$1,610,000
$505,000
$1,630,000 $25,000
$20,000
ordinary
Previous shares of Kadjustment balance $320,000
period FV
Total portfolio $1,610,000
$1,630,000 $20,000
Previous period FV adjustment balance
70,000
Fair value adjustment
Tewedaje records this adjustment as
$(50,000 )
follows.
Unrealized Holding Gain or Loss—Income
50,000
Fair Value Adjustment 50,000
 Equity Investments—Non-Trading (OCI)
The accounting entries to record non-trading equity investments
are the same as for trading equity investments, except for
recording the unrealized holding gain or loss.
 Report the unrealized holding gain or loss as other
Illustration: On December 10, 2015, Republic Corporation
comprehensive income (OCI).
purchased 1,000 ordinary shares of Hawthorne Company for
€20.75 per share (total cost €20,750). The investment represents
less than a 20 percent interest. Hawthorne is a distributor for
Republic products in certain locales, the laws of which require a
minimum levelEquity
of share ownership of a
Investments company in that region.
20,750
The investment inCash
Hawthorne meets this regulatory requirement.
20,750
 Equity Investments—Non-Trading (OCI)
On December 27, 2015, Republic receives a cash dividend of €450 on its investment in the ordinary
shares of Hawthorne Company. It records the cash dividend as follows.
Cash 450
Dividend Revenue 450
At December 31, 2015, Republic’s investment in Hawthorne has the carrying value and fair value
shown.

Republic records this adjustment as follows.

Fair Value Adjustment 3,250

Unrealized Holding Gain or Loss—Equity
 Equity Investments—Non-Trading (OCI)

On December 20, 2016, Republic sold all of its Hawthorne Company

ordinary shares receiving net proceeds of €22,500 .
 Equity Investments—Non-Trading (OCI)
Entry to adjust the carrying value of the non-trading investment.
Unrealized Holding Gain or Loss—Equity 1,500
Fair Value Adjustment 1,500

On December 20, 2016, Republic sold all of its Hawthorne Company

ordinary shares receiving net proceeds of €22,500.

Entry to record the sale of the investment.

Cash 22,500
Equity Investments 20,750
Fair Value Adjustment 1,750
 Holdings Between 20% and 50%
An investment (direct or indirect) of 20 percent or more of the voting
shares of an investee should lead to a presumption that in the absence
of evidence to the contrary, an investor has the ability to exercise
significant influence over an investee.
In case of “significant influence,” the
Equity investor must account for the
Method
investment using the equity method.
Record the investment at cost and subsequently adjust the amount each period for
 the investor’s proportionate share of the earnings (losses) and
 dividends received by the investor.

If investor’s share of investee’s losses exceeds the carrying amount of the investment, the investor
ordinarily should discontinue applying the equity method.
 Holdings Between 20% and 50%

Controlling Interest - When one corporation acquires a voting interest of more than 50
percent in another corporation.
 Investor is referred to as the parent.
 Investee is referred to as the subsidiary.
 Investment in the subsidiary is reported on the parent’s books as a long-term investment.
 Parent generally prepares consolidated financial statements.
Reporting Treatment of Investments
Intermediate /advanced Financial Accounting

By Kibrysfaw Tutor (IFRS consultant & trainer, lecture, PhD

candidate) +251911063618
 DEFINITION OF IMPORTANT TERMS
Accounting Profit or loss for the period before
profit/loss deducting tax expense. (IFRS)
+Expense recognized but not deductible for
tax purpose
- Expense not recognized but deductible for
tax purpose
-income
Taxablerecognized,
Thebut not(loss)
profit underfortax
a law
period, determined in
+ income not accordance
recognized, butwith applicable
included undertax rules on
profit/loss
tax law which income taxes are payable
Current The amount of income taxes payable
income tax (recoverable) in respect of the taxable profit
Taxable (tax loss) for a period
Tax expense
profit/loss Tax rate
***
Tax payable
 Cont’d

Differences

permanent Temporary
Differences Differences
 Differences between the
 Are differences that will
carrying amount of an asset or
remain unsolved period after
liability in the statement of
period. Eg- donation,
financial position and its tax
entertainment deference-
 Entities shall deduct or add base
 Reconciled through periods
back permanent differences  Entities shall deduct or add back
from accounting profit in
permanent differences from
order to determine taxable
accounting profit in order to
profit
determine taxable profit &
 Cont’d
The Government specifies that:
Ethio telecom must each year pay a tax = 30% of taxable
profit for the year
taxable profit is determined in accordance with IFRS
adjusted for specified expenses that are excluded from the
calculation of taxable income (ie donations and
entertainment)
If the determination of taxable business income results in a
loss in a tax period, that loss may be set off against taxable
income in the next five (5) tax periods, earlier losses being
set off before later losses.
Ethio telecom determines, accounting profit in accordance with
IFRS:
profit for 2014 to be 900,000 (donation expense = 100,000)
 Cont’d
The aggregate amount included in the
Income tax
determination of net profit or loss for the period
in respect of current tax and deferred tax
Current Deferred
income tax income tax
Substa
 payable to tax office Accounting measure
nce
Base  Taxable profit/loss  Temporary Difference
Timin   Future period
Current period
g
Deferred Income tax payable or recoverable in future
income tax periods in respect of the temporary differences ,
unused tax losses Tax
and unused tax credits
Temporary
difference rate
 Differed income
tax:
Temporary
Asset Liability
differences
arrying amount Tax Base carrying amount Tax Base

CA> TB CA < TB CA<TB CA> TB

Deductible Temporary
axable Temporary Deductible Temporary
Taxable Temporary
differences differences differences differences

Differed tax Liability Differed tax Asset

ffered tax Liability Differed tax Asset
Differed tax Differed tax Asset Differed tax Differed tax
expense ** ** Differed expense ** Asset **
Differed tax Income ** Differed tax Differed tax
 Example 1

A company Purchased an asset Costing $1,500. At the end of 2014 the carrying amount is $1,000. The cumulative depreciation for tax purpose is
$900 and the current tax rate is 25%

Carrying amount of the asset = 1,000 Tax base of the Asset = $1,500,00- 900 = 600

Temporary Difference = 1,000- 600 = 400

Since Carrying amount of the asset is greater than its tax base the temporary difference is Taxable temporary Difference (Differed tax
liability)

DTL = Temporary Difference x Tax rate = 400 * 0.25 = 100

 Example 2
Xyz co Recognized a liability of $10,000 for accrued Product
warranty costs on 31 December 2013. these product warranty
costs will not be deductible for tax purpose Until the entity pays
claims . The tax rate is 30%
Carrying amount of the Liability = 1,0000 Tax base of the Asset = $0

Temporary Difference = 10,000- 0 = 10,000

Since Carrying amount of the Liability is greater than its tax base the temporary difference is Deductible
temporary Difference (Differed tax Asset)

DTA = Temporary Difference x Tax rate = 10,000 * 0.3 = 10,000

Intermediate Financial Accounting

15
R S
IF

By Kibrysfaw Tutor
 Definitions
Revenue Income arising in the course of an entity's
ordinary activities

An agreement between two or more

Contract parties that creates enforceable rights and
obligations
An entity's right to consideration in
Contract
exchange for goods or services that is
asset conditioned on something other than the
passage of time (for example the entity's
future performance).

An entity's right to consideration that is

Receivable unconditional – ie only the passage of time is
required before payment is due
 • An entity's obligation to transfer goods
Contract
liability
or services to a customer for which the
entity has received consideration (or the
• amount is due) from the customer
A promise in a contract with a
Performance customer to transfer to the customer
obligation
goods or services that are distinct
• The price at which an entity would
Stand-alone sell a promised good or service
selling price
separately to a customer
The amount of consideration to which
an entity expects to be entitled in
Transactio exchange for transferring promised
n price goods or services to a customer,
excluding amounts collected on behalf
Revenue recognition and measurement – 5 step model
St
e • Identify the contract(s) with a customer
p
1
St
e • Identify the performance obligation(s) in the contract
p
2
St
e • Determine the transaction price
p
3
St • Allocate the transaction price to the performance
e obligations in the contract
p
4
St • Recognize revenue when (or as) the entity satisfies a
e performance obligation
p
5
Assume that Marathon Motor signs a contract to sell A specified car to its customer. In addition to the
car marathon agrees to provide a 2 year service and 1 year warranty to its customer for Birr 7,000,000.
The company sells the same car for Birr 6,500,000 without the service
A contract is an agreement between two
Step 1: Identify parties that creates enforceable rights or
the contract obligations. In this case, Marathon motor has
with customers. signed a contract to deliver Car, 2 year service
Step 2: Identify and 1 year assurance to its customer
the separate
performance Marathon has two performance obligation—to
obligations in the deliver the car and to provide 2 year service ..
contract.
Step 3: Transaction price is the amount of consideration
Determine the that a company expects to receive from a
transaction customer in exchange for transferring a good or
price. service. In this case, the transaction price is
straightforward—it is Br.7million.
Step 4: Allocate the In this case, marathon needs to
Cont’d
transaction price to the allocate the transaction price to the
separate performance car and its service performance
obligations. obligations .
Airbus recognizes revenue of Br.6.5
Step 5: Recognize million for the sale of the car when it
revenue when each satisfies its performance obligation—the
performance obligation delivery of the car and 500,000 when it
is satisfied. performs the service.
Contract with Customers—Step 1
 Contract is an Agreement between two or more parties that creates enforceable rights or
obligations.
 Can be written, oral, or implied from customary business practice.

Company applies the revenue guidance to a contract according to the following criteria in
Contract Criteria for Revenue Guidance
Apply Revenue Guidance to Contracts If: Disregard Revenue
Guidance to
 The contract has commercial substance;  The contract
Contracts If: is
 The parties to the contract have approved the wholly
contract and are committed to perform their unperformed,
respective obligations; and
 The company can identify each party’s rights  Each party can
regarding the goods or services to be transferred; unilaterally
and terminate the
 The company can identify the payment terms for the contract without
goods and services to be transferred. compensation.
 It is probable that the company will collect the
consideration to which it will be entitled.

LO 3
 Separate Performance Obligations—Step 2
To determine whether a company has to account for multiple performance obligations, it
evaluates a second condition.

Whether the product is distinct within the contract.

► If performance obligation is not highly dependent on, or interrelated with, other promises
in the contract, then each performance obligation should be accounted for separately.
► If each of these services is interdependent and interrelated, these services are combined
and reported as one performance obligation.
Determining Transaction Price—Step 3
Transaction price
Amount of consideration that company expects to receive from a customer.
In a contract is often easily determined because customer agrees to pay a fixed amount.
LO 4
 Separate Performance Obligations—Step 2

Existence of
Variable consideration significant Non-cash
financing consideration
Amount of component
consideration can vary Adjust
because of discounts, consideration if
rebates, refunds, timing provides Measure at fair value
credits, price customer or entity
concessions, with significant
incentives, benefit of financing
performance bonuses Practical expedient –
etc If fair value cannot be
no adjustment if the estimated, measure
period between consideration
consideration and indirectly by reference
Estimate using Expected
Value or Most Likely transfer of good and to stand-alone selling
Amount) service is one year price of the goods or
or less services transferred
 Variable Consideration
Facts: Solomon Construction Company enters into a contract with a
customer to build a warehouse for Br.100,000, with a performance bonus of
Br.50,000 that will be paid based on the timing of completion. The amount
of the performance bonus decreases by 10% per week for every week
beyond the agreed-upon completion date. The contract requirements are
similar to contracts that Solomon has performed previously, and
management believes that such experience is predictive for this contract.
Management estimates that
Question: How there
should is a account
Solomon 60% probability
for this revenuethat the contract will
arrangement?
be completed by the agreed-upon completion date, a 30% probability that it
will60%
be chance
completed 1 week
of Br.150,000 = late, and Br. only
90,000a 10% probability that it will be
completed
30% chance2ofweeks late.
Br.145,000 = 43,500
10% chance of Br.140,000 = 14,000
Br.147,500
Most likely outcome, if management believes they will meet the deadline and receive the Br.50,000 bonus, the
total transaction price would be?
LO 5
 Step 4- Allocating Transaction Price to Separate
 Performance
Based on their relative Obligations
fair values (selling price of the good or
service for on a standalone basis.)
 If not available, companies should use their best estimate of what
the good or service might sell for as a standalone unit .

LO 6
5. Recognizing Revenue When (or as) Each
Performance Obligation
Company satisfies Is Satisfied
its performance obligation when the customer
obtains control of the good or service.
Change in Control Indicators
1. Company has a right to payment for asset.
2. Company has transferred legal title to asset.
3. Company has transferred physical possession of asset.
4. Customer has significant risks and rewards of ownership.
5. Customer has accepted the asset.

LO 7
 Cont’d

Revenue Recognition Situations

Type of Sale
Saleofofproduct
product Performing
Performingaa Permitting
Permittinguse
useofof Sale
Saleofofasset
assetother
other
Transaction from inventory
from inventory service
service an
anasset
asset than inventory
than inventory

Description Revenue
Revenuefromfrom
Revenue
Revenuefrom
from Revenue
Revenuefrom
from Gain
Gainororloss
losson
on
interest,
interest, rents,and
rents, and
of Revenue sales
sales fees or services
fees or services
disposition
disposition
royalties
royalties

Timing of Services As
Date Services Astime
timepasses
passes
Revenue Dateofofsale
sale(date
(date performed
Date
Dateof
ofsale
saleor
or
ofofdelivery) performedand
and or
or assetsare
assets are trade-in
Recognition delivery) billable used trade-in
billable used

LO 4
 Summary of five steps
Step in Process A performance Implementation
obligation is a
1.Identify the A company applies the revenue
promise in a
contract with contract to guidance to contracts with
customers. provide a product
customers and must determine if
new performance obligations are
or service to a created by a contract
customer. modification.

2. Identify the A contract may be comprised of

separate multiple performance obligations.
performance A performance Accounting is based on
obligations in the obligation exists evaluation of whether the
contract if the customer product or service is distinct
can benefit from within the contract.
LO 7
 Summary of five steps
Step in Process Description Implementation
3.Determine the Transaction price In determining the transaction
transaction is the amount of price, companies must consider the
price. consideration that following factors:
a company 1. variable consideration,
expects to receive
2. time value of money,
from a customer in
exchange for 3. Non-cash consideration, and
transferring goods 4. consideration paid or payable to
and services. customer.

4.Allocate the
Companies satisfy performance
transaction price If more than one obligations either at a point in time
to the separate performance or over a period of time.
performance obligation exists, Companies recognize revenue over
obligation allocate the a period of time if LO 7
 Summary of five steps
Step in Process
Description Implementation
5.Recognize A company satisfies Companies satisfy
revenue when its performance performance obligations
each obligation when the either at a point in time or
performance customer obtains
over a period of time.
obligation is control of the good or
service. Companies recognize
satisfied. revenue over a period of
time if
1.the customer controls the
asset as it is created or
2.the company does not
have an alternative use for
the asset.
LO 7
 Intermediate Financial Accounting

15)
I F R S
(
Part 2 Revenue recognition in the long-
term Contracts
By Kibrysfaw Tutor
 Revenue recognition for long Term Contracts
The entity satisfies a performance obligation by transferring control of a
promised
A good obligation
performance or service can
to the satisfied .at a point in time, such as when
becustomer
goods are delivered to the customer, or over time
A company recognizes revenue over time if at least one of the
following two criteria is met:
1. Company’s performance creates or enhances an asset (e.g., work
in process) that the customer controls as the asset is created or
enhanced;
In addition or one of the following criteria must be met:
at least
a.
2. The customerperformance
Company’s simultaneously receives
does and consumes
not create an asset the benefits
with an of the
entity’s performance as the entity performs.
alternative use. In addition…
b. Another company would not need to substantially re-perform the work the
company has completed to date if that other company were to fulfill the
remaining obligation to the customer.
 Revenue recognition for long Term Contracts

If criterion 1 or 2 is met, then a company recognizes revenue over time if it can reasonably
estimate its progress toward satisfaction of the performance obligations.
 Company recognizes revenues and gross profits each period based upon the progress of the
construction—referred to as the percentage-of-completion method.
 If criteria are not met, the company recognizes revenues and gross profit when the contract is
completed, referred to as the cost-recovery (zero-profit) method.
Percentage-of-Completion Method
Measuring the Progress Toward Completion
Most popular input measure used to determine the progress toward
completion is the cost-to-cost basis.
 LONG-TERM CONSTRUCTION CONTRACTS

Percentage-of-Completion Method (%
Determined using cost-cost base)
Illustration: Hardhat Construction Company has a contract to construct a
Br.4,500,000 bridge at an estimated cost of Br.4,000,000. The contract is to
start in July 2015, and the bridge is to be completed in October 2017. The
following data pertain to the construction period.

2015 2016 2017

Cost to Date 1,000,000 2,916,000 4,050,000
Estimated cost to complete 3,000,000 1,134,000 0
Total Estimated cost of the project 4,000,000 4,050,000 4,050,000
% completed to date (1M/4M)*100% =25% (2.916M/4.05M)*100% =72% (4.050M/4.05M)*100 =100%
% Completed (current year) 25% 72-25 = 47% 28%
Revenue of the period 25%*4,500,000= 47%4,500,000 =2,115,000 28%*4,500,000= 1,260,000
1,125,00
Cost incurred (current year) 1,000,000 1,916,000 1,134,000
Gross profit (Current year) 125,000 199,000 126,000
 PERCENTAGE-OF-COMPLETION METHOD

ILLUSTRATION 3A-5
 2015 2016 2017
% completed to date (1M/4M)*100% =25% (2.916M/4.05M)*100% =72% (4.050M/4.05M)*100 =100%
% Completed (current year) 25% 72-25 = 47% 28%
Revenue of the period 25%*4,500,000= 47%4,500,000 =2,115,000 28%*4,500,000= 1,260,000
1,125,00
Cost incurred (current year) 1,000,000 1,916,000 1,134,000
Gross profit (Current year) 125,000 199,000 126,000
PERCENTAGE-OF-COMPLETION METHOD

Content of Construction in Process Account—Percentage-of-Completion Method

Financial Statement Presentation—Percentage-of-Completion

Computation of Unbilled Contract Price at 12/31/15
 PERCENTAGE-OF-COMPLETION METHOD

Financial Statement Presentation—Percentage-

of-Completion Method (2015)
 PERCENTAGE-OF-COMPLETION METHOD

Financial Statement Presentation—Percentage-

of-Completion Method (2016)
LONG-TERM CONSTRUCTION CONTRACTS

Cost-Recovery (Zero-Profit) Method

This method recognizes revenue only to the extent of costs incurred that are expected to be
recoverable. Only after all costs are incurred is gross profit recognized.
COST-RECOVERY (ZERO-PROFIT) METHOD
COST-RECOVERY (ZERO-PROFIT) METHOD
Financial Reporting (IFRSs)

IAS 7 STATEMENT OF CASH FLOW

BY: Kibrysfaw Getahun

Lecturer, trainer & consultant
 STATEMENT OF CASH FLOWS
Cash and cash equivalent
Cash Cash on hand, demand deposits, cheeks …..
Cash equivalent short term investment which are readily convertible to
known amount of cash with in short period of time
 Statement of cash flow is An important element of financial reporting with
objective of “Assessing the amounts, timing, and uncertainty of cash
flows.”
 IASB requires the statement of cash flows (also called the cash flow
statement).
 Differ from other Financial statements because it follows cash base of
LO 4
 STATEMENT OF CASH FLOWS

Primary Purpose: To provide relevant information about the cash

receipts and cash payments of an enterprise during a period.
Statement provides answers to the following questions:
1. Where did the cash come from?
2. What was the cash used for?
3. What was the change in the cash balance?

LO 4
STATEMENT OF CASH FLOWS

Content and Format (has Three Section)

Operating Investing Financing
Activities Activities Activities
Transactions that Making and Transactions
enter into the collecting loans involving liability
determination of and acquiring and and equity items
net income disposing of
investments and
property, plant,
and equipment

LO 5
CONTENT AND FORMAT

LO 5
Format of the Statement of Cash Flows

LO 2
 STATEMENT OF CASH FLOWS

Preparation of the Statement of Cash Flows

Sources of Information
Information obtained from several sources:
1. comparative statements of financial position,

2. current income statement, and

3. selected transaction data.

Two approaches to prepare statement of cash flow

1. Direct approach

2. Indirect approach
LO 6
Classification of Cash Flows

Income
Statement
Items

LO 2
Classification of Cash Flows

Generally
Investments
and Non-
Current Asset
Items

Generally
Equity and
Non-Current
Liability Items

LO 2
Indirect Method—Additional Adjustments

LO 6
 Preparation of Statement of Cash Flows

Illustration: On January 1, 2015, in its first year of

operations, Telemarketing Inc. issued 50,000 ordinary shares
of $1 par value for $50,000 cash. The company rented its
office space, furniture, and telecommunications equipment and
performed marketing services throughout the first year. In June
2015, the company purchased land for $15,000.

The following Illustration shows the company’s comparative

statements of financial position at the beginning and end of
2015.

LO 6
 Increase in accounts receivable
reflects a non-cash increase of
$41,000 in revenues.

Cash provided by operating activities

LO 6
 Increase in accounts payable
reflects a non-cash increase of
$12,000 in expenses.

Cash provided by operating activities

LO 6
Preparing the Statement of Cash Flows

Telemarketing Inc.’s investing and financing activities.

 Purchased land for $15,000.
 Issued ordinary shares for $50,000.
 Paid $14,000 in dividends.

LO 6
Investing
and
Financing
Activities

Purchased land
for $15,000
(Investing)

LO 6
Investing
and
Financing
Activities

Issued ordinary
shares for
$50,000
(Financing)

LO 6
Investing
and
Financing
Activities

Paid $14,000 in
dividends
(Financing)

LO 6
Preparation of Statement of Cash Flows

Keyser Beverage Company reported the following items in the

most recent year.
Activity
Net income $40,000 Operating
Dividends paid 5,000 Financing
Increase in accounts receivable 10,000 Operating
Increase in accounts payable 7,000 Operating
Purchase of equipment 8,000 Investing
Depreciation expense 4,000 Operating
Issue of notes payable 20,000 Financing

Required: Determine if each item should be classified as an

operating, investing, or financing activity.
LO 6
BE 5-12
Statement of Cash Flow (in thousands)
Operating activities
Net income $ 40,000
Increase in accounts receivable (10,000)
Increase in accounts payable 7,000
Depreciation expense 4,000
Net cash provided by operating activities 41,000
Investing activities
Purchase of equipment (8,000)
Financing activities
Dividends paid (5,000)
Proceeds from notes payable 20,000
Net cash provided by financing activities 15,000
Increase in cash $ 48,000
LO 6
 Preparation of Statement of Cash Flows

Question
In preparing a statement of cash flows, which of the following
transactions would be considered an investing activity?
a. Sale of equipment at book value
b. Sale of merchandise on credit
c. Declaration of a cash dividend
d. Issuance of bonds payable.

LO 6
Preparation of Statement of Cash Flows

Significant Non-Cash Activities

Reported in a separate note to the financial statements.

Examples include:
 Issuance of ordinary shares to purchase assets.
 Conversion of bonds into ordinary shares.
 Issuance of debt to purchase assets.
 Exchanges on long-lived assets.

LO 6
Usefulness of Statement of Cash Flows

Without cash, a company will not survive.

Cash flow from Operations:

 High amount - able to generate sufficient cash from
operations to pay its bills without further borrowing.
 Low or negative amount - may have to
► borrow or
► issue equity securities.

LO 7
PREPARATION OF STATEMENT OF CASH
FLOWS

Usefulness of the Statement of Cash Flows

Provides information to help assess:
1. Entity’s ability to generate future cash flows.

2. Entity’s ability to pay dividends and meet obligations.

3. Reasons for the difference between net income and net

cash flow from operating activities.

4. Cash and noncash investing and financing transactions

during the period.

LO 1