LIABILITIES (PART III)

NON CURRENT LIABILITIES

I. NOTE PAYABLE
II. BONDS PAYABLE
III. DEBT RESTRUCTURING

NOTES PAYABLE

A promissory note is an unconditional promise in writing by one person to another, signed by the maker, engaging to
pay on demand or at a fixed or determinable future time sum certain in money to order or to bearer.

Initial Measurement
1. If not designated at fair value through profit or loss measured at fair value minus transaction costs (directly
attributable)
2. If irrevocably designated at fair value through profit or loss transaction costs are expensed immediately

FV = PV of future cash flow

Subsequent measurement
1. Amortized cost
2. Fair value if designated irrevocable as measured at fair value through profit or loss

Illustration 1 (Cash consideration)

On November 1, 2020 an entity discounted its own note of P1,000,000 at 12% for one year. Prepare the pertinent journal
entries.

Illustration 2 (Issued for property Interest Bearing)

When a property or noncash asset is acquired by issuing promissory note which is interest bearing, the Property asset
is recorded at the purchase price.

The purchase price is reasonably assumed to be the present value of the note and therefore, the fair value of the
property because the note issued is interest bearing.

On January 1, 2020, an entity acquired an equipment for P1,000,000 payable in 5 annual equal installments every December
31 of each year. Interest is 10% on the unpaid balance. Prepare the pertinent journal entries.

Illustration 3 (Issued for property Non-interest bearing)

When a noninterest bearing note is issued for property, the property is recorded at the cash price of the property. The
cash price is assumed to be the present value of the note issued.

The difference between the cash price and the face of the note issued represents the imputed interest.

On January 1, 2020, an entity acquired an equipment with a cash price of P350,000 for P500,000, P100,000 down and the
balance payable in 4 equal annual installments.

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Illustration 4 (No cash price)

On January 1, 2020, and entity acquired an equipment for P1,000,000 payable in 5 equal annual installments at an appropriate
rate of 10% every December 31 of each year. The present value of an ordinary annuity of 1 for 5 years at 10% is 3.7908.
Prepare the pertinent journal entries.

Illustration 4 (No cash price lump sum)

On January 1, 2020, an entity acquired an equipment for P1,000,000. The entity paid P100,000 down and signed a noninterest
bearing note for the balance which is due after three years on January 1, 2023. There was no established cash price for the
equipment. The prevailing interest rate for this type of note is 10%. The present value of 1 for 3 periods is .7513. Prepare the
pertinent journal entries.

Illustration 5 (Fair value option of measuring note payable)

 A note payable may be irrevocably designated as at fair through profit or loss

 Gain or loss on financial liability designated at fair value through profit or loss shall be accounted for as
a. The change in fair value attributable to credit risk is recognized in OCI
b. The remaining of the change in fair value is recognized in profit or loss
 Transaction cost is recognized as outright expense
 No amortization of discount and premium on note payable

On January 1, 2020, an entity borrowed from a bank P4,000,000 on a 12% 5-year interest bearing note. The entity received
P4,000,000 which is the fair value of the note on January 1, 2020. Transaction cost of P 100,000 was paid by the entity.
The fair value of the note payable was P3,500,000 on December 31, 2020. The entity has elected irrevocably the fair value
option for measuring the note payable. The change in fair value comprised P50,000 attributable to credit risk and P450,000
attributable to interest risk. Prepare the pertinent entries.

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BONDS PAYABLE

A bond is a formal unconditional promise, made under seal to pay a specified sum of money at a determinable future
date and to make periodic interest payment at a stated rate until the principal sum is paid.

Types of Bonds
1. Term bonds are bonds with a single date of maturity.
2. Serial bonds are bonds with a series of maturity dates instead of a single one.
3. Mortgage bonds are bonds secured by a mortgage on real properties.
4. Collateral trust bonds are bonds secured by shares and bonds of other corporation
5. Debenture bonds are unsecured or bonds without collateral security.
6. Registered bonds require the registration of the name of the bondholders on the books of the corporation.
7. Coupon or bearer bonds are unregistered bonds in the sense that the name of the bondholder is not
recorded on the entity books.
8. Convertible bonds are bonds that can be exchanged for shares of the issuing entity.
9. Callable bonds are bonds which may be called in for redemption prior to the maturity date.
10. Guaranteed bonds are bonds issued whereby another party promises to make payment if the borrower
fails to do so.
11. Junk bonds are high-risk, high-yield bonds issued by entities that are heavily indebted or otherwise in
weak financial condition.
12. Zero-coupon bonds are bonds that pay no interest but the bonds offer a return in the form of a "deep
discount" or huge discount from the face amount.

Initial measurement
Bonds payable not designated at fair value through profit or loss share be measured initially at fair value minus
transaction cost otherwise bond issue cost are treated as expense immediately. (FV = Present value of future cash
payments).

Subsequent measurement either

1. At amortized cost using the effective interest method
2. At fair value through profit or loss

The amortized cost of bonds payable is the amount at which the bond liability is measured initially minus principal
repayment, plus or minus the cumulative amortization using the effective interest method of any difference between
the face amount and present value of the bonds payable. Actually, the difference between the face amount and
present value is either discount or premium on the issue of the bonds payable.

Illustration (Bonds issued at a premium)

An entity issued bonds with face amount of P5,000,000 at 105. Prepare the necessary journal entry and the presentation in the
statement of financial position.

Illustration (Bonds issued at a discount)

An entity issued bonds with face amount of P5,000,000 at 95. Prepare the necessary journal entry and the presentation in the
statement of financial position.

Illustration (Bonds issued at interest dates)

On June 1, 2020 an entity issued bonds with face amount of P5,000,000 at 97. The bonds mature in 5 years and pay 12%
interest semiannually on June 1 and December 1. The straight line method is used for simplicity in amortizing discount on
bonds payable. Prepare the pertinent journal entries.

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Illustration (Bonds issued between interest dates)
On April 1, 2020 an entity issued bonds with face amount of P5,000,000 at P5,228,000 plus accrued interest. The bonds are
dated January 1, 2020, mature in 5 years and pay 12% interest semiannually on January 1 and July 1. Prepare the pertinent
journal entries.

Illustration (Bonds issue at a discount effective interest method)

Cash proceeds (Carrying Effective interest rate Effect of amortization on

Amount) compared to face
amount
Discount Cash proceeds (Carrying
Amount) is less than face
amount
Premium Cash proceeds (Carrying
Amount) is greater than
face amount
compared to nominal interest expense
interest rate
Effective interest rate is Interest expense is greater
higher than nominal interest than interest paid
rate
Effective interest rate is Interest expense is less than
lower than nominal interest interest paid
rate

On January 1, 2019, ABC Co. issued 1,000, P1,000, 10% 3 year bonds for P951,963. Principal is due at maturity but interest
is due annually every year end. The effective interest rate is 12%. Record the issuance of the bonds and prepare the
amortization table for subsequent measurement.

Illustration (Bonds issue at a premium effective interest method)

On January 1, 2019, ABC Co. issued 1,000, P1,000, 12% 3 year bonds for P1,049,737. Principal is due at maturity but interest
is due annually every year end. The effective interest rate is 10%. Record the issuance of the bonds and prepare the
amortization table for subsequent measurement.

Illustration (Bonds issued with transaction cost)

Transaction cost that are directly attributable to the issue of a financial liability shall be included in the initial
measurement of the financial liability. It includes bond issue cost
 Bond issue cost will increase discount on bonds payable and decrease premium on bonds payable.
 Under the effective interest method bond issue cost must be “lumped” with the discount on bonds payable and
“netted” against the premium on bonds payable.
On January 1, 2019 ABC Co. issued 1,000, P1,000, 10%, 3 year bonds for P951,963. Principal is due on December 31, 2021
but interest is due annually every year end. In addition, ABC incurred bonds issue costs of P44,829. The effective interest is
14%. Record the issuance of the bonds and prepare the amortization table for subsequent measurement.

Illustration (Bond Retirement)

 When bonds are retired any bond premium or bond discount should be amortized up to the date of retirement
 Any accrued interest to the date of retirement should be determined
 Total cash payment = retirement price + accrued interest
 Retirement price > Carrying amount – Loss
 Retirement price < Carrying amount – Gain
On January 1, 2019, ABC Co. issued new bonds with face amount of P10,000,000 for P10,800,000. ABC used the proceeds to
retire an existing 10 year, 12% P8,000,000 bonds issued five years earlier. The unamortized discount on the existing bonds is
P340,000. ABC retired the bonds at a call premium of P400,000. ABC incurred P50,000 direct costs of retirement. Compute
for the gain or loss on the retirement.

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Illustration (Compound financial instruments [Convertible bonds])

A compound financial instrument is a financial instrument that from the issuer’s perspective contains both a liability and
an equity component. These are classified and accounted for separately. Examples are convertible bonds and bonds with
share warrants.
 Cash proceeds from issuance of compound instrument - FV of debt component without equity feature
= equity component
On January 1, 2019, ABC Co. issued 10% 3 year, P1,000,000 convertible bonds at face amount. Each P1,000 bond is
convertible into 8 shares with par value of P100 per share. On issuance date, the bonds were selling at 98 without the
conversion option. ABC incurred P50,000 transaction costs on the issuance. Prepare the entry to record the issuance of the
compound instrument.

Illustration (Compound financial instruments [Bonds with share warrants])

To improve salability, bonds are sometimes issued with share warrants. Share warrants can either be detachable or non-
detachable.
On January 1, 2019 ABC Co. issued 3 year 10% 1,000 P1,000 bonds at 97. Each bond has one detachable share warrant
entitling the holder to buy 10 shares of ABC Co. with par value of P100 at P120 per share. Shortly after issuance, the bonds
are selling at 95 ex-warrants. Half of the warrants were exercised on September 21, 2021. The remaining half of the warrants
expired on December 31, 2023. Prepare the pertinent journal entries.

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DEBT RESTRUCTURING

“Debt restructuring is a situation where the creditor for economic or legal reasons related to the debtor’s financial
difficulties. Grants to the debtor concession that would not otherwise be granted in a normal business relationship”

Types of debt restructuring

1. Asset Swap – transfer by the debtor to the creditor of any asset (real estate, inventory, receivables, investment) in full
payment of an obligation.
2. Equity Swap – is a transaction whereby a debtor and creditor may renegotiate the terms of a financial liability with
the result that the liability is fully or partially extinguished by the debtor issuing equity instruments to the creditor.
3. Modification of Terms – may involve either the interest, maturity value, or both
- substantial modification of terms shall be accounted for as an extinguishment of the old financial liability and
the recognition of a new financial liability
- there is a substantial modification of terms if the gain or loss on extinguishment is at least 10% of the old
financial liability
- Carrying amount of the old liability – PV of the new or restructured liability = gain or loss on extinguishment
- old effective rate is used in computing the PV of the new liability
- Any cost or fees incurred shall be part of gain or loss on extinguishment

Illustration (Modification of Terms)

On January 1, 2020, an entity showed the following
Note payable – due 1/1/2020 at 14% 5,000,000
Accrued interest payable 1,000,000

The entity is granted by the creditor the following concessions on January 1, 2020:
a. accrued interest of P1,000,000 is forgiven
b. the principal obligation is reduced to P4,000,000
c. the new interest rate is 10% payable every December 31.
d. the new date of maturity is December 31, 2023.

PV of 1 at 14% for 4 periods is 0.5921

PV of an ordinary annuity of 1 at 14% for 4 periods is 2.9137

Compute for the gain or loss on extinguishment of debt.

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