HI5020 Corporate Accounting

Session 2c
Accounting for Liabilities
 Session Objectives (cont.)
E. Understand how to calculate the issue price of
securities such as debentures
F. Know the accounting for debenture, and treatment of
interest expense
 Debentures Issued at a Discount
If the market requires a rate of return in excess
of the coupon rate
• The issue price must be discounted to a price at
which the cash flows to the investor represent
the rate of return required by the market, i.e.
debentures issued at a discount
The present value of the future receipts,
discounted to the market’s required rate of
return, needs to be calculated.
 Debentures issued at a discount (cont.)
Issue of debentures (assume direct private
placement)

Debit Cash at bank XX

Credit Debentures XX

In the past, the discount that arises on a

debenture would have been separately disclosed
and accounted for, but pursuant to AASB139,
separate disclosure is no longer made.
 Example
You want to know the PV of future cash flows.
You can use your calculator OR will need to refer to your
tables
Appendix A:
(PV of $1 in n periods = 1/(1+k)yx +/-n, where k is the
discount rate).
Appendix B: (PV of an annuity of $1 per period for n
periods).
 In-class Exercise
Newpart Ltd. issues debentures of $5,000,000 at
$500,000 (coupon) at 22% p.a discount rate
(discounted semi-annually) for 10 periods.
Calculate the PV of future cash flows and then
journal.
You should use your calculator for this as the
tables only work in “full” %. Whilst will be close,
not really close enough.
 Class Exercise Solution
PV of interest payments:
(1-(1/(1+k)^n))/k
K = 22% / 2 = 11% (semi-annual)
n=10
0.647815521/0.11 = 5.889232011
500,000 x 5.889232011 = $2,944,616
Present value of principal repayments
1/(1+k)^n = 0.352184478
0.352184478 x 5,000,000 = $1,760,922
Total PV of future cash flows $4,705,538
Journal entry
Cash 4,705,538
Debentures 4,705,538
 11% Net Liability

0 Opening Rate Coupon 4,705,538.00

1 4,705,538.00 517,609.18 500,000.00 17,609.18 4,723,147.18

2 4,723,147.18 519,546.19 500,000.00 19,546.19 4,742,693.37

3 4,742,693.37 521,696.27 500,000.00 21,696.27 4,764,389.64

4 4,764,389.64 524,082.86 500,000.00 24,082.86 4,788,472.50

5 4,788,472.50 526,731.98 500,000.00 26,731.98 4,815,204.48

6 4,815,204.48 529,672.49 500,000.00 29,672.49 4,844,876.97

7 4,844,876.97 532,936.47 500,000.00 32,936.47 4,877,813.43

8 4,877,813.43 536,559.48 500,000.00 36,559.48 4,914,372.91

9 4,914,372.91 540,581.02 500,000.00 40,581.02 4,954,953.93

10 4,954,953.93 545,044.93 500,000.00 45,044.93 4,999,998.87

8
Interest expense 517,609.18
Debentures 17,609.18
Cash at bank 500,000

9
 Debentures Issued at a Premium
Amount paid for a security in excess of its
par/face value

• Debentures are issued that provide a coupon

rate in excess of that demanded by the
market.
• The issue price will rise to the point where the
effective rate of return will equal the market’s
required rate of return.
 Debentures Issued at a Premium (cont.)
Again, we need to calculate the present value of
the future cash flows discounted at the market’s
required rate of return
 Debentures Issued at a Premium (cont.)

Issue of debentures (direct placement)

Debit Cash at bank XX
Credit Debentures XX

Interest payment
Debit Interest expense XX
Debit Debentures XX
Credit Cash at bank XX
 Example
Going back to the Newpart example, assume that the
market demands 14% on the debentures.
PV of interest payments
1/(1.07)yx +/-10 = 0.491650707
0.491650707/0.07 = 7.023581541
500,000 x 7.023581541 = $3,511,791
Present value of principal repayments
(1.07)yx +/-10 = 0.508349292
0.508349292 x 5,000,000 = $2,541,746
Total PV of future cash flows $6,053,537
 Example (cont.)
Journal entries:
30/6/15
Cash 6,053,537
Debentures 6,053,537
31/12/15
Interest expense 423,748 (6,053,537 x .07)
Debentures 76,252 (500,000 – 423,748)
Cash 500,000
Note: Next year interest expense is $418,410
 0.07 Reduction of Net Liability

0 Opening Rate Coupon Liability 6,053,537.00

1 6,053,537.00 423,747.59 500,000.00 76,252.41 5,977,284.59

2 5,977,284.59 418,409.92 500,000.00 81,590.08 5,895,694.51

3 5,895,694.51 412,698.62 500,000.00 87,301.38 5,808,393.13

4 5,808,393.13 406,587.52 500,000.00 93,412.48 5,714,980.65

5 5,714,980.65 400,048.65 500,000.00 99,951.35 5,615,029.29

6 5,615,029.29 393,052.05 500,000.00 106,947.95 5,508,081.34

7 5,508,081.34 385,565.69 500,000.00 114,434.31 5,393,647.04

8 5,393,647.04 377,555.29 500,000.00 122,444.71 5,271,202.33

9 5,271,202.33 368,984.16 500,000.00 131,015.84 5,140,186.49

10 5,140,186.49 359,813.05 500,000.00 140,186.95 4,999,999.55

15
THE END