Issuance of bonds payable

When an entity acquires an asset by issuing bonds payable, PFRS 9, paragraph 5.1.1, provides that
the entity shall measure the financial liability at fair value plus transaction costs that are directly
attributable to the issue of the financial liability. Accordingly, the asset acquired by issuing bonds
payable is measured in the following order:
a. Fair value of bonds payable
b. Fair value of asset received
c. Face amount of bonds payable

ILLUSTRATION:
A building is acquired by issuing bonds payable with face amount of ₱5,000,000. At the time of
acquisition, the fair value of the building is ₱6,000,000 and quoted price of the bonds is ₱5,800,000
Journal Entry:

a. The fair value of the bonds payable is used:

Building 5,800,000
Bonds payable 5,000,000
Premium on bonds payable 800,000

b. The fair value of the building is used:

Building 6,000,000
Bonds payable 5,000,000
Premium on bonds payable 1,000,000

c. The face amount of the bonds payable is used

Building 5,000,000
Bonds payable 5,000,000

Exchange Transaction
PAS 16, Paragraph 24, provides that the cost on an item of property, plant and equipment acquired
in exchange for a nonmonetary asset or a combination of monetary and nonmonetary asset is
measured at fair value. However, the exchange is recognized at carrying amount under the
following circumstances:
a. The exchange transaction lacks commercial substance
b. The fair value of the asset given or the fair value of the asset received is not reliably
measurable.

Definition of Commercial Substance

Commercial substance is a new notion and is defined as the event of transaction causing the cash
flows of the entity to change significantly by reason of the exchange. An exchange transaction has
commercial substance when the cash flows of the asset received differ significantly from the cash
flows of the asset transferred. In assessing whether this has occurred, the entity shall consider if
the amount, timing and risk of the cash flows from the new asset are different from the cash flows
of the old asset. Moreover, the entity-specific value of the portion of the entity’s operation affected
by the transaction changes as a result of the exchange. Entity-specific value is the present value of
the cash flows an entity expects to arise from the continuing use of an asset and from the disposal
at the end of useful life or expects to incur when setting a liability.

Exchange with Commercial Substance

If a property is acquired in an exchange, the cost of the property is equal to the following:
a. Fair value of asset given plus any cash payment - on the part of the payor
b. Fair value of asset given minus any cash received - on the part of the recipient
ILLUSTRATION:
AL Company and MA Company exchanged equipment. The following data are available on the
exchange:
AL MA
Equipment (cost) ₱ 500,000 ₱ 300,000
Accumulated depreciation 300,000 50,000
Fair value of equipment 180,000 220,000
Cash paid by AL to MA 40,000
The configuration (risk, timing, and amount) of the cash flows of the equipment are determined to
be significantly different.
Required:
1. How much should AL record the asset?
2. How much is the gain or loss on exchange of AL?
3. Prepare the journal entry to record the transaction in the books of AL.
4. How much should MA record the asset?
2. How much is the gain or loss on exchange of MA?
3. Prepare the journal entry to record the transaction in the books of MA.

SOLUTION:
1.
AL
Fair value of the asset given ₱ 180,000
Cash paid by AL to MA 40,000
Cost of new equipment ₱ 220,000
2.
AL
Fair value of the asset given ₱ 180,000
Less: Book value of the equipment (200,000)
Loss on exchange (₱ 20,000)

3.
Equipment – new 220,000
Accumulated depreciation 300,000
Loss on exchange 20,000
Equipment – old 500,000
Cash 40,000

4.
MA
Fair value of the asset given ₱ 220,000
Less: Cash received 40,000
Cost of new equipment ₱ 180,000

5.
MA
Fair value of the asset given ₱ 220,000
Less: Book value of the equipment (250,000)
Loss on exchange (₱ 30,000)

6.
Equipment – new 180,000
Accumulated depreciation 50,000
Loss on exchange 30,000
 Cash 40,000
Equipment - old 300,000

Exchange - No Commercial Substance

If the exchange transaction lacks commercial substance, the acquired item of property, plant and
equipment is measured at the carrying amount of the asset given. No gain or loss is recognized
when the exchange lacks commercial substance. Of course, any cash involved is added to the
carrying amount on the part of the payor and deducted from the carrying amount of the part
recipient.

ILLUSTRATION:
AL Company and MA Company exchanged equipment. The following data are available on the
exchange:
AL MA
Equipment (cost) ₱ 500,000 ₱ 300,000
Accumulated depreciation 300,000 50,000
Fair value of equipment 180,000 220,000
Cash paid by AL to MA 50,000
The configuration (risk, timing, and amount) of the cash flows of the equipment are determined to
be insignificant.

Required:
1. How much should AL record the asset?
2. How much is the gain or loss on exchange of AL?
3. Prepare the journal entry to record the transaction in the books of AL.
4. How much should MA record the asset?
2. How much is the gain or loss on exchange of MA?
3. Prepare the journal entry to record the transaction in the books of MA.

SOLUTION:
1.
AL
Book value of the asset given ₱ 200,000
Cash paid by AL to MA 50,000
Cost of new equipment ₱ 250,000

2. No gain or loss on exchange is recognized because the transaction lacks commercial substance.

3.
Equipment – new 250,000
Accumulated depreciation 300,000
Equipment – old 500,000
Cash 50,000

4.
MA
Book value of the asset given ₱ 250,000
Less: Cash received 50,000
Cost of new equipment ₱ 200,000

5. No gain or loss on exchange is recognized because the transaction lacks commercial substance.

6.
Equipment – new 200,000
 Accumulated depreciation 50,000
Cash 50,000
Equipment - old 300,000

Trade In
 Trade in is a form of exchange.
 This means that a property is acquired by exchanging another property as part of payment
and the balance payable in cash or any other form of payment in accordance with agreed
terms.
 Trade in usually involves a significant amount of cash and therefore, the transaction has
commercial substance.
As an exchange with commercial substance, the new asset is recorded at the following in the order
of priority.
a. Fair value of asset given plus cash payment.
b. Trade in value of asset given plus cash payment

ILLUSTRATION: Trade In
On January 1 of the current year, ALMA Company traded in an old equipment for a newer model.
Data relative to the old and new machine follow:
Old Equipment
Original cost ₱ 1,400,000
Accumulated depreciation, Jan 1 1,000,000
Carrying amount 400,000
Trade in value 500,000
Fair value 350,000
New Equipment
List price 2,000,000

Required:
1. How much should ALMA record the asset?
2. How much is the gain or loss on trade in?
3. Prepare the journal entry to record the transaction.

SOLUTION:
1.
Fair value of the asset given ₱ 350,000
Add: Cash payment 1,500,000
Cost of new asset ₱ 1,850,000

2.
Fair value of the asset given ₱ 350,000
Less: Carrying amount 400,000
Loss on exchange (₱ 50,000)

3.
Equipment – new 1,850,000
Accumulated depreciation 1,000,000
Loss on exchange 50,000
Equipment - old 1,400,000
Cash 1,500,000
BORROWING COSTS
Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing
of funds.

Qualifying asset
A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its
intended use or sale.

Accounting for Borrowing Costs

Borrowing costs that are directly attributable to the acquisition, construction, or production of a
qualifying asset form part of the cost of that asset, and should be capitalized. The following costs
are eligible for capitalization:
1. Asset financed by specific borrowing
2. Asset financed by general borrowing
3. Asset financed by specific and general borrowing
4. Specific borrowing that was used for general purposes

Asset financed by specific borrowings

The amount of borrowing costs eligible for capitalization on that asset shall be determined as the
actual borrowing costs incurred on the said borrowing during the period less any investment
income on the temporary investment of those borrowings especially for the purpose of obtaining
or constructing a qualifying asset.

ILLUSTRATION: Asset financed by specific borrowings

ALMA Company began the construction of its administration building at an estimated cost of
₱10,000,000 on January 1, 2018. The construction is expected to be completed on December 31,
2020. To finance borrowings, ALMA borrowed ₱10,000,000, 10% 3-year note dated January 1,
2018, both principal and interest are payable on December 31, 2020. In the first phase of the
construction, there were idle funds which the company invested. Income from this investment was
₱50,000.

Questions:
1. How much is the capitalizable borrowing cost in 2018?
2. How much is the interest expense in 2018?
3. How much is the income from investment in 2018?
4. Prepare the journal entries in 2018.

SOLUTION:
1.
Actual borrowing cost (10M * 10%) ₱ 1,000,000
Less: Investment income (50,000)
Capitalizable borrowing cost ₱ 950,000

2.
Actual borrowing cost (10M * 10%) ₱ 1,000,000
Less: Capitalizable borrowing cost (950,000)
Interest expense ₱ 50,000

3. ₱50,000

4.
Building 950,000
Interest expense 50,000
 Accrued interest payable 1,000,000

Cash 50,000
Investment income 50,000

ILLUSTRATION: Asset financed by general borrowing

ALMA Company began the construction of its administration building at an estimated cost of
₱2,000,000 on January 1, 2018. The building was completed on December 31, 2018. The company
had the following loans outstanding during the year:
Rate Types Principal
10% General loan ₱ 500,000
12% Loans payable 1,500,000

The following expenditures were made during 2018:

Date Amount
January 1 ₱300,000
July 1 700,000
November 1 600,000

What is the cost of the building on December 31, 2018?

SOLUTION:
Step 1: Compute for the capitalization rate for general borrowings.
Rate Types Principal Interest
10% General loan ₱ 500,000 ₱ 50,000
12% Loans payable 1,500,000 180,000
11.50% ₱2,000,000 ₱230,000

Step 2: Compute for the weighted average carrying amount of expenditures.

Date Amount Months Amount
Outstanding
January 1 ₱300,000 12 ₱3,600,000
July 1 700,000 6 4,200,000
November 1 600,000 2 1,200,000
Total 9,000,000
Divided by 12
Weighted average
carrying amount ₱750,000

Step 3: Compute for the average borrowing cost

Weighted average carrying amount ₱ 750,000
Multiply by: Capitalization rate 11.50%
Weighted average borrowing cost ₱ 86,250

Step 4: Compare the weighted average borrowing cost with the actual borrowing cost and get the
lower figure as the capitalizable borrowing cost.
Weighted average borrowing cost ₱ 86,250
Vs. Actual borrowing cost 230,000
Capitalizable borrowing cost (lower) ₱ 86,250

Total expenditures ₱ 1,600,000

Add: Capitalizable borrowing cost 86,250
Total cost of the building ₱ 1,686,250
ILLUSTRATION: Asset financed by specific and general borrowing
On January 1, 2018, ALMA Company began the construction of a building to be used as its office
headquarters. The building was completed on December 31, 2018. Expenditures on the project
were as follows:
Date Amount
January 3 ₱1,000,000
March 1 600,000
June 30 800,000
October 1 600,000

On January 3, 2018, the company obtained a ₱3,000,000 construction loan with a 10% interest
rate. The loan was outstanding on 2018 and 2019. The company’s other interest-bearing debt
included two long term notes of ₱4,000,000 and ₱6,000,000 with interest rates of 6% and 8%
respectively. Both notes were outstanding on 2018 and 2019.

Required: Compute for the following under each independent case:

1. Capitalizable borrowing cost, 2018
2. Interest expense, 2018
Case 1: Specific interest method
Case 2: Weighted-average method
Case 3: Assume ALMA Company incurred additional ₱1,350,000 on February 1, 2018.

SOLUTION:
Case 1:
Rate Principal Interest
6% ₱ 4,000,000 ₱ 240,000
8% 6,000,000 480,000
7.20% ₱10,000,000 ₱720,000

Date Amount Months Total

Outstanding/12
January 3 ₱1,000,000 12/12 ₱1,000,000
March 1 600,000 10/12 500,000
June 30 800,000 6/12 400,000
October 1 600,000 3/12 150,000
Weighted average expenditure ₱ 2,050,000

Requirement 1:
Weighted average carrying amount ₱ 2,050,000
Multiply by: Specific borrowing rate 10%
Capitalizable borrowing cost ₱ 205,000

Requirement 2:
Specific borrowings (3M * 10%) ₱ 300,000
General borrowings 720,000
Total borrowing cost 1,020,000
Less: Capitalizable borrowing cost (205,000)
Interest expense ₱ 815,000
Case 2:
Rate Principal Interest
6% ₱ 4,000,000 ₱ 240,000
8% 6,000,000 480,000
7.20% ₱10,000,000 ₱720,000

Date Amount Months Total

Outstanding/12
January 3 ₱1,000,000 12/12 ₱1,000,000
March 1 600,000 10/12 500,000
June 30 800,000 6/12 400,000
October 1 600,000 3/12 150,000
Weighted average expenditure ₱ 2,050,000

Requirement 1:
Weighted average carrying amount ₱ 2,050,000
Multiply by: Capitalization rate 7.20%
Capitalizable borrowing cost ₱ 147,600

Requirement 2:
Specific borrowings (3M * 10%) ₱ 300,000
General borrowings 720,000
Total borrowing cost 1,020,000
Less: Capitalizable borrowing cost (147,600)
Interest expense ₱ 872,400

Case 3:
Rate Principal Interest
6% ₱ 4,000,000 ₱ 240,000
8% 6,000,000 480,000
7.20% ₱10,000,000 ₱720,000

Date Amount Months Total

Outstanding/12
January 3 ₱1,000,000 12/12 ₱1,000,000
February 1 1,350,000 11/12 1,237,500
March 1 600,000 10/12 500,000
June 30 800,000 6/12 400,000
October 1 600,000 3/12 150,000
Weighted average expenditure ₱ 3,287,500

Requirement 1:
Specific borrowing
Actual borrowing cost (3,000,000 * 10%) ₱300,000
Less: Investment income - ₱300,000
General borrowing
Weighted average expenditures 3,287,500
Less: Principal amount of specific borrowings (3,000,000)
Amount related to general borrowings 287,500
Multiply by: Capitalization rate 7.20% 20,700
Weighted average cost ₱320,700
Requirement 2:
Specific borrowings (3M * 10%) ₱ 300,000
General borrowings 720,000
Total borrowing cost 1,020,000
Less: Capitalizable borrowing cost (320,700)
Interest expense ₱ 699,300

References:

Asuncion, et. al. (2018). Applied Auditing Book 1 of 2, Baguio City: Real Excellence Publishing
Guerrero, P. (2018) Cost Accounting Principles and Procedural Application, Manila,
Philippines: GIC Enterprises and Co., Inc.
Valix, et. al. (2016). Financial Accounting Volume 1, Manila Philippines

Assessment 7.2:
1. During 2018, ALMA Company constructed asset costing ₱5,000,000. The weighted average
expenditures totaled ₱3,000,000. To help pay for construction, ₱2,200,000 was borrowed at 10%
on January 1, 2018. Funds not needed for construction were temporarily invested in short-term
securities yielding ₱45,000 revenue. Other that construction funds borrowed, the only other debt
outstanding during the year was a ₱2,500,000, 10-year 9% note payable dated January1, 2017.

Required: Compute for the following:

a. Capitalizable borrowing cost, 2018
b. Interest expense, 2018

2. AL Company and MA Company exchanged equipment. The following data are available on the
exchange:
AL MA
Equipment (cost) ₱ 1,000,000 ₱ 1,400,000
Fair value of equipment 1,200,000 1,500,000
Cash paid by AL to MA 300,000
The configuration (risk, timing, and amount) of the cash flows of the equipment are determined to
be insignificant.

Required:
1. What amount should AL record as cost of the asset?
2. How much is the gain or loss on exchange of AL?
3. What amount should MA record as cost of the asset?
4. How much is the gain or loss on exchange of MA?