[Date] Intermediate

Accounting 2
BACC121A

Professor: Dr. Glen de Leon, CPA

Section/Schedule BSA 1A TTH 0730-

0930
MODULE 2: FINANCIAL LIABILITIES, NOTES PAYABLE, BONDS
PAYABLE, AND DEBT RESTRUCTURING
TOPIC OVERVIEW
This chapter discusses financial liabilities, it’s characteristics, classification, initial
recognition, initial measurement, subsequent measurement, reclassification, derecognition
and financial statement presentation. It also tackles the process and application of debt
restructuring.

LEARNING OBJECTIVES:
After studying this chapter, you should be able to:
1. Identify and describe the different types of financial liabilities.
2. Describe credit risk.
3. Describe the initial recognition, initial measurements, subsequent measurement,
reclassification, derecognition and financial statement presentation of financial liabilities.
4. Describe and apply debt restructuring.
5. Different accounting for financial liabilities under full PFRS and PFRS for SMEs.
6. Differentiate the accounting for FL@FVTPL, and FL@FAAC.
7. Calculate the correct amount of financial liabilities and its related accounts.

FINANCIAL LIABILITIES

As discussed in the previous chapter, a financial liability is any liability that is:
a. a contractual obligation:
I. to deliver cash or another financial asset to another entity, or
II. to exchange financial assets or financial liabilities with another entity under
conditions that are potentially unfavorable to the entity, or
b. a contract that will or may be settled in the entity’s own equity instruments and is:
I. a non-derivative for which the entity is or may be obliged to deliver a variable
number of the entity’s own equity instruments; or
II. a derivative that will or may be settled other than by the exchange of a fixed amount
of cash or another financial asset for a fixed number of the entity’s own equity instruments.

Other liabilities that did not meet the above requirements are non-financial liabilities.

COMMON EXAMPLES OF FINANCIAL LIABILITIES

Examples of financial liabilities include the following:
a. Accrued payable
b. Notes payable
c. Loans payable

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 d. Bonds payable
e. Mortgage payable
f. Lease liability
g. Salaries payable
h. Accrued interest expense/Interest payable
i. Utilities payable
j. Cash dividend payable

MAJOR CLASSIFICATION OF FINANCIAL LIABILITIES

1) Financial liabilities at fair value through profit or loss (FL@FVTPL)
a. Held for trading
b. designated at fair value through profit or loss
2) Financial liabilities at amortized cost (FL@AC)

FINANCIAL LIABILITIES AT FAIR VALUE THROUGH PROFIL OR LOSS

An entity may, at initial recognition, irrevocably designate a financial liability as measured
at fair value through profit or loss when doing so.
a) Eliminates or significantly reduces a measurement or recognition inconsistency
(sometimes referred to as ‘an accounting mismatch’) that would otherwise arise from
measuring assets or liabilities or recognizing the gains and losses on them on different
bases, or
b) A group of financial liabilities or financial assets and financial liabilities is managed and
its performance is evaluated in a fair value basis, in accordance with a documented risk
management or investment strategy, and information about the group is provided
internally on that basis to the entity’s key management personnel.

Measurement of F:@FVTPL
A. Initial Measurement-FL@FVTPL
Financial liabilities at fair value through profit or loss shall be initial measured at fair
value.
Transaction Costs Incurred on FL@FVTPL
Such costs may include printing costs of certificates, legal, accounting and other
professional fees; registration fees; and commissions or underwriters or arrangers.
Transaction cost or bond issuance costs directly attribute to the issuance of financial
liabilities at fair value through profit or loss is treated as an outright expense during the
period incurred.
B. Subsequent Measurement- FV@FVTPL
Subsequent to initial measurement, financial liabilities at fair value through profit or loss is
measured at fair value.

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Accounting for Changes in Fair Value
A. Changes in fair value of liabilities held for trading at fair value through profit
or loss
Changes in fair value are recognized as either unrealized gain or loss on held for
trading financial liabilities at fair value through profit or loss is to be presented in profit or
loss.

B. Changes in fair value of liabilities designated as at fair value through profit or

loss
Changes in fair value are recognized either unrealized gain or loss on the financial
liability designated as fair value through profit or loss is to be presented as follows:
1) Change in fair value not attributable to change in the credit risk- Present the
unrealized gain or loss in the profit or loss.
2) Change in fair value attributable to change in the credit risk
a. If it would create or enlarge an accounting mismatch in profit or loss,
present all unrealized gain or losses on that liability (including the effects
of changes in the credit risk of that liability) in profit or loss.
b. If it would not create or enlarge an accounting mismatch in profit or loss,
present the unrealized gain or loss attributable to changes in the credit
risk of that liability in the other comprehensive income(OCI)
c. Remaining amount on change in the fair value, present the unrealized
gain or loss in the profit or loss.

Credit Risk
PFRS 7 defines credit risk as the risk that one party to a financial instrument will cause a
financial loss for the other party by failing to discharge an obligation.

Determining the effects of changes in credit risk

An entity shall determine the amount of change in the fair value of the financial liability
that is attributable to changes in the credit risk of that liability either
a.) As the amount of change in its fair value that is not attributable to changes in
market conditions that give rise to market risk; or
b) Using an alternative method the entity believes more faithfully represents the
amount of change in the liability’s fair value that is attributable to changes in its credit risk.

If the only significant and relevant changes in market conditions for a liability are changes
in an observed (benchmark) interest rate, the amount of change in the fair value of the
financial liability can be estimated as follows:
a) First, the entity computes the liability’s internal rate of return at the start of the
period using the fair value of the liability and the liability’s contractual cash flows at

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 the start of the period. It deducts from this rate of return the observed
(benchmark) interest rate at the start of the period to arrive at an instrument-
specific component of the internal rate of return.
b) Next, the entity calculated the present value of the cash flows associate with the
liability using the liability’s contractual cash flows at the end of the period and a
discount rate equal to the sum of:
i. The observed (benchmark) interest rate at the end of the period and;
ii. The instrument-specific component of the internal rate of return as
determined in (a).
c) The difference between the fair value of the liability at the end of the period and the
amount determined in (b) is the change in the fair value that is not attributable in
changes in the observed (benchmark) interest rate. This is the amount to be
presented in other comprehensive income.
This method would not be appropriate if changes in fair value arising from other factors
are significant.

ILLUSTRATION: Financial Liabilities at FVTPL (Interest Expense and Unrealized

Gains or Losses)- No Changes Due to Credit Risk
On January 1, 2016, Nation’s Foremost CPA Review Inc. issued 4-year bonds with a face
value of P2,000,000 for P1,935,152. The bonds carry an interest of 8% per year payable
annually on December 31. On the date of issuance, the company incurred and paid
commissions to underwriters of P10,000.
The bonds to be appropriately classified as financial liability at FVTPL on December 31,
2016, the bonds are quoted at 103%.

Assume that there no changes due to credit risk.

Requires:
1) How much is the interest expense for 2016?
2) How much is the unrealized loss (or gain) in 2016 to be recognized in the profit or loss?
3) Prepare necessary journal entries for the year 2016.
SOLUTION:
Requirement No.1
Face value P 2,000,000
Multiply by: Nominal ratio 8%
Multiply by: Months outstanding 12/12
Interest Expense P 160,000

Requirement No.2
Fair value of the bonds P 2,060,000

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Less: Carrying value 1,935,152
Unrealized loss-P&L P 124,848

Requirement No. 3: Journal Entries

1/1/2016 Financial liability-FVTPL 1,935,152
Commission expense 10,000
Cash 1,945.152

12/31/16 Interest Expense 160,000

Cash 160,000

Unrealized loss 124,848

Financial liability-FVTPL 124,848

ILLUSTRATION: Unrealized Gain or Loss of FVTPL-with Change Due to Credit Risk

On January 1, 2016, Bacolod Co. issues a 10-year bond with a par value of P1,500,000 and
an annual fixed coupon rate of 8%, which is consistent with market rates for bonds with
similar characteristics.

Bacolod uses observed (benchmark) interest rate. At the date of inception of the bonds, this
rate is 5%. At the end of the first year

a.) Observed (benchmark) interest rate has decreased to 4.75%

b) The fair value interest rate of the bonds is 7.60%

Bacolod is required to present the effects of changes in the liability’s credit risk in the other
comprehensive income.

Required:
1) How much is the unrealized gain or loss to be recognized in the OCI during 2016?
2) How much is the unrealized gain or loss to be recognized in the P&L during 2016?
3) Prepare the journal entry at the end of the period.

SOLUTION:
Requirement No. 1
Market price of the liability, end of the period (at 7.06%) P 1,538,052
Less: FV of liability using the sum observed interest rate

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 And instrument specific IRR (at 7.75%) 1,523,688
Unrealized loss-OCI P 14,364

Note:
 Increase in the market price of the liability will result to an unrealized loss while
decrease in the market price of the liability will result to a unrealized gain.

Internal rate of return at the start of the period-yield or effective rate 8%

Less: Observed (benchmark) interest rate, date of inception 5%
Instrument specific- IRR 3%

Observed (benchmark) interest rate, end of period 4.75%

Add: Instrument specific- IRR 3%
Discount rate 7.75%

Market price of the liability, end of the period using 7.60% for the remaining 9 periods
Present value of Principal (1,500,000 x 0.5172) P 775,800
Add: PV of interest payments (1.5M x 8% x 6.3521) 762,252
Market price of the liability, end of the period P 1,538,052

FV of liability using the sum observed interest rate and instrument specific IRR using
7.75%
Present value of Principal (1,500,000 x 0.5108) P 766,200
Add: PV of interest payments (1.5M x 8% x 6.3124) 757,488
FV of liability using the sum observed interest rate and
Instrument specific IRR P 1,523,688

Requirement No. 2
Market price of the liability of the period P 1,538,052
Less: Carrying amount of FVTPL 1,500,000
Increase in FVTPL 38,052
Less: Unrealized loss in the OCI 14,364
Unrealized loss in the P&L P 23,688

Requirement No. 3 Journal entry:

Unrealized loss-OCI P 14,364
Unrealized loss- P&L 23,688
Financial liability at FVTPL P 38,052
(Increase in fair value of the liability)

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Derecognition of Financial Liability- FL@FVTPL
A financial liability should be removed from the statement of financial position when, and
only when, it is extinguished, that is, when the obligation specified in the contract is either
discharged, cancelled, or expired.
Derecognition gain or loss on held for financial liabilities at fair value through profit or loss
is computed as the difference between the consideration paid and the carrying amount
(fair value at the previous reporting date). But for financial liabilities designated as at fair
value through profit or loss, the amounts presented in other comprehensive income shall
not be subsequently transferred to profit or loss. However, the entity may transfer the
cumulative gain or loss within equity.

ILLUSTRATION: Derecognition of Held for Trading Debt Securities

On January 1, 2016, Occidental Co. Acquired a 4-year bonds with a face value of P2,000,000
for P1,935,152. The bonds carry an interest of 8% per year payable every December 31.

The bonds are to be appropriately classified as held for trading. On December 31, 2016, the
bonds are quoted at 103%.

On January 3, 2017, the bonds were retired at 104%.

Required:
1) How much is the realized loss (or gain) on sale in 2017 to be recognized in the profit or
loss?
2) Prepare the Journal entry on the date of sale.

SOLUTION:
Requirement No. 1
Retirement Price (2M x 104) P 2,080,000
Less: Carrying value 2,060,000
Loss on sale P 20,000

Requirement No. 2Journal entry

Financial liability at FVTPL P 2,060,000
Loss on derecognition (sale) 20,000
Cash P 2,080,000

ILLUSTRATION: Realized Gain or Loss of FVTPL- with Change Due to Credit Risk
On January 1, 2016, Bacolod Co. issues a 10-year bond with a par value of P1,500,000 and
an annual fixed coupon rate of 8%, which is consistent with market rates for bonds with
similar characteristics.

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Bacolod uses observed (benchmark) interest rate. The entity is required to present the
effects of changes in the liability’s credit risk in the other comprehensive income. On
December 31, 2016, when the fair value of the financial liability is P1,538,052, Bacolod
appropriately recorded unrealized loss in the other comprehensive income of P14,364 and
in the profit or loss amounting to P23,688.

On January 3, 2017, the bonds were retired at 104%

Required:
1) How much is the realized loss (or gain) on sale in 2017 to be recognized directly in the
equity?
2) Prepare the Journal entry on the date of retirement.

SOLUTION:
Requirement No. 1
Retirement Price (1.5M x 104%) P 1,560,000
Less: Carrying Value 1,538,052
Loss on sale recognized directly through equity
(i.e. Retained earnings) P 21,948

Requirement No. 2 Journal entry

Financial liability at FVTPL P 1,538,052
Retained earnings 21,948
Cash P 1,560,000
To record the unrealized loss previously recognized in the OCI to equity

Financial Statement Presentation of Financial Liabilities through Profit or Loss

Financial liabilities through profit or loss should be presented in the current liability
section of the statement of financial position.

FINANCIAL LIABILITIES AT AMORTIZED COST (FL@AC)

Examples of a financial liability measured at amortized cost include the following
a. Bonds payable
b. Notes payable
c. Loan payable

The following discussion is therefore based on accounting treatment of these three

financial liabilities.

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BONDS PAYABLE

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

Parties involved include the bond issue (borrower),

bondholder (investor/lender), and underwriter/arranger (one
who serves as middleman for a free from the borrower or gain
in reselling the investments).

In addition, bonds are financial instruments since they

represent contractual obligation to pay cash or other financial
assets.
Recognition When the entity becomes a party to the contract or when
transfer of resources transpired.
Presentation Presented in the liability section in the statement of financial
position and classified as to either current or non-current
depending on the expected settlement date.
Measurement-Bonds Payable
A. Initial measurement
Bond payable classified as FL@AC shall be initially measured at fair value minus
transaction cost. Normally, it is equal to the net proceeds from the issuance of the bonds
(in the case of issuance at interest date).

Fair value is determined thru (in order of priority)

a) Quotation from an active market.
b) Present value of all principal and interest payments.

Transaction Costs Incurred on Financial Liabilities at Amortized Cost

Transaction cost or bond issuance cost directly attributed to the issuance of bonds payable
is treated as an adjustment to premium (deducted from) or discount (added to) on bonds
payable and non-treated as an outright expense.

B. Subsequent measurement
Bonds payable are subsequently measured at amortized cost using the effective interest
method.

Issuance of Bonds
Bonds may be issued thru the following scheme:

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 Scheme Characteristics
Proceeds (P) vs. Effective (E) vs. Maturity
Face Amount (FA) Nominal rate (N) value
At face amount P=FA E=N FA
At a premium P>FA E<N FA
At a discount P<FA E>N FA

Financial Statements Presentation- FL@AC

The net carrying value is to be reported on the face of the Statement of Financial position as
part of the liabilities section. Net carrying value is determined as follows:
Net carrying value
1) Bonds issued at face amount Face amount xx

2) Bonds issued at a discount Face amount xx

Less: Discount on bonds payable xx
Net Carrying Value xx

3) Bonds issued at a premium Face amount xx

Add: Premium on bonds payable xx
Net Carrying Value xx

TERM BONDS
ILLUSTRATION 1: Issuance of Bonds on Interest Dates
On January 1, 2016, Zambonga Co. issued 10%, three-year P 1,000,000. Interest on these
bonds are due annually every year-end.

Required: Provide the necessary journal entry/ies on the date of issuance under the
following independent situations:
1) Bonds were issued at face amount
2) Bonds were issued to yield 8%
3) Bonds were issued to yield 12%
4) Bonds were issued to yield 12% but were quoted at 98

SOLUTION:
1) Bonds were issued at face amount.
Since the bonds were issued at face amount, it shall be recognized at P 1,000,000. The
transaction shall be recorded as follows:
Cash P 1,000,000
Bonds Payable P 1,000,000

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Note: Since the bonds were issued at face amount and on interest date, the carrying value
of the bonds will be equal to its face amount at any given point in time.

2) Bonds were issued to yield 8%.

The effective rate of the bonds is lower than its stated rate. With this, bonds are said to be
issued at a premium. To determine the issuance price, let us compute for the present value
using the effective rate of 8% for three periods.

Present value of principal (1,000,000 x 0.7938) P 793,800

Add: Present value of interest (1,000,000x 10% x 2.5771) 257,710
Total present value P 1,051,510

The transaction is then recorded as follows:

Cash P 1,051,510
Bonds payable (at face amount) P 1,000,000
Premium on bonds payable 51,510

Note: the bonds will be amortized using effective interest method using 8%.

3) Bonds were issued to yield 12%

The effective rate of the bonds is higher than its stated rate. With this, bonds are said to be
issued at a discount. To determine the issuance price, let us compute for the present value
using the effective rate of 12% for three periods.

Present value of principal (1,000,000 x 0.7118) P 711,800

Add: Present value of interest (1,000,000 x 10% x 2.4018) 240,180
Total P 951,980

The transaction is then recorded as follows:

Cash P 951,980
Discount on bonds payable (1M-951,980) 49,020
Bonds payable (at face value) P 1,000,000

4) Bonds were issued to yield 12% and were quoted at 98

Since the bonds were quoted. The quoted price shall be used in determining the issuance
price of the bonds.

Issuance price (1,000,000 x 98%) P 980,000

The transaction is then recorded as follows:

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Cash P 980,000
Discount on bonds payable 20,000
Bonds payable (at face amount) P 1,000,000

Note: In amortizing these bonds, a new effective rate shall be computed thru interpolation.

ILLUSTRATION 2: Issuance of Bonds at a Premium on Interest Date

Sibugay Corporation is authorized to issue P 1,000,000 of five-year bonds dated June 30,
2016 with a stated interest rate of 10%. Interest on the bonds is payable semi-annually on
June 30 and December 31. The company uses the effective interest method. The bonds
were sold to yield 8%.

Required: Determine the following: (Round off present value factors to four decimal places)
1) Bond issue price
2) Interest expense for 2016 and 2017
3) Carrying value of the bonds on December 31, 2016 and 2017

SOLUTION:
Present value of 1 using 4% for 10 periods is .6756 while the present value of ordinary
annuity using 4% of 10 periods is 8.1109

1) Issue Price, 06/30/2016

Present value of principal (1,000,000 x 0.6756) P 675,000
Present value of Interest (1,000,000 x 5% x 8.1109) 405,545
Total Issue price- June 30, 2016 P 1,081,145

Amortization table
Date Interest Interest Premium Present
Payment Expense Amortizatio Value
n
06/30/2016 1,018,145
12/31/2016 50,000 43,246 6,754 1,074,391
6/30/2017 50,000 42,976 7,024 1,067,366
12/31/2017 50,000 42,695 7,305 1,060,061
6/30/2018 50,000 42,402 7,598 1,052,464
12/31/2018 50,000 42,099 7,901 1,044,562
6/30/2019 50,000 41,782 8,218 1,036,345
12/31/2019 50,000 41,454 8,546 1,027,798
6/30/2020 50,000 41,112 8,888 1,018,910
12/31/2020 50,000 40,756 9,244 1,009,667
6/30/2021 50,000 40,387 9,666 1,000,000

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For requirement (2) and (3), see amortization table above:
2) Interest expense for 2016 and 2017
Interest expense, 12/31/2016 P 43,246
Interest expense from 01/01/2017 to 06/30/2017 P 42,976
Interest expense from 07/01/2017-12/31/2017 42,695
Total interest expense, 12/31/2017 P 85,671
3) Carrying amount for 2016 and 2017
Carrying amount, 12/31/2016 P 1,074,391
Carrying amount, 12/31/2017 P 1,060,061

Entries to record transactions on 2016

1. To record the issuance of the bonds on June 30, 2016
Cash P 1,081,145
Bonds payable (@face amount) P 1,000,000
Premium on bonds payable 81,145

2. To record interest payment on December 31, 2016

Interest Expense P 50,000
Cash (1,000,000 x 12% x 6/12) P 50,000

3. To record premium amortization on December 31, 2016

Premium on bonds payable P 6,574
Interest expense P 6,574

Financial Statement Presentation (2016)

Statement of Financial Position (Non-current liability section)
Bonds payable P 1,074,391

Statements of Comprehensive Income

Interest Expense P 43,246

Notes to Financial Statements

Bonds payable P 1,000,000
Add: Premium on Bonds payable 74,391
Net carrying amount P 1,074,391

ILLUSTRATION 3: Issuance of Bonds at Discount on Interest Date

Assume the same information on the previous illustration that the bonds were sold to
yield 12%

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Required: Determine the following (Round off present value factors to four decimal places)

1) Issue Price, 06/31/2016

Present value of Principal (1,000,000 x 0.5584) P 558,400
Present value of interest (1,000,000 x 5% x 7.3601) 368,005
Total issue price- June 30, 2016 P 926,405

Amortization table
Date Interest Interest Premium Present
Payment Expense Amortizatio Value
n
06/30/2016 926,405
12/31/2016 50,000 55,584 5,584 931,989
06/30/2017 50,000 55,919 5,919 937,909
12/31/2017 50,000 56,275 6,275 944,183
06/30/2018 50,000 56,651 6,651 950,834
12/31/2018 50,000 57,050 7,050 957,884
06/30/2019 50,000 57,473 7,473 965,357
12/31/2019 50,000 57,921 7,921 973,279
06/30/2020 50,000 58,397 8,397 981,675
12/31/2020 50,000 58,901 8,901 990,576
06/30/2021 50,000 59,435 9,424 1,000,000
For requirement (2) and (3), refer to amortization table:
2) Interest expense for 2016 and 2017
Interest expense, 12/31/2016 P 55,584
Interest expense from 01/01/2017 to 06/30/2017 P 55,919
Interest expense from 07/01/2017-12/31/2017 56,275
Total Interest expense, 12/31/2017 P 112,194

3) Carrying amount for 2016 and 2017

Carrying amount, 12/31/2016 P 931,989
Carrying mount, 12/31/2017 P 944,183

Entries to record transactions in 2016

1. To record the issuance of the bonds on June 30, 2016
Cash P 926,405
Discount on bonds payable 73,595
Bonds payable (@ face amount) P 1,000,000

2. To record interest payment on December 31, 2016

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 Interest Expense P 50,000
Cash (1,000,000 x 12% x 6/12) P 50,000

3. To record premium amortization on December 31, 2016

Interest Expense P 5,584
Discount on bonds payable P 5,584

Financial Statement Presentation (2016)

Statement of Financial Position (Non-current liability section)
Bonds payable P 931,989

Statement of Comprehensive Income

Interest Expense P 55,584

Notes to Financial Statements

Bonds payable P 1,000,000
Less: Discount on Bonds Payable 68,011
Net Carrying amount P 931,989
Important notes to Effective Interest Method
When using the effective interest method, the behaviour of the following items should be
noted:

Issuance Carrying Value Interest Expense Amortization

At a premium Declining Declining Increasing
At a discount Increasing Increasing Increasing

SERIAL BONDS
ILLUSTRATION: Issuance on Interest Date of Serial Bonds
Biliran Corporation issued bonds with face value of P6,000,000 on January 1, 2016. The
nominal rate of 6% is payable annually on December 31. The bonds are issued with an 8%
effective yield. The bonds mature on every December 31 each year at the rate of
P2,000,000 for three years.

Required: Based on the preceding information, determine the following (Round off present
value factors to four decimal places)
1) Issue price of the serial bonds
2) Interest expense in 2016
3) Carrying value of the serial bonds payable at December 31, 2016

SOLUTION:

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1) Issue Price
Present value of Principal Payments
(P2,000,000 x 2.5771) P 5,154,200
Present value of Interest Payments
2016 (P6,000,000 x 6 % x 0.9259) P 333,324
2017 (P4,000,000 x 6 % x 0.8573) P 205,752
2018 (P2,000,000 x 6% x 0.7938) P 95,256
634,332Total P
5,788,532

Amortization table
Date Total Interest Reduction to Present
Payment Expense Principal Value
01/01/2016 P5,788,532
12/31/2016 2,360,000 463,083 1,986,917 3,891,615
12/31/2017 2,240,000 311,329 1,928,671 1,962,944
12/31/2018 2,120,000 157,035 1,962,944 0

Note: Total payment consists of principal and interest payment.

2) Interest expense (see amortization table above)

Interest expense, 2016 P 463,083

3) Carrying Amount (see amortization table above)

Carrying amount, 12/31/2016 P 3,891,615

Note: Alternatively, the present value of serial bonds may be computed as follows (any
difference is due to rounding off):
Amortization table
Date Total Payment PV of 1 Present Value

12/31/2016 2,000,000+360,000 .9259 P2,185,124

12/31/2017 2,000,000+240,000 .8573 1,920,352
12/31/2018 2,000,000+120,000 .7938 1,682,856
P5,788,332

Entries to record transactions in 2016

1. To record the issuance of the bonds on January 1, 2016
Cash P 5,788,532
Discover on bonds payable 211,468

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 Bonds payable (@face amount) P 6,000,000

2. To record interest payment on December 31, 2016

Interest Expense P 360,000
Cash (P1,000,000 x 12% x 6/12) P 360,000

3. To record principal payment on December 31, 2016

Bonds payable P 2,000,000
Cash P 2,000,000

4. To record discount amortization on December 31, 2016

Interest Expense P 103,083
Discount on bonds payable P 103,083

Financial Statement Presentation (2016)

Statement of Financial Position
Current liability section
*Bonds payable-non-current portion P 1,928,671

Non-current liability Section

Bonds payable-non-current portion P 1,962,944

Statement of Comprehensive Income

Interest Expense P 463,083

Notes to Financial Statements

Bonds Payable P 4,000,000
Less: Discount on Bonds Payable (108,385)
Net Carrying amount P 3,891,615

*Reduction of Principal in 2017. See amortization table above.

ILLUSTRATION: Issuance of Bonds between Interest Dates

On March 1, 2016, Samar Co. issued 12%, five-year P1,000,000 at 98 including accrued
interest. These bonds were dated January 1, 2016. In addition, interests on these bonds are
due annually every December 31, 2016.

Required: Compute for the initial carrying amount of the bonds on March 1, 2016.

SOLUTION:

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When bonds are issued between interest dates, the total proceeds from the issuance is
composed of two; (1) amount received from issuance of bonds; and (2) amount received
for interest which had accrued from interest date to issuance date.

The initial measurement of the bonds shall be equal to portion of the total proceeds
applicable to the bonds or total proceeds, net of accrued interest.

In the given data, the bonds were issued 98% of the face amount or P980,000 (P1,000,000
x 98%). This is allocated as follows:
Total proceeds P 980,000
Less: Accrued interest (P1,000,000 x 12% x 2/12) 20,000
Proceeds applicable to the bonds P 960,000

The transaction is then recorded as follows:

Cash P 980,000
Discount on Bonds payable 40,000
Bonds payable (at face amount) P 1,000,000
Interest expense* 20,000

*The accrued interest may also be credited to interest payable account.

Pro-forma entries for transaction related to the issuance in 2016 include:

1. To record interest payment on December 31, 2016
If accrued interest in credited to interest expense
Interest expense P 120,000
Cash (P1,000,000 x 12%) P 120,000

If accrued interest is credited to interest payable

Interest expense P 100,000
Interest Payable 20,000
Cash (P1,000,000 x 12%) P 120,000

2. To record discount amortization on December 31, 2016

Interest expense P120,000
Discount on bonds payable P120,000

Note: To amortize these bonds an effective interest rate shall be computed through
interpolation.

ILLUSTRATION: Issuance of Term Bonds between Interest Dates

18
On January 1, 2016, Leyte Co. is planning to issue a 12%, five-year P1,000,000 bonds.
Interests on these bonds are due annually every year-end. Leyte determines that the
current market rate on January 1 is 15%.

Required: Compute for the amount of proceeds received from issuance assuming bonds
were issued on (Round off present value factors into four decimal places)
1) January 1, 2016
2) March 1, 2016

SOLUTION:
1) Bonds were issued on January 1, 2016
Present value of Principal Payments
(P1,000,000 x 0.4972) P 497,200
Present value of Interest Payments
(P1,000,000 x 3.3522) 402,264
Total P 899,464

2) Bonds were issued on March 1, 2016

In computing for proceeds from issuance between interest dates, we can simply
compute for the carrying amount on issue date assuming the bonds were issued at
interest date. In this example, let us compute for the carrying amount on March 1,
2016 assuming that the bonds were issued on January 1, 2016.

Since we have already computed for the issuance price on January 1, 2016, all we have to
do is to amortize it as follows:

Interest Interest Discount

Date Carrying Value
Payment Expense Amortization
01/01/2016 P 899,464
12/31/2016 120,000 134,920 14,920 914,384
12/31/2017 120,000 137,158 17,158 931,541
12/31/2018 120,000 139,731 19,731 951,272
12/31/2019 120,000 142,691 22,691 973,963
P 1,000,000
12/31/2020 120,000 146,094 26,036
*

Based on the above amortization table, we can say that the issue price on March 1, 2016 is
between the carrying value as of January 1, 2016 and December 31, 2016 amounting to
P899,464 and P914,384, respectively.
Also, let us note that the difference between these two amounts represent the discount
amortization for one year or twelve (12) months.

19
With these, the issue price would be:
Carrying amount, January 1, 2016 P 899,464
Add: Discount amortization from January 1
to March 1 (P14,920 x 2/12) 2,487
Proceeds applicable to the bonds P 901,951
Add: Accrued interest (P1,000,000 x 12% x 2/12) 20,000
Total proceeds from issuance P 921,951

Alternatively, the proceeds applicable to the bonds may be computed as if the bond issued
on interest date (January 1, 2016) was amortized for two months or up to March 1, 2016.

Interest Interest Discount

Date Carrying Value
Payment Expense Amortization
01/01/2016 P 899,464
03/01/2016 20,000 22,487 2,487 901,951

Derecognition – Bonds Payable

A financial liability should be removed from the statement of financial position when, and
only when, it is extinguished, that is, when the obligation specified in the contract is either
discharged, cancelled, or expired.

Retirement of Nonconvertible Bonds Payable

(Note: If the problem is silent, assume that the bonds are nonconvertible)

Summary of accounting treatments

Retirement price
applicable to principal Difference is recognized as
Retirement of bonds gain or loss on
prior to date of extinguishment of bonds
maturity Carrying amount of (part of profit or loss for
bonds on the date of the period)
maturity

20
Settlement price and
Retirement of carrying amount will
bondson maturity be equal to Face No gain or loss is recognized
date
Procedural approach in retiring regular bonds
Step 1: Update the amortization of the bonds payable as of the date of retirement.
Step 2: Compute for the gain or loss on retirement using this formula:
Retirement price applicable to principal xxx
Less: Carrying amount of bonds payable xxx
Loss/(gain) on retirement of bonds xxx

Note: No gain or loss on retirement of bonds on maturity

Step 3: Record the transaction as follows:

Bonds payable (@ face amount) xxx
Premium on bonds payable (if applicable) xxx
Loss on retirement of bonds (if applicable) xxx
Cash (retirement price) xxx
Discount on bonds payable (if applicable) xxx
Gain on retirement of bonds (if applicable) xxx

ILLUSTRATION: Retirement of Bonds

Tacloban Corporation is authorized to issue P1,000,000 of five-year bonds dated June 30,
2015 with a stated interest rate of 10%. Interest on the bonds is payable semi-annually on
June 30 and December 31. The company uses the effective interest method. The bonds
were sold to yield 8%.

Required: Determine the amount of gain or loss assuming the bonds were retired under
the following independent situations:
1) On January 1, 2016 at face amount
2) On April 1, 2018 at 105
3) On June 30, 2020

SOLUTION:
The data in this illustration are similar with that of illustration 2 Issuance of bonds at a
premium on interest date. With this, we can simply copy the amortization table to be able to
address the requirements of this problem.

Date Interest Interest Premium Carrying

21
 Payment Expense Amortization Value
06/30/2015 P1,081,145
12/31/2015 50,000 43,246 6,754 1,074,391
06/30/2016 50,000 42,976 7,024 1,067,366
12/31/2016 50,000 42,695 7,305 1,060,061
06/30/2017 50,000 42,402 7,598 1,052,464
12/31/2017 50,000 42,099 7,901 1,044,562
06/30/2018 50,000 41,782 8,218 1,036,345
12/31/2018 50,000 41,454 8,546 1,027,798
06/30/2019 50,000 41,112 8,888 1,018,910
12/31/2019 50,000 40,756 9,244 1,009,667
06/30/2020 50,000 40,387 9,666 P1,000,000 *

* Prior to principal payment

1) January 1, 2016 at face amount

Retirement price P 1,000,000
Less: Carrying amount (see amortization table) ( 1,074,391)
Gain on retirement of bonds (P 74,391)

2) April 1, 2018 at 105

Retirement price (P1,000,000 x 105%) P 1,050,000
Less: Carrying amount (see amortization table)
Carrying amount, 12/31/2017 P 1,044,562
Less: Amortization up to 04/31
(P8,218 x 3/6) ( 4,109)( 1,040,453)
Loss on retirement of bonds P 9,547

3) June 30, 2020

Zero.On June 30, 2020 maturity date, the retirement price and the carrying amount is
equal to the face amount of the bonds. Thus, no gain or loss shall be recognized.

COMPOUND FINANCIAL INSTRUMENTS

Compound financial instruments are financial instruments that have both a liability and an
equity component from the issuer’s perspective. Examples include the following:
a. Convertible bonds
b. Debt instruments issued with detachable share purchase warrants

22
Accounting Treatment
Split accounting
According to PAS 32, the component parts of compound financial instruments must be
accounted for and presented separately according to their substance based on the
definitions of liability and equity.

Approach on how to split

According to par. 31 of PAS 32, “when the initial carrying amount of a compound financial
instrument is required to be allocated to its equity and liability components, the equity
component is assigned the residual amount after deducting from the fair value of the
instrument as a whole, the amount separately determined for the liability component.”
This is otherwise known as “with-and-without method” and “residual approach”.

When to split
The split is made at issuance and not revised for subsequent changes in market interest
rates, share prices, or other event that changes the likelihood that the conversion option
will be exercised.

BONDS PAYABLE WITH DETACHABLE WARRANTS

Bonds may be issued with detachable warrants. These warrants entitle the bondholder to
acquire equity securities of the bond issuer at an agreed subscription price. Because of this
entitlement, it is presumed that aside from the bonds issued, the entity has also issued an
equity instrument. Thus, the total proceeds should be allocated both the bonds and
warrants using the residual approach.

Appropriate allocation is performed as follows:

Total proceeds xxx
Less: Fair value of the bonds payable xxx___
Value assigned to warrants xxx___

Furthermore, the following are the pro-forma entries to record transactions involving
warrants.
1. To record the issuance of the bonds
Cash xx
Discount on bonds payable (if applicable) xx
Bonds payable (@ face amount) xx
Premium on bonds payable (if applicable) xx
Share warrants outstanding xx

2. When warrants are exercised

Cash xx
Share premium – warrants outstanding xx
Share capital (@ par value) xx
Share premium xx

3. When warrants expire or not exercised

23
 Share premium – warrants outstanding xx
Share premium xx

ILLUSTRATION: Bonds Payable with Warrants

Ormoc Company issued bonds payable with warrants of 4,000, 10% 5-year bonds, face
value of P1,000 at 98 on January 1, 2016. Each bond is accompanied by warrant that
permits the bondholder to purchase 20 shares of common stock, par P50, at P55 per share.
The nominal rate is payable annually on December 31. The bonds mature on December 31,
2020. When the bonds are issued, the prevailing market rate of interest for similar bonds
without warrants is 12% per annum.

Required: Based on the preceding information, determine the following:

(Round off present value factors to four decimal places)
1) Amount allocated to warrants
2) Interest expense in 2016
3) Carrying value of the serial bonds payable at December 31, 2016
4) Net effect to equity assuming 60% of warrants were exercised.
5) Net effect to equity assuming the other 40% of warrants expired.

SOLUTION:
1) Amount allocated to warrants
Proceeds from issuance of bonds payable with warrants
(4,000,000 x 98%) P 3,920,000
Less: Fair value of bonds without warrants
Present value of Principal Payments
(4,000,000 x 0.5674) P 2,269,600
Present value of Interest Payments
(4,000,000 x 10% x 3.6048) 1,441,9203,711,520
Amount allocated to warrants P 208,480

For requirements (2) and (3):

The amortization table for the bonds payable is as follows:

Interest Interest Discount

Date Carrying Value
Payment Expense Amortization
01/01/2016 P 3,711,520
12/31/2016 400,000 445,382 45,382 3,756,902
12/31/2017 400,000 450,828 50,828 3,807,731
12/31/2018 400,000 456,928 56,928 3,864,658
12/31/2019 400,000 463,759 63,759 3,928,417
12/31/2020 400,000 471, 410 71,583 P 4,000,000

24
 * Prior to principal
payment

2) Interest expense
Interest expense, 2016 P 445,382

3) Carrying amount
Carrying amount, 12/31/2016 P 3,756,902

Entries to record transactions in 2016

1.To record the issuance of the bonds on January 1, 2016
Cash P 3,920,000
Discount on bonds payable (4M – 3,711,520) 288,480
Bonds payable (@ face amount) P 4,000,000
Share warrants outstanding 208,480

2. To record interest payment on December 31, 2016

Interest Expense P 400,000
Cash (P4,000,000 x 10%) P 400,000

3. To record premium amortization on December 31, 2016

Interest Expense P 45,382
Discount on bonds payable P 45,382

Financial Statement Presentation (2016)

Statement of Financial Position (Non-current liability section)
Bonds Payable P 3,756,902
*Share premium – warrants outstanding P 208,480
Statement of Comprehensive Income
Interest Expense P 445,382

Notes to Financial Statements

Bonds Payable P 4,000,000
Less: Discount on Bonds Payable ( 243,098)
Net carrying amount P 3,756,902

*Prior to any exercise or expiration.

4) 60% of warrants were exercised

Cash* P 2,640,000
Share warrants outstanding** 125,088
Common stock (P4,000 x 60% x 20 x P50) P 2,400,000
Share premium (balancing figure) 365,088

25
 *(P4,000 x 60% x 20 shares x P55)
**(P208,480 x 60%)
Increase in share premium (general) P 365,088
Less: Decrease in share warrants outstanding ( 125,088)
Net increase in share premium P 240,000

5) 40% of warrants expired or not exercised

When warrants issued expired, the net effect to equity would be ZERO. The balance of
share warrants outstanding will be reclassified as part of general share premium.
Share warrants outstanding (P208,480 x 40%) P 83,392
Share premium P 83,392

CONVERTIBLE BONDS
Convertible bonds are bonds that give the holder an option to convert the bonds into bond
issuer’s equity securities. An entity recognizes separately the components of a financial
instrument that:
a. creates a financial liability of the entity and
b. grants an option to the holder of the instrument to convert it into an equity
instrument of the entity.
Thus, the total proceeds should be allocated to both the bonds and conversion option using
the residual approach.

Furthermore, the following are the accounting treatment of possible transaction involving
conversion option.

Issuance of convertible bonds

1. Allocation of the proceeds
Appropriate allocation is performed as follows:
Total proceeds xxx
Less: Fair value of the bonds payable xxx__
Value assigned to conversion option xxx__

2. To record the issuance of the bonds

Cash xx
Discount on bonds payable xx
Bonds payable (@ face amount) xx
Premium on bonds payable (if applicable) xx
Share premium – conversion privilege xx

26
Retirement of convertible bonds

Difference is recognized as a
Retirement price change allocated to equity:
 increase (share premium)
 decrease (to be charged on
share premium –
Retirement price conversion privilege and
Retirement of bonds applicable to liability any excess, if any, to
prior to date of (i.e Present value of retained earnings)
maturity the bonds using
current rate
Difference is recognized as gain
or loss on
extinguishment of bonds
Carrying amount of (part of profit or loss for the
bonds on the date of period)
maturity

Retirement of No gain or loss is recognized

convertible Settlement price and and share premium –
bondson maturity carrying amount will be conversion privilege may be
date equal to face amount transferred to general share
premium (excess over par)

Procedural approach in retiring convertible bonds

Step 1 Update the amortization of the bonds payable as of the date of the retirement.
Step 2 Compute for the gain or loss on retirement using this formula:
Fair value of bonds payable xxx
Less: Carrying amount of bonds payable (xxx)_
Loss/(Gain) on retirement of bonds xxx__

27
 Note: No gain or loss on retirement of bonds on maturity

Step 3 Compute for the increase or decrease in equity using this formula:
Fair value of bonds payable xxx
Less: Retirement price applicable to principal (xxx)_
Increase/(Decrease) allocated to equity xxx__

Alternatively, the change in equity may be computed as follows:

Decrease in SP – Conversion Privilege (xxx)
Decrease in Retained Earnings (if applicable) (xxx)
Increase in Share Premium excess over par (if any) xxx_
Total Increase/(Decrease) allocated to equity xxx_

Step 4 Record the transaction as follows:

Bonds payable (@ face amount) xx
Loss on retirement of bonds (if applicable) xx
Premium on bonds payable (if applicable) xx
Share Premium – conversion privilege xx
Retained earnings (bal. figure) xx
Cash (retirement price) xx
Discount on bonds payable (if applicable) xx
Gain on retirement of bonds xx
Share premium excess over par (bal. figure) xx

Conversion of Convertible Bonds

PAS 32 states that on conversion of a convertible instrument, the entity derecognizes the
liability component and recognizes it as equity. The original equity component remains as
equity (although it may be transferred from one line item within equity to another).
Furthermore, the conversion shall not be accounted for as an “debt to equity swap” in
compliance with the requirements of IFRIC 19.

There are two types of conversion of bonds:

1. Regular conversion – no gain or loss on conversion shall be recognized.
2. Induced conversion – loss on conversion may be recognized but not gain on
conversion.

Summary of Accounting Treatment for Regular conversion

Carrying amount (CA)  If the sum of carrying

of bonds on the date of amount and conversion
maturity privilege is greater than
Conversion of bonds par or stated, the
on or prior to date difference is recognized as
of maturity
an increase in share
28
premium.
 If the sum of carrying
amount and conversion is
 Par or stated value of
share capital issued

Procedural approach for the regular conversion of bonds

Step 1 Update the amortization of the bonds payable as of the date of conversion.
Step 2 Record the transactions as follows:
Bonds payable (@ face amount) xx
Premium on bonds payable (if applicable) xx
Share premium – conversion privilege xx
Discount on share capital (bal. figure) xx
Cash (retirement price) xx
Discount on bonds payable (if applicable) xx
Share premium excess over par (bal. figure) xx

Induced conversion
Recognition of Expense upon Conversion
The debtor enterprise shall recognize an expense equal to the fair value of all securities and
other consideration transferred in the transaction in excess of the fair value of securities
issuable pursuant to the original conversion terms.

The fair value of the securities or other consideration shall be measured as of the date the
inducement offer is accepted by the convertible debt holder.

Normally this will be the date the debt holder converts the convertible debt into equity
securities or enters into a binding agreement to do so.
(Financial Accounting Standards 83 of the US GAAP)

According to Application Guidance par 35 of PAS 32, “an entity may amend the terms of a
convertible instrument to induce early conversion, for example, by offering a more
favorable conversion ratio or paying other additional consideration in the event of
conversion before a specified date.

The difference, at the date the terms are amended, between the fair value of the
consideration the holder receives on conversion of the instrument under the revised

29
terms and the fair value of the consideration the holder would have received under the
original terms is recognized as a loss in profit or loss.”

Formula
In cases where there would be amendments of terms to induce conversion, additional loss
should be recognized in the profit or loss for the period. This shall be computed as follows:

Fair value of shares converted xxx

Less: Fair value of shares under original conversion xxx_
Debt conversion expense or loss on induced conversion xxx_

Face amount of debt securities converted xxx

Divide by: New conversion price xxx_
Number of shares issued upon conversion xxx
Multiply by: fair value of shares on the conversion date xxx_
Fair value of shares converted xxx

Face amount of debt securities converted xxx

Divide by: Old conversion price xxx_
Number of shares issued under original conversion xxx
Multiply by: fair value of shares on the conversion date xxx_
Fair value of shares under original conversion xxx_

Alternatively, the loss may computed as follows:

Shares to be issued – amended
(face value/new conversion price) xxx
Less: Shares to be issued – original
(face value/old conversion price) (xxx)
Incremental shares to be issued xxx
Multiply by: market price of share capital
at amendment date xxx_
Debt conversion expense or loss due to induced conversion xxx_

Note:
The new conversion price should be lower than the old conversion price so that the
bondholder will be encouraged or induced to convert their bonds. This will result to a loss
due to induced conversion but not gain on induced conversion.

Conversion of Nonconvertible Bonds

Conversion of nonconvertible bonds is within the scope of IFRIC 19. Accordingly, the
debtor should measure the equity instruments issued to the creditor at fair value, unless
fair value is not reliably determinable, in which case the equity instruments issued are
measured at the fair value of the liability extinguished.

30
The debtor recognizes in profit or loss the difference between the carrying amount of the
financial liability (or part) extinguished and the measurement of the equity instruments
issued.

Formula:
Fair value of equity instruments issued (or if not reliably
determinable, use the fair value of liability) xxx
Less: Carrying amount of liability xxx_
Loss (or Gain) on extinguishment of liability xxx_

Fair value of equity instruments issued (or if not reliably

Determinable, use the fair value of liability) xxx
Less: Total par or stated value of equity issued xxx_
Share premium (or Discount) xxx_

ILLUSTRATION: Conversion of Convertible and Nonconvertible Bonds

On January 1, 2016, Bohol Company converted its 5,000, P1,000 face value, 12% bonds
payable with a carrying amount of P5,248,634 for 100,000 ordinary shares with a par value
of P50. The fair value of the bonds on the date of retirement is P5,400,000.

Required: Prepare all the necessary entries on the date conversion.

CASE NO. 1: Assume that the bonds are convertible bonds and the share premium from
conversion option was P180,000.

CASE NO. 2: Assume that the bonds are nonconvertible and the conversion is a result of
debt for equity swap.

SOLUTION:
CASE NO. 1: Journal entries
Bonds payable P5,000,000
Share premium – conversion option 180,000
Premium on bonds payable (5,248,634 – 5M) 248,634
Ordinary shares (100,000 x 500) P5,000,000
Share Premium 428,634

Note that there is no gain or loss on regular conversion of convertible bonds.

CASE NO. 2: Journal entries

Bonds payable P5,000,000
Loss on settlement of liability 151,366
Premium on bonds payable (5,248,634 – 5M) 248,634
Ordinary shares (100,000 x 500) P5,000,000
Share Premium 400,000

The gain or loss on settlement of liability is computed as follows:

Fair value of liability P5,400,000

31
Less: Carrying amount of the bonds payable 5,248,634
Loss on settlement of liability P 151,366

The share premium is computed as follows:

Fair value of liability P5,400,000
Less: Total par value of the shares issued 5,000,000
Share Premium P 400,000
Note that if the problem is silent, the bonds payable are assumed to be nonconvertible.

ILLUSTRATION: Induced Conversion

On January 1, 2015, Cebu Co. issued, P1,200,000, 8%, convertible bonds due after 4 years.
The bonds were sold for P1,123,910 and are convertible into P10 par ordinary shares at a
conversion price of P25 per share.

On December 31, 2016, Cebu Co, in an effort to induce conversion of the bonds into
ordinary share, reduced the conversion price to P20 per share for bondholders that
converted within 40 days. On this date, the fair value of the bonds is P1,500,000 and the
bonds have a carrying amount of P1,158,332. All the bond holders accepted the offer on
December 31, 2016. On the date of conversion, the fair value of the Cebu Co.’s ordinary
share is P28 per share.

Required:
Prepare journal entry on December 31, 2016.

SOLUTION:
Face amount of debt securities converted P1,200,000
Divide by: New conversion price 20
Number of shares issued upon conversion 60,000
Multiply by: Fair value of shares on the conversion date 28
Fair value of shares converted P1,680,000

Face amount of debt securities converted P1,200,000

Divide by: Old conversion price 25
Number of shares issued under original conversion 48,000
Multiply by: Fair value of shares on the conversion date 28
Fair value of shares under original conversion P1,344,000

Fair value of shares converted P1,680,000

Less: Fair value of shares under original conversion 1,344,000
Debt conversion expense or loss on induced conversion P336,000

Bonds payable (at face amount) P1,200,000

Debt conversion expense or loss on induced 336,000
Conversion
Discount on bonds payable (1.2M – 1,158,332) P41,668
Ordinary shares (60,000 x 10) 600,000

32
 Share premium (to balance the journal entry) 894,332

Number of shares issued upon conversion 60,000

Multiply by: Par value 10
Ordinary shares 600,000

Note:
 Cash is not debited equal to the conversion price because the market conversion price
merely indicates the ratio of shares to be issued upon conversion of the bonds.
 The market conversion price is determined by dividing the current market price of
the convertible security by the security’s conversion ratio.
(http://www.investinganswers.com)

SUMMARY OF RETIREMENT AND CONVERSION OF BONDS PAYABLE

Scenario Accounting Treatment

Retirement of Bonds (Non-convertible Gain or loss may be recognized on
bonds) retirement of bonds prior to maturity.

No gain or loss on retirement of bonds on

maturity.

(Retirement price minus carrying amount

= gain or loss)
Retirement of convertible bonds (PAS Gain or loss may be recognized on
32) retirement of bonds prior to maturity.

Net increase or decrease in equity shall

also be computed.

No gain or loss on retirement of bonds on

maturity date.
Conversion of convertible bonds No gain or loss on conversion of
convertible bonds (unless under induced
conversion)
Conversion of nonconvertible bonds Gain or loss on conversion may be
because of equity swap (IFRIC 19) recognized (fair value of equity instrument
(or if not reliably determinable fair value of
liability) minus carrying amount of liability
= Loss (or Gain)

33
Bonds payable to be redeemed contractually at a premium or discount
If the bonds payable are to be redeemed contractually at a premium or discount, the
liability will need to be accreted over time such at the redemption date, the carrying
amount of the liability is equal to the redemption price. The accretion of the redemption
premium attributable to an accounting period will be presented together with the accrued
dividends as interest expense for that period in the profit or loss. On the other hand, the
accretion of the redemption discount shall be deducted from the interest expense for that
period.

ILLUSTRATION: Issuance of Bonds with Redemption Price

Quezon Company issued 20,000 unsecured, P10, 12% bonds on January 1, 2016 at a
discount of 4% to be redeemed on December 31, 2018 at a premium of 5%. These
debentures were issued at an effective interest rate of 15.1948%.

Required: (Carry all decimal places during the computation)

1)Compute for the present value (fair value) of the financial liability and prepare the
amortization table.
2) Prepare for the journal entries on 2016, 2017 and 2018.

SOLUTION:
Requirement No.1
Present value of the principal including premium on the
redemption date (P10 x 20,000 x (15%) x .6542) P137,379
Add: Present value of interest (10 x 20,000 x 12% x 2.2759) 54,621__
*Present value P 192,000_

Note: Carry all decimal places during the computation

Amortization table:
Interest Interest Present
Date Payment expense Amortization value
01/01/2016 P192,000
12/31/2016 24,000 29,174 5,174 197,174
12/31/2017 24,000 29,960 5,960 203,134
12/31/2018 24,000 30,866 6,866 P210,000
The amortization shall be allocated pro-rata to the discount and premium using these
ratios:
Amount Payment Disc/Prem Ratio
Discount (P10 x 20,000 x 4%) 8,000 8/18 .4444
Premium (P10 x 20,000 x 5%) 10,000 10/18 .5556
Total 18,000 18/18

Requirement No. 2

34
Journal entries are:
Jan 1, Cash (20,000 x P10 x (1-4%)) P192,000
2016 Discount on bonds 8,000
Bonds payable P200,000

Dec 31, Interest expense P29,174

2016 Discount on bonds payable (5,174 x 44.44%) P2,300
Premiums on redemption of bonds (5,174 x 55.56%) 2,874
Cash 24,000

Dec 31, Interest expense P29,960

2017 Discount on bonds payable (5,960 x 44.44%) P2,649
Premiums on redemption of bonds (5,960 x 55.56%) 3,311
Cash 24,000

Dec 31, Interest expense P30,866

2018 Discount on bonds payable (6,866 x 44.44%) P3,052
Premiums on redemption of bonds (5,960 x 55.56%) 3,814
Cash 24,000

Dec 31, Bonds payable P200,000

2018 Premiums on redemption of bonds 10,000
Cash 210,000

Note:
 The premium on redemption of bonds shall be treated as an addition to the bonds
payable.
 The total interest expense is equal to the total interest paid of 72,000(10 x 20,000 x
12% x 3 years) plus total discount of P8,000 (P10 x 20,000 x 4%) plus total premium
on redemption of P10,000 (P10 x 20,000 x 5%).

Financial Statement Presentation (2016)

Statement of the Financial Position (Non-current liability section)
Bonds payable P200,000
Discount on bonds payable (P8,000 – P2,300) (5,700)
Premium on redemption of bonds 2,874__
Total P197,174__

Statement of the Comprehensive Income (2016)

Interest expense P29,174__

PREFERENCE SHARE
A preference share is an equity instrument that gives the holder certain preferences over
ordinary shareholders. This instrument shall be classified as either part of equity or
financial liability depending on the following:

35
a. If the preference shares are non-redeemable or redeemable at the option of the
corporation (also known as callable preference shares), these shall be treated as part
of shareholders’ equity.
b. If the preference shares are mandatorily or compulsorily redeemable, or are
redeemable at the option of the holder at a fixed or determinable date, these shall be
treated as financial liability.

Accounting for preference shares as part of shareholders’ equity is discussed in Chapter 29

Shareholder’s Equity.

Redeemable Preference shares to be redeemed contractually at a premium or

discount
If the preference shares are to be redeemed contractually at a premium or discount, the
liability will need to be accreted over time such at the redemption date, the carrying
amount of the liability is equal to the redemption price. The accretion of the redemption
premium attributable to an accounting period will be presented together with the accrued
dividends as interest expense for that period in the profit or loss. On the other hand, the
accretion of the redemption discount shall be deducted from the interest expense for that
period.

ILLUSTRATION: Redeemable Preference Shares

Aguinaldo Limited issued 15,000, P10 par, 10% redeemable preference shares on January
1, 2016. The shares are subject to compulsory redemption by the company on December
31, 2018 at a premium of P.20 per share. The effective interest rate on the date of issuance
is 15.7203%.

On December 31, 2018 the directors resolved to redeem the preference shares at a
premium of P.20 per share. This was in accordance with the terms of the original issue.

Required:
1) Compute for the present value (fair value) of the financial liability (i.e. redeemable
preference share) and prepare the amortization table.
2) Prepare the journal entries on 2016 and 2017.

SOLUTION:
Requirement No.1
Present value of principal including premium on the
redemption date [P10 x 15,000 x (1.20) x .6453] P116,157
Add: Present value of interest (10 x 15,000 x 10% x 2.2649) 33,843_
Present value P150, 000_

Note: Carry all decimal places during the computation

Amortization table:
Interest Interest Present
Date Payment expense Amortization value
36
 01/01/2016 P150,000
12/31/2016 15,000 23,580 8,580 158,580
12/31/2017 15,000 24,929 9,929 168,510
12/31/2018 15,000 26,490 11,490 P180,000

Requirement No. 2
Journal entries are:
Jan 1, Cash (15,000 x P10) P150,000
2016 Preference shares P150,000

Dec 31, Interest expense P23,580

2016 Premium on redemption of pref. shares P8,580
Cash 15,000

Dec 31, Interest expense P24,929

2017 Premium on redemption of pref. shares P9,929
Cash 15,000

Dec 31, Interest expense P26,490

2018 Premium on redemption of pref. shares P11,490
Cash 15,000

Dec 31, Preference shares P150,000

2018 Premiums on redemption of pref. shares 30,000
Cash P180,000

Note:
 The premium on redemption of the preference shares shall be treated as an addition to
the preference shares.
 Total interest expense is equal to the total interest paid of P45,000 (10 x 15,000 x 10%
x 3 years) plus total premium on redemption of P30,000 (15,000 x P10 x P.20).

Financial Statement Presentation (2016)

Statement of Financial Position (Non-current liability section)
Preference shares P 150,000
Premium on redemption of pref. shares 8,580__
Total P158,580__

Statement of Comprehensive Income (2016)

Interest expense P23,580__

NOTES PAYABLE
Characteristics
Description A promissory note is a financial instrument, in which one party called
the maker or issuer promises in writing to pay a sum certain money to

37
 the other party called the payee either on demand of the latter or at a
fixed or determinable future time.
Recognition When the entity becomes a party to the contract or when transfer of
resources transpired
Presentation Presented in the liability section in the statement of financial position
and classified as to either current or non-current depending on the
expected settlement date.

The net carrying value is to be reported on the face of the Statement of

Financial position as part of the liabilities section. Net carrying value is
determined as follows:
Face amount P xxx
Less: Discount on Notes Payable xxx
Net Carrying Value xxx

Measurement
1. Initial measurement- notes payable shall be initially measured at fair value minus
transaction cost. However, standards allow short-term notes payable to be measured
at face amount since the difference between the face amount and its fair value is
considered to be immaterial.

Furthermore, in the absence of fair value, the notes shall be measured at discounted or
present value. The following diagram shows the basis of measuring the long-term notes
payable’s discounted or present value on the date of initial recognition.

Category Characteristics Measurement

Interest bearing Nominal interest rate Face amount
liabilities approximates the prevailing
market rate or

Nominal interest rate PV of principal and

substantially different with interest payments
market rate

--------------------------------------------------------------------------------------------------------------------

Non-interest Issued solely for cash PV is equal to cash

bearing
liabilities Issued for non-cash assets PV is equal to either of
the following (in order
of priority):
a. Cash price
equivalent
38
b. PV of principal
payments
*Note: Any difference between the face amount
and measurement basis is debited to Discount
on Notes Payable.

2. Subsequent measurement – notes payable are subsequently measured at amortized

cost using the effective interest method.

Illustration: Issuance of Interest-bearing note – lump sum

On January 1, 2016, Aklan Co. acquired a machine from Antique Co. In lieu of cash payment,
Aklan gave Antique a 3-year, P600,000, 3% note payable. Principal is due on December 31,
2018 but interest is due annually every December 31. The prevailing interest rate for this
type of note is 10%.

Required: Compute for the carrying amount of the note payable on December 31, 2016.

SOLUTION:
In the given data, no information is available to measure the note‘s fair value. Thus, the
note shall be measured at discounted or present value.

The note bears an interest of 3% which is significantly different with market rate of 10%.
With this, the note shall be initially recognized on January 1, 2016 at present value of
principal and interest payments.

Present value of Principal (P600,000 x 0.7513) P450,780

PV of interest payments (P600,000 x 3% x 2.4869) 44,764_
Present value of the notes payable P495,544_

Subsequently, it will be measured at amortized cost. The following table shows the
amortization of the note.

Amortization table:
Interest Interest Discount Present
Date Payment expense Amortization value
01/01/2016 P495,544
12/31/2016 18,000 49,554 31,554 527,099
12/31/2017 18,000 52,710 34,710 561,809
12/31/2018 18,000 56,191 38,191 P600,000

Carrying Amount, 12/31/2016 P 527,099

The carrying amount is to be presented in the noncurrent liability section of the

statement of financial position because the principal amount of the note is payable beyond
one year from the reporting date.

39
The succeeding present value on December 31, 2016 may be computed as follows: (PV, beg
x (100% + Effective rate x months outstanding/12) – payment or [(P495,544 x (1 + (10% x
12/12)) – P18,000] = P527,099

Pro-forma entries to record transactions in 2015

1. To record the issuance of the notes
Machinery P495,544
Discount on Notes Payable (600,000 – 495,544) 104,456
Notes Payable (@ face amount) P600,000

2. To record interest payment

Interest Expense P18,000
Cash P18,000

3. To record amortization of discount

Interest Expense P31,554
Discount on Notes Payable P31,554

Illustration: Issuance of Non-Interest Bearing Note with One-Time Payment of the

Principal
On January 1, 2016, Capiz Co. acquired a machine from Guimaras Co. In lieu of cash
payment, Capiz gave Guimaras a 3-year, P600,000 noninterest-bearing note payable due on
December 31, 2018. The prevailing rate of interest for this type of note is 10%.

Required: How much is the amount that should be recorded as a net liability on December
31, 2016?

SOLUTION:
Present value of prinicipal (P600,000 x 0.7513) P450,780

Amortization table:
Date Interest expense Present value
01/01/2016 P450,780
12/31/2016 45,078 495,858
12/31/2017 49,586 545,444
12/31/2018 54,556 P600,000
P495,858, carrying amount on 12/31/2016 to be presented in the noncurrent liability
section of the statement of financial position because the principal amount of the note is
payable beyond one year from the reporting date.

Illustration: Issuance of Non-Interest Bearing Notes with Uniform Payment of the

Principal
On January 1, 2016, Iloilo Co. acquired a machine from Negros Co. In lieu of cash payment,
Iloilo gave Negros a 3-year P600,000 noninterest-bearing note payable. Principal is due in
equal payments every December 31 beginning on December 31, 2016.

40
The prevailing rate of interest for this type of note is 10%.

Required: How much is the amount that should be recorded as a net liability on December
31, 2016?

SOLUTION:
Present value of principal (200,000 x 2.4869) 497,380

Amortization Table:
Annual Interest Discount Present
Date Payment expense Amortization value
01/01/2016 P497,380
12/31/2016 200,000 49,738 150,262 347,118
12/31/2017 200,000 34,712 165,288 181,830
12/31/2018 200,000 18,170 181,830 -

The amount to be reported on December 31, 2016 as net liability is P347,118. It is divided
into current and non-current liabilities in the statement of financial position as follows:

Total Current Noncurrent

Notes payable
Discount on NP
Carrying amount

Total Current Noncurrent

Notes payable P400,000 P200,000 P200,000
Discount on NP 52,882 34,712 18,170__
Carrying amount P347,118 P165,288 P181,830__

The gross current note payable of P200,000 is amount payable within one year from the
reporting date whereas the P200,000 noncurrent note payable is the amount payable
beyond one year from the reporting date.

Illustration: Noninterest-bearing Note – With Cash Price Equivalent

On January 1, 2016, Oriental Co. acquired inventory with a list price of P800,000 and a cash
price of P497,380 by issuing 3-year P600,000 noninterest-bearing note payable. Principal
is due in equal payments every December 31 beginning on December 31, 2016. The
effective rate of interest interpolated for the cash price is 10%.

Required: Determine the following:

1) The carrying amount of the note on initial recognition.
2) The carrying amount of the note for the year ended December 31, 2016.

SOLUTION:
Requirement 1:

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The carrying amount of the note on initial recognition is equal to the cash price of
P497,380.

Amortization Table:
Annual Interest Discount Present
Date Payment expense Amortization value
01/01/2016 P497,380
12/31/2016 200,000 49,738 150,262 347,118
12/31/2017 200,000 34,712 165,288 181,830
12/31/2018 200,000 18,170 181,830 -

Requirement 2:
Carrying Amount, 12/31/2016 P347,118

Notes:
When the principal
amount is payable Treatment
Lump sum The entire present value at the end of the
reporting period shall be presented as
noncurrent liability not unless that the
liability is payable within one year from the
reporting period in which case it shall be
presented as current liability
Periodically The present value shall be divided into
current and noncurrent liability not unless
that the liability is payable within one year
from the reporting period in which case it
shall be presented as current liability.

LOAN PAYABLE
Characteristics
Description Financial liabilities other than short-term trade payables on normal
credit terms. It is similar to notes payable except that this borrowing is
normally obtained from financial or lending institution.
Recognition When the entity becomes a party to the contract or when transfer of
resources transpired.
Presentation Presented in the liability section in the statement of financial position
and classified as to either current or non-current depending on the
expected settlement date.

Measurement

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1. Initial – loans payable shall be initially measured at fair value minus transaction
cost

Determination of Initial Measurement

Fair value XXX
Less: Transaction cost (e.g. origination fees) XXX
Initial carrying amount of loans payable XXX

2. Subsequent – liabilities are subsequently measured at amortized cost using the

effective interest method.

Illustration Loans Payable

On January 1, 2016 Occidental Co. borrowed 10%, ₱2,500,000 five-year loan from National
Bank. Interests are payable annually starting December 31, 2016. National charges 5%
non-refundable loan origination fee representing service fee.

Required: Determine the following:

1) Carrying amount of the loan payable on January 1, 2016
2) Carrying amount of the loan payable on December 31, 2016
3) Total interest expense for the year ended December 31, 2018

SOLUTION:

1) Carrying amount of the loans payable on January 1, 2016

The loan bears an annual interest of 10% which is presumed to approximate the market
rate. With this, the note shall be initially recognized on January 1, 2016 at face amount of
₱2,500,000 adjusted by transaction costs.
Face amount ₱2,500,000
Loan origination fees (5% x ₱2.5M) (125,000)
Initial carrying amount of loans payable ₱2,375,000

2) Carrying amount of the note payable on December 31, 2016

To amortize the loan, a new effective rate shall be computed through interpolation or trial
and error technique that will approximate the amount received from issuance of the loan.

In determine the rate to be used, let us use the bank concept that if effective rate is higher
than its nominal rate, the iten is issued at a discount. Considering the loan was issued at a
discount, we expect that its effective rate is higher than its nominal rate of 10%.

Initially, let us try 12%

43
Present value at 12%
PV of principal (₱2,500,000 x 0.5674) ₱1,418,500
PV of principal (₱2,500,000 x 10% x 3.6048) 901,200
Total ₱2,319,700

Since the present value at 12% is lower than the initial carrying amount, we expect a lower
effective interest rate. Note again that there is no premium or discount if the effective is the
same as the nominal rate so if we get the nominal rate of 10% as the effective rate, the
present value is equal to the face value.

After the second rate is computed, we can say that the effective rate for the loan is between
12% and 10% as the effective interest by using ratio and proportion as follows:

Gap Gap
Effective rate Present value Differences Percentage

10% ₱2,500,000
₱ 125,000
? ₱2,375,000 2%
₱ 55,300
12% ₱2,319,700 ____________
Total gap difference ₱ 180,300

Computation using the lower rate as a starting point:

( PVofX −PVofX )
X = Lower rate - [ ( HR−LR ) X
PVofLR−PVofHR ]
125 , 000
X = 10% + [( 12%−10 % ) X
180 , 300 ]
X = 11.39%

44
Computation using the higher rate as a strating point:

( PVofX−PVofHR)
X = Higher rate - [ ( HR−LR ) X
PVofLR−PVofHR ]
125 , 000
X = 12 % - [( 12%−10 % ) X
180 , 300 ]
X = 11.39%

Legend:
LR - Lower rate HR - Higher rate PV - Present value

Using the effective rate of 11.39% the following amortization table’s prepared:
Date Interest Interest Discount Carrying Value
Payment Expense Amortization

01/01/2016 ₱ 2,375,000
12/31/2016 250,000 270,432 20,432 2,395,432
12/31/2017 250,000 272,758 22,758 2,418,190
12/31/2018 250,000 275,350 25,350 2,443,540
12/31/2019 250,000 278,236 28,236 2,471,776
12/31/2020 250,000 278,224 28,224 ₱ 2,500,000
The difference is due to rounding off

Answer: ₱ 2,395,432 (see amortization table)

3) Total interest expense for the year ended December 31, 2018

Answer: ₱ 275,350 (see amortization table)

DEBT RESTRUCTURING

Debt restructing is a process that allows entitles facing cash for problems and financial
distress, to reduce and renegotiate its delinquent debts in order to improve or restore
liquidity and rehabilitate so that it can continue its operation. Debt restucting aims to
avoid default on existing debt, minimize unfavorable consequences of noncompliance with
debt agreements, or takes advantage of lower interest rate.

Debt restructing could either be a legal requirement or mutual agreement between a

financially troubled debtor and its creditors to reorganize its liabilities as a more feasible
alternative to foreclosure or liquidation.

45
Categories of Debt Restructing
Debt restructing may involve the following:
1) Debt forgiveness
2) Asset swap – payment through transfer of noncash asset
3) Equity swap – conversation of debt, wholly or partially, into equity.
4) Modification of terms (e.g. debt rescheduling, modification of interest or maturity value
or both; and exchange of debt instruments with substantially different terms)

Accounting for Costs Incurred

Any transaction costs incurred related to debt restruction may be treated as adjustment to
the amount recognized as gain (deducted from) or loss (added to) on extinguishment of
debt.

Accounting for debt restructing per category

A. Debt forgiveness
Liability may be extinguished thru forgivenesss of the debt by the creditor. The carrying
amount of liability forgiven is ismply recognized as gain on extinguishment of debt by the
debtor in profit or loss.

ILLUSTRATION: Debt Forgiveness

Negros Co. provided the following balances on December 31, 2016:

Note payable ₱ 1,000,000

Accrued interest payable 100,000

On December 31, 2016, the creditor forgave the accrued interest and 40% of the notes.

Required: provide the journal entry for 2016 in the books of Negros.

SOLUTION:
To record the forgiveness of debt
Note payable (40% x 1M) ₱400,000
Accrued interest payable 100,000
Gain on extinguishment of debt ₱500,000

B. Asset swap
In asset swap, the liability is extinguished by delivery of non-cash asset by the debtor. Gain
or loss on extinguishment of debt to be included in profit or loss for the period is
determined as follows:
Carrying amount of asset given XX
Less: Carrying amount of liabilty extinguished XX
Loss/(Gain) on extinguishment of Debt XX

ILLUSTRATION: Asset Swap

46
Siquijor, Inc. provide the following balances on December 31, 2016.

Note payable ₱ 1,600,000

Accrued Interest payable 200,000

On December 31, 2016, the entity transferred to the creditor land recorded at a cost of
₱ 2,500,000 .as of this date, the land has a fair value of ₱ 2,000,000.

Required: Determine the amount of gain or loss to be recorded in the company’s statement
of comprehensive income.

SOLUTION:
Carrying amount of land ₱ 1, 500,000
Less: Carrying amount of liabilities extinguished
Notes payable ₱ 1,600,000
Accrued interest payable 200,000 1,800,000
Gain on extinguishment of debt ₱ 300,000

To record the transaction

Note payable 1,600,000
Accrued Interest payable 1,500,000
Land 1,500,000
Gain on Extinguishment of debt 300,000

C. Equity Swap or Debt for Equity Swap

In equity swap, the liability is extinguished through issuance of own equity securities by
the debtor to the creditor .Under this category, gain or loss on extinguishment of debt is
determined as follows:
Initial measurement of shares capital issued XX
Less: Carrying amount of liability extinguished XX
Loss /(Gain) on extinguishment of Debt XX

Furthermore, any difference between the initial measurement and par value of share
capital issued shall be credited to share premium.

Initial measurement of share capital Issued (IFRIC 19)

When equity instrument issued to a creditor to extinguish all or part of a financial liability,
an entity shall measure them at (in order of priority)
1. Fair value of the equity instruments issued, unless that fair value cannot be reliably
measured.

47
2. Fair value of the financial liability extinguished.

Non-availability of Fair Value

In the absence of fair value that would be initially assigned to share capital issued, the
carrying amount of liability extinguished will be used.

Therefore, no gain or loss from extinguishment of debt will be recognized.

ILLUSTRATION: Equity Swap

Lapu-Lapu Corporation showed the following data on December 31, 2016:

Bonds payable ₱ 4,500,000

Accrued Interest payable 300,000

On December 31, 2016, the entity issued share capital with a total per value of ₱2,000,000.
Both share capital issued and bonds payable are quoted in an active market at ₱4,400,000
and ₱4,700,000, respectively.

Required: Determine the following:

1) Amount of gain or loss to be recorded in the company’s income statement.
2) Amount credited to share premium from the extinguishment of the liability?

SOLUTION:
1) Gain or loss on extinguishment of debt
Initial measurement of share capital issued ₱ 4,400,000
Less: Carrying amount of liabilities extinguished
Bonds payable ₱ 4,500,000
Accrued interest payable 300,000 4,800,000
Gain on extinguishment of debt ₱ (400,000)

2) Share premium arising from extinguishment of debt

Initial measurement of share capital issued ₱ 4,400,000
Less: Par value of share capital issued 2,000,000
Amount to be credited to share premium ₱ 2,400,000

To record the transaction

Bonds payable ₱ 4,400,000
Accrued interest payable 300,000
Ordinary shares ₱ 2,000,000
Shares premium 2,400,000

48
 Gain on extinguishment of debt 400,000

Important notes
An entity shall not apply these rules to transaction in situations where:
a. The creditor is also a direct or indirect shareholder and is acting in its capacity as a
direct or indirect existing shareholder.
b. The creditor and the entity are controlled by the same party or parties before and after
the transaction and the substance of the transaction includes an equity distribution by,
or contribution to, the entity.
c. Extinguishing the financial liability by issuing equity shares is in accordance with the
original terms of the financial liability.

D. Modification of terms
Modification of terms may involve one or combination of the following :
a. Debt rescheduling or modification of maturity date ;
b. Modification of interest or maturity value or both ; and
c. Exchange of debt instruments with substantially different terms.

For exchange of debt instruments with substantially different terms

The entity accounts the modification of terms or substantially different terms as n
extinguishment of the original financial liability and the recognition of a new financial
liability.

When to consider terms as substantially different (PFRS 9)

Debt instruments are considered “substantially different terms” if the resulting gain or loss
on extinguishment of debt is at least 10% of the carrying amount of old liability,
otherwise, the modication will just be treated as an adjustment of the original liability.

Gain or loss on extinguishment of debt

Gain or loss on extinguishment of debt is determined as follows:
*Present value of the modified terms XX
Less : carrying amount of liability extinguished XX
Loss/(Gain) on extinguishment of Debt XX
*Discounted using the original effective interest rate.

ILLUSTRATION : Modification of Terms

Mandaue Company has an overdue notes payable to national bank of ₱8,000,000 and
recorded accrued interest of ₱840,000 , based on 12 % interest rate.

49
As a result of a settlement on December 31, 2015, National Bank agreed to the following
restructuring arrangement:
 Reduced the principal obligation to ₱7,000,000.
 Forgive the ₱840,000 accrued interest.
 Extended the maturity date to December 31, 2017.
 Annual interest of 10% is to be paid on December 31, 2016 and 2017.

Required: Determine the amount gain or loss to be recorded in the company’s income
statement (round off present value factor into four decimal places).

SOLUTION :
Fair value of new liability :
PV of principal (7,000,000 x 0.7972) ₱ 5,580,400
PV of interest (7,000,000 x 10% x 1.6901) 1,183,070 P 6,763,470
Less: Carrying amount of liabilities extinguished:
Notes payable ₱ 8,000,000
Accrued interest payable 840,000 8,840,000
Gain on extinguishment of debt ₱2,076,530

*Note: The old interest rate of 12 % was used to determine the present value factors.

Computation of the percentage of gain or loss over carrying amount of the old liability

Percentage = P 2,076,530
8,840,000
Percentage = 23.49%

Since the gain is more than 10% the debts instrument is considered ‘substantially different
terms’. Any gain or loss therefore is recognized immediately.

To record the transaction:

Notes payable (old) ₱ 8,000,000
Accrued interest payable 840,000
Discount on noted payable 236,530
Notes payable (new) ₱ 7,000,000
Gain on extinguishment of debt 2,076,530

Summary of classification, measurement (initial and subsequent) and derecognition

of different categories of financial liabilities
Classification of Financial liabilities at fair Other finantial liabilities
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 Financial value through profit or loss measured at amortized cost
Liabilities (FVTPL)
Description Like the equivalent classification If financial liabilities are not
for financial assets, this will measured at FVTPL they are
include financial liabilities measured at amortized cost.
incurred for trading purposes
and also derivatives that are not
part of a hedging arrangement.
Initial recognition Financial liabilities are recognized on the statement of financial
position whrn the entity becomes party to the contractual provisions
of the instrument.
Initial Fair value excluding transaction Fair value including (i.e. minus)
measurement cost transaction cost

Subsequent Fair Value Amortized cost using effective

measurement interest method

Interest expense Based on nominal or stated rate Based on effective interest rate
(if any )

Remeasurement Held for trading –profit or loss N/A

gain or loss Designated as FVTPL
i. The amount of change in the
fair value that is attributable
to changes in the credit risk
of the credit risk of the
liability – Other
comprehensive income
(OCI)
ii. The remaining amount of
change in the fair value of the
liability – profit or loss

If it would create or enlarge an

accounting mismatch in profit or
loss, present all unrealized gains
or losses on that liability
(including the effects of changes
in the credit risk of that liability)
in profit or loss.
Derecognition When discharged, cancelled, expires or substantial modification of
terms
Derecognition Consideration paid less carrying value – gain or loss on
gain or loss derecognition to P&L

51