FINANCIAL ACCOUNTING AND REPORTING II
CHAPTER 2 – NON – CURRENT LIABILITIES
 DEBT FINANCING VS. EQUITY FINANCING
Debt Financing – when a corporation desires to
raise additional funds for long-term purposes, it
may borrow by issuing bonds and notes.
Equity Financing – when a corporation desires
to raise additional funds for long-term purposes,
it may obtain funds by issuing additional share
capital to shareholders.
DEBT FINANCING OVER EQUITY FINANCING:
1. By issuing bonds, therefore, a corporation
does not spread or dilute control of management
over a large number of owners
2. The interest incurred in debt financing is a
deductible expense in arriving at taxable income
while dividends on share capital are not.
3. The charge for interest on the debt may be
less than the amount of dividends that might be
expected by shareholders.
DISADVANTAGES OF DEBT FINANCING:
1. A corporation can only avail debt financing if it
has adequate security offered to creditors.
2. Interests on debt are required to be paid
periodically regardless of the enterprise’s
financial performance and financial position. If
the interest is not paid on the dates specified by
the contract, the creditors may bring legal action
and there is the possibility of take over by the
creditors.
 NON – CURRENT LIABILITIES
Non-current Liabilities – it includes the portion
of long-term obligations expected to be settled
beyond twelve months from the end of the
reporting period and obligations where the
enterprise has an unconditional right to defer
settlement for more than twelve months after the
reporting date.
MOST COMMON TYPES OF NON-CURRENT LIABILITIES:
 Long-term bank borrowings
 Notes
 Mortgages
 Similar Obligations which are related to
general financial condition of the
enterprise rather than to the operating
cycle and are due beyond 12 months from
the end of reporting period
 Liabilities arising from finance leases that
are not due within 12 months from the
end of the reporting period
 Deferred Income Tax Liabilities
 BONDS PAYABLE
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.
- (Face Value or Par Value)
commonly issued in denominations
of, P1000, P5000, or P10000
Underwriter – an investment firm, where the
corporation sells all of its bonds then resells it to
the investing public
Bond Indenture – the contract between the
issuing corporation and the bondholder
- it specifies the terms of the bonds,
rights and duties of both parties,
restrictions on the issuing
corporation and all other important
details affecting contracting
parties
TYPES OF BONDS:
 Term Bonds – bonds that mature on a
single date
 Serial Bonds – bonds that mature in
installments
 Secured Bonds – provides security and
protection to investors in the form of
specific assets of the issuer, such as real
estate or other collateral
o Real Estate Mortgage Bond –
secured by a lien against real
estate
o Collateral Trust Bond – secured
by shares of stocks and bonds held
by the issuer as investments
o Chattel Mortgage Bond – is
secured by a lien against movable
property like motor vehicles
 Unsecured Bonds (Debentures) – are
not protected by the pledge of any specific
asset of the issuing corporation.
- generally based on the credit
rating of the company, as these
bonds are backed only by the
issuer’s general favorable credit
standing
 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 (Coupon) Bonds – very
transferrable, 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 issuer eliminates the need for
recording changes in the
ownership as well as preparing
and mailing periodic interest
checks
 Callable Bonds or Redeemable Bonds
– those that give the issuing company the
right to call or retire the bonds before
maturity date, usually specified on the
bond indenture.
- the issuer pays the bondholder an
amount in accordance with the call
provisions
 Convertible Bonds – those that give the
bondholders the right to exchange their
bond holdings into a specified or
predetermined number of issuing
corporation’s shares of stock
 Zero-Interest Bonds (Deep Discount
Bonds) – are issued 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
 ISSUANCE OF BONDS PAYABLE
Bonds Payable are initially
recognized at the date of the
actual issue of the bonds.
Bonds Payable are initially
recognized at their discounted
value – net proceeds from their
issuance.
Issue price - 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.
Contract Rate, Stated Rate, Nominal Rate –
rate of interest stated on the face of the bonds.
- 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 rates
company offers to sell bond issue is
relatively low
As the risk factor increases, the
company needs to offer a higher
interest rate in order to attract
investors
Market Rate, Yield, or Effective Interest
Rate – the interest rate which investors are
willing to accept on a bond at the time of its issue
depends upon some factors such as the market
evaluation of the quality of the bond issue as
evidenced by the financial strength of the
business, the firm’s earning prospects and the
particular provisions of the bond issue.
Discount – Effective > Stated; Issue
Price < Face Value
Premium – Effective < Stated; Issue
Price > Face Value
A. Bonds are sold at Face Value
Cash xx
Bonds Payable xx
B. Premium
Cash(at the selling price) xx
Bonds Payable(FV) xx
Premium on Bonds Payable xx
C. Discount
Cash(at the selling price) xx
Discount on Bonds Payable(FV – SP) xx
Bonds Payable(FV) xx
Discount on Bonds Payable is
reported as a direct deduction from
the face value of the bonds payable
 Premium on Bonds Payable is an
adjunct account and reported as an
addition to the face value of the
bonds payable
97 ½ = 97.5 % or quoted at 105 =
105%
When the 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.
Accrued Interest on Bonds Issued is
added to the issue price of the bond
to determine the total cash proceeds
from the bond issuance.
Bond Issue Costs – are expenditures incurred
by the issuing corporation for legal fees, printing
and engraving of bond certificates, taxes,
commissions and similar charges.
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 higher is the yield, the lower is
the present value and the lower is the
yield, the higher is the present value.
 SUBSEQUENT MEASUREMENT OF BONDS
PAYABLE
Amortized Cost – 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.
Amortization – bond premium or bond discount
should be allocated over the life of the bonds
using effective interest method.
- It is a deduction or addition to the
interest expense.
- It results to gradual adjustment of
the bond’s carrying value towards
the bond’s face value and
adjustment of the nominal interest
to the effective interest
Effective Interest Method – a constant interest
rate based on the carrying or book value of the
bonds is recognized as interest expense each
period, resulting in unequal recorded amounts of
interest expense.
- It provides an increasing premium
or discount amortization each
period.
To obtain a period’s interest expense
under Amortization, the bond’s
carrying value at the beginning of
each period is multiplied by the
effective interest rate. The difference
between this amount and the amount
interest paid or accrued is the amount
of discount or premium amortization.
Premium Amortization
1) Nominal Interest = FV * Interest
Stated Rate
2) Effective Interest = Bond CV, beg.
period * effective rate
3) Premium Amortization = Nominal –
Effective
4) Carrying Value = Bond CV, beg. period
– Premium Amortization
The amortization of premium tends to
reduce both the varying value and the
interest expense on the bond.
Interest Expense decreases each
period, because the carrying value
also decreases as the premium is
amortized.
Premium Amortization increases each
period as the difference between the
nominal interest and the effective
interest becomes wider each period.
Discount Amortization
1. Nominal Interest = FV * Interest
Stated Rate
2. Effective Interest = Bond CV, beg.
period * effective rate
3. Discount Amortization = Effective
Interest – Nominal Interest
4. Carrying Value = Bond CV, beg. period
+ Discount Amortization
Discount Amortization increases
the carrying value of the bonds,
 such that on maturity date, the
carrying value will equal the face
value.
Interest Expense increases each
period because the carrying value
also increases as the discount is
amortized.
The amount of the discount
amortization increases each period
as the difference between the
nominal interest and the effective
interest becomes wider.
When 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.
 RETIREMENT OF BONDS
Retirement of Bonds can be:
a) At Maturity Date
b) Before the Maturity Date
 By redeeming the bonds
 Repurchasing them in an open
market
If 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.
The amount of cash paid is equal to
the face value of the bonds.
Bonds Payable xx
Cash xx
If the bonds are retired prior to their
maturity date and the retirement price is
less than the carrying amount of the
bonds, the corporation 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.
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.
The following must be observed if bonds are
retired before maturity date:
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.
Bond Refunding – the replacement of an
outstanding bonds payable with a new bond issue
bearing a lower interest rate.
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.
 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.
Investor’s Dual Set of Rights:
1. The right to receive interest and principal
payment on the bonds
2. The right to acquire ordinary shares and
participate in the potential appreciation of the
market value of shares
Usually, bonds of this nature are
attractive to investors and will
generally result in either a relatively
lower interest rate or greater proceeds
Bonds with Non-Detachable Share Warrants
– 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 of period.
Residual Approach – a method of bifurcation,
when warrants are included in the issue of bond,
the issue shall be allocated between the debt (the
bond) and the equity (the warrants).
- Based on this concept, the equity
represents residual interest in the
assets of the corporation, the
equity component is assigned the
residual amount after deducting
from the fair value of the
compound instrument (bond with
warrant) as a whole the amount
separately determined for the
liability component.
The account Share Warrants
Outstanding is reported as part of the
additional paid-in capital in the equity
section of the statement of financial
position.
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.
Convertible Bonds – give the holders thereof the
right to exchange their
 LONG – TERM NOTES
Interest-Bearing Notes Payable
It is initially recorded at its
face value since this represents
the present value of the note.
After initial recognition, it is
measured at face value plus
accrued interest.
Principal Matures in Lump Sum,
Interest is Payable Periodically
Principal and Interest are
Payable Periodically
prevailing interest rate on similar
notes or based on incremental
borrowing rate of the issuer
Maturity Value is Payable in Lump
Sum
Maturity Value is Payable in
Installments
 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.
3 Forms of Troubled-Debt Restructuring:
a. Settlement of Debt by Transfer of
Assets (Asset Swap)
- A transfer of non-cash assets (real
estate, receivables, or other
assets)
The difference between the
carrying value of a the financial
liability (or part of financial
liability) extinguished or
transferred to another party
and the consideration paid,
including any non-cash assets
transferred or liabilities
assumed, shall be recognized
in profit or loss.

Non – Interest Bearing Notes Payable

It is written in a form where the face

value includes an imputed interest.
Initial recognition: Market Value of
the goods or services received in
exchange for the note.
If the Market Value is not readily
determinable, the present value of
the note is determined based on a