CHAPTER 14 & 16

NON-CURRENT LIABILITIES

ACCT5170
Corporate Financial Reporting II
Shiheng Wang@ HKUST

14-1
 Learning Objectives
1. Describe the accounting and valuation for bonds at date of
issuance.
2. Apply the methods of bond discount and premium amortization.
3. Describe the accounting for the extinguishment of non-current
liabilities.
4. Describe the accounting for the issuance, conversion and
retirement of convertible bonds (chapter 16).

14-2
 INTRODUCTION TO BONDS

14-3
 Issuing Bonds

 Bond contract known as a bond indenture.

 Represents a promise to pay:
(1) sum of money at designated maturity date, plus
(2) 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.
 Used when the amount of capital needed is too large for one
lender to supply.

14-4
 Ratings of Bonds

Corporate bond listing.

14-5
 ACCOUNTING FOR BONDS

14-6
 Valuation of Bonds Payable

Interest Rate
 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.

 Rate of interest actually earned by the bondholders.

14-7
 Valuation of Bonds Payable
Assume Stated Rate of 8%

Market Interest Bonds Sold At

6% Premium
市場做緊6%， 你肯用8%借 代表你啲bonds一
定會貴啲（人地而家比>100 我地淨係還100）

8% Par Value
市場做緊8%， 你肯用8%借 正常價格

10% Discount
市場做緊10%， 你淨係用8%借 代表你啲
bonds一定要平啲啲（人地而家比<100 我地
淨係還100）
14-8
 Bonds Issued at Par

Illustration: Santos Company issues $100,000 in bonds dated

January 1, 2022, due in five years with 9 percent interest
payable annually on January 1. At the time of issue, the market
rate for such bonds is 9 percent.
Illustration 14-1

14-9
 Bonds Issued at Par
Illustration 14-1

Illustration 14-2

100000/1.09^5

9000/1.09
+9000/1.09^2
+9000/1.09^3
+9000/1.09^4
+9000/1.09^5
working佔分 考試要寫
14-10
 Bonds Issued at Par

Journal entry on date of issue, Jan. 1, 2022.

Cash 100,000
Bonds payable 100,000

Journal entry to record accrued interest at Dec. 31, 2022.

Bond interest expense 9,000

Bond interest payable 9,000

Journal entry to record first payment on Jan. 1, 2023.

Bond interest payable 9,000

Cash 9,000
14-11
 Bonds Issued at a Discount

Illustration: Assuming now that Santos issues $100,000 in

bonds, due in five years with 9 percent interest payable
annually at year-end. At the time of issue, the market rate for
such bonds is 11 percent.
Illustration 14-3

14-12
 Bonds Issued at a Discount
Illustration 14-3

Illustration 14-4

100000/1.11^5

9000/1.11
+9000/1.11^2
+9000/1.11^3
+9000/1.11^4
+9000/1.11^5

14-13 discounted bonds

 Bonds Issued at a Discount

Journal entry on date of issue, Jan. 1, 2022.

Cash 92,608
Bonds payable 92,608

Journal entry to record accrued interest at Dec. 31, 2022.

Bond interest expense 92608*0.11 10,187
Bond interest payable 9,000
Bonds payable 1,187

Journal entry to record first payment on Jan. 1, 2023.

Bond interest payable 9,000
Cash 9,000
14-14
 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 value, but they actually earn at an effective rate
because they paid less than face value for the bonds.

14-15
 Effective-Interest Method

Bond issued at a discount - amount paid at maturity is more

than the issue amount.

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 (also called present value amortization).

14-16
 Effective-Interest Method

Effective-interest method produces a periodic interest expense

equal to a constant percentage of the carrying value of the bonds.

Illustration 14-5

14-17
 Effective-Interest Method

Bonds Issued at a Discount

Illustration: Evermaster Corporation issued $100,000 of 8%

term bonds on January 1, 2022, due on January 1, 2027, with
interest payable each July 1 and January 1. Investors require an
effective-interest rate of 10%. Calculate the bond proceeds.
Illustration 14-6

100000/1.05^10

(4000/0.05)(1-1/(1.05^10))

14-18
 Effective-Interest Method
Illustration 14-7

14-19
 Effective-Interest Method
Illustration 14-7

Journal entry on date of issue, Jan. 1, 2022

Cash 92,278
Bonds payable 92,278

14-20
 Effective-Interest Method
Illustration 14-7

Journal entry to record first payment and amortization of the

discount on July 1, 2022.

Bond interest expense 92278*0.05 4,614

Bonds payable 614
Cash 4,000
14-21
 Effective-Interest Method
Illustration 14-7

Journal entry to record accrued interest and amortization of the

discount on Dec. 31, 2022.

Bond interest expense (92278+614)*0.05 4,645

Bond interest payable 4,000
Bonds payable 645
14-22
 Effective-Interest Method

Bonds Issued at a Premium

Illustration: Evermaster Corporation issued $100,000 of 8%

term bonds on January 1, 2022, due on January 1, 2027, with
interest payable each July 1 and January 1. Investors require an
effective-interest rate of 6%. Calculate the bond proceeds.
Illustration 14-8

100000/1.03^10

(4000/0.03)(1-1/(1.03^10))

14-23
 Effective-Interest Method
Illustration 14-9

14-24
 Effective-Interest Method
Illustration 14-9

Journal entry on date of issue, Jan. 1, 2022.

Cash 108,530
Bonds payable 108,530

14-25
 Effective-Interest Method
Illustration 14-9

Journal entry to record first payment and amortization of the

premium on July 1, 2022.

Bond interest expense 108530*0.03 3,256

Bonds payable
744
Cash 4,000
14-26
 buy back of bonds

EXTINGUISHMENT OF BONDS

14-27
 Extinguishment of Non-Current Liabilities

Holding the Bonds to Maturity

 The company will have fully amortized any premium or

discount at the date the bonds mature.

 As a result, the carrying amount, the maturity (face) value,

and the fair value of the bond are the same.

 Therefore, no gain or loss exists.

14-28
 Extinguishment of Non-Current Liabilities

Extinguishment with Cash before Maturity

 Reacquisition price > Net carrying amount => Loss

 Reacquisition price < Net carrying amount => Gain

 At time of reacquisition, unamortized premium or discount

must be amortized up to the reacquisition date.

14-29
 Extinguishment of Debt

Illustration: Evermaster bonds issued at a discount on January 1,

2022. These bonds are due in five years. The bonds have a par value
of $100,000, a coupon rate of 8% paid semiannually, and were sold to
yield 10%.

14-30
 Extinguishment of Debt

Two years after the issue date on January 1, 2024, Evermaster calls
the entire issue at 101 and cancels it.
Illustration 14-22

本身還94925就得 我地用101000 call loan 所以係loss

Evermaster records the reacquisition and cancellation of the bonds

Bonds payable 94,925

Loss on extinguishment of bonds 6,075
Cash 101,000

14-31
 Extinguishment of Non-Current Liabilities

Extinguishment by Exchanging Assets or Securities

 Creditor should account for the non-cash assets or equity

interest received at their fair value.

 Debtor recognizes a gain equal to the excess of the

carrying amount of the payable over the fair value of the
assets or equity transferred.

14-32
 Extinguishment of Non-Current Liabilities
Illustration: Hamburg Bank loaned €20,000,000 to Bonn Mortgage
Company. Bonn, in turn, invested these monies in residential
apartment buildings. However, because of low occupancy rates, it
cannot meet its loan obligations. Hamburg Bank agrees to accept
from Bonn Mortgage real estate with a fair value of €16,000,000 in full
settlement of the €20,000,000 loan obligation. The real estate has a
carrying value of €21,000,000 on the books of Bonn Mortgage. Bonn
(debtor) records this transaction as follows.

Note Payable to Hamburg Bank 20,000,000

Loss on Disposition of Real Estate 5,000,000
Real Estate 21,000,000
Gain on Extinguishment of Debt 4,000,000
用fair value為基準
1 無左NCA 等於realize NCA at fair value = 處理gain & loss on disposal
14-33 2 用fair value還左債 扣債+記錄係賺/虧
 Extinguishment of Non-Current Liabilities

Illustration: Now assume that Hamburg Bank agrees to accept from

Bonn Mortgage 320,000 ordinary shares (€10 par) that have a fair
value of €16,000,000, in full settlement of the €20,000,000 loan
obligation. Bonn Mortgage (debtor) records this transaction as follows.

Notes Payable (to Hamburg Bank) 20,000,000

Share Capital—Ordinary 3,200,000
Share Premium—Ordinary 16000000-3200000 12,800,000
Gain on Extinguishment of Debt 4,000,000

14-34
 Extinguishment of Non-Current Liabilities

Extinguishment with Modification of Terms

Creditor may offer one or a combination of the following

modifications:
1. Reduction of the stated interest rate.
2. Extension of the maturity date of the face amount of the
debt.
3. Reduction of the face amount of the debt.
4. Reduction or deferral of any accrued interest.

14-35
 Extinguishment of Non-Current Liabilities

Illustration: On December 31, 2022, Morgan National Bank enters into

a debt modification agreement with Resorts Development Company,
which is experiencing financial difficulties. The bank restructures a
$10,500,000 loan receivable issued at par (interest paid to date) by:
► Reducing the principal obligation from $10,500,000 to $9,000,000;
► Extending the maturity date from December 31, 2022, to
December 31, 2026; and
► Reducing the interest rate from the historical effective rate of 12
percent to 8 percent. Given Resorts Development’s financial
distress, its market-based borrowing rate is 15 percent.
after changes: FV=9000000, maturity = 4 yrs, interest rate = 8%, discounting rate = 15%

14-36
 Extinguishment of Non-Current Liabilities

IFRS requires the modification to be accounted for as an

extinguishment of the old note and issuance of the new note,
measured at fair value.
Illustration 14-23

9000000/1.15^4

720000/1.15+720000/1.15^2+720000/1.15^3
+720000/1.15^4

(1-1/(1.15^4))/(0.15) = 2.85498

after changes: FV=9000000, maturity = 4 yrs, interest rate = 8%, discounting rate = 15%

14-37
 Extinguishment of Non-Current Liabilities

The gain on the modification is $3,298,664, which is the difference

between the prior carrying value ($10,500,000) and the fair value of
the restructured note, as computed in Illustration 14-23 ($7,201,336).
Resorts Development makes the following entry to record the
modification.

Note Payable (Old) 10,500,000

Gain on Extinguishment of Debt 3,298,664
Note Payable (New) 7,201,336

舊債蓋新債 相差入gain / loss

14-38
 Extinguishment of Non-Current Liabilities
Amortization schedule for the new note. Illustration 14-24

Resorts Development recognizes interest expense on this note using

the effective rate of 15 percent. Thus, on December 31, 2023 (date of
first interest payment after restructure), Resorts Development makes
the following entry.
Interest Expense 7201336*0.15 1,080,200
Notes Payable 360,200
Cash 720,000
14-39
 CONVERTIBLE DEBT

14-40
 Convertible Debt

Bonds which can be changed into other corporate

securities are called convertible bonds.

Benefit of a Bond (guaranteed interest and principal)

+
Privilege of Exchanging it for Shares
(at the holder’s option)

14-41
 Convertible Debt

Two main reasons corporations issue convertibles:

Desire to raise equity capital without giving up more

ownership control than necessary.

Obtain debt financing at cheaper rates.

可以轉成更賺錢的equity>>著數
從利率中扣走
（本身要比好多利息債主 但因為已經比左著數 所以可以比少啲利息）

14-42
 Convertible Debt

Accounting for Convertible Debt

Convertible debt is accounted for as a compound instrument.

Companies use the “with-and-without” method to value
compound instruments.
Illustration 16-1

14-43
 Convertible Debt

Implementation of the with-and-without approach:

1. First, determine total fair value of convertible debt with both

liability and equity component.

2. Second, determine liability component by computing net present

value of all contractual future cash flows discounted at the market
rate of interest.

3. Finally, subtract liability component estimated in second step from

fair value of convertible debt (issue proceeds) to arrive at the
equity component. balancing figure
pv of debt = pv of liabilitities + pv of equity
pv of equity = pv of debt - pv of liabilitities

14-44
 Convertible Debt

At Time of Issuance

Illustration: Roche Group (DEU) issues 2,000 convertible

bonds at the beginning of 2022. The bonds have a four-year
term with a stated rate of interest of 6 percent, and are issued
at par with a face value of €1,000 per bond (the total proceeds
received from issuance of the bonds are €2,000,000). Interest
is payable annually at December 31. Each bond is convertible
into 250 ordinary shares with a par value of €1. The market rate
of interest on similar non-convertible debt is 9 percent.
$1000=250 shares 250 shares/bond
>>$4/share 2000 bonds= 2000*250 shares = 500000 shares

14-45
 Convertible Debt

At Time of Illustration 16-2

Issuance

2000000/1.09^4 1/1.09^4 = 0.70843 Illustration 16-3

(1/0.09)(1-1/(1.09^4)) = 3.23972
2000000x0.06=120000

Illustration 16-4

淨係值1805606 但係賣2000000 貴左嗰啲=equity value

14-46
 Convertible Debt

At Time of Issuance
Illustration 16-3

Illustration 16-4

Cash 2,000,000
Journal
Entry Bonds Payable 1,805,606
Share Premium—Conversion Equity 194,394

14-47
 Convertible Debt

Settlement of Convertible Bonds

Repurchase at Maturity. If the bonds are not converted at

maturity, Roche makes the following entry to pay off the
convertible debtholders.

Bonds Payable 2,000,000

Cash 2,000,000
if not converted, the convertible bonds premium would be retained as capital

14-48
 Convertible Debt

Settlement of Convertible Bonds

Conversion of Bonds at Maturity. If the bonds are converted

at maturity, Roche makes the following entry.

Share Premium—Conversion Equity 194,394

Bonds Payable 2,000,000
Share Capital—Ordinary 2000*250 500,000
Share Premium—Ordinary 1,694,394
1694394=1500000+194394=(4-1)*500000+194394
liabilities部分 bonds的本金 轉換比率係$4/share 即係本身已經有$3 premium 再加convertible bonds的premium就係全部premium
NOTE: The amount originally allocated to equity of €194,384 is transferred to
the Share Premium—Ordinary account.

14-49
 Convertible Debt

Settlement of Convertible Bonds

Conversion of Bonds before Maturity.

Illustration 16-5

1805626*0.09

14-50
 Convertible Debt

Settlement of Convertible Bonds

Conversion of Bonds before Maturity. Assuming that Roche

converts its bonds into ordinary shares on December 31, 2023.

Share Premium—Conversion Equity 194,394

Bonds Payable 1,894,444
Share Capital—Ordinary 500,000
Share Premium—Ordinary (balancing figures) 1,588,838
1588838=194394 (premium on convertible bonds) + (1894444-500000)

NOTE: The amount originally allocated to equity of €194,384 is transferred to

the Share Premium—Ordinary account.
(1894444-500000) = bonds payable - 500000 (share capital, par value)
如果到maturity先兌換，bonds payable已經做曬compounding, liabilities變左face value of bonds, 所以可以好似前面頁數
咁直接用converted value per share - par value of shares, (as converted value per share is derived from the future nominal value
14-51 of the bond) 但而家Bonds未養成好就兌換左 所以share premium from bonds value唔再係4-1=3
 Convertible Debt

Settlement of Convertible Bonds

公司主動回購

Repurchase before Maturity. Roche determines the fair value

of the liability component of the convertible bonds at December 31,
2023, and then subtracts the fair value of the convertible bond
issue (including the equity component). Then,

1. The difference between the consideration allocated to the

liability component and the carrying amount of the liability is
recognized as a gain or loss, and

2. The amount of consideration relating to the equity component is

recognized (as a reduction) in equity.

14-52
 Convertible Debt

Settlement of Convertible Bonds

Repurchase before Maturity. Assume:

 Fair value of the convertible debt (including both liability and

equity components), based on market prices at December 31,
2023, is €1,965,000.

 The fair value of the liability component is €1,904,900. This

amount is based on computing the present value of a non-
convertible bond with a two-year term (which corresponds to
the shortened time to maturity of the repurchased bonds.)

14-53
 Convertible Debt

Settlement of Convertible Bonds

First, determine the gain or loss on debt repurchase.

Illustration 16-6

Next, determine any adjustment to the equity.

Illustration 16-7

14-54
 Convertible Debt

Settlement of Convertible Bonds

Illustration 16-6 & 7

Bonds Payable 1,894,464

Journal Share Premium—Conversion Equity 60,100
Entry Loss on Repurchase 10,436
Cash 1,965,000
14-55