Topic 1: Accounting for Financial Liabilities (MFRS 139

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Objectives
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To describe long-term liabilities and describe how they are valued To identify the nature and types of long-term liabilities-bond

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To explain the methods of bond discount and premium amortization
To prepare the related journal entries

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To describe the accounting treatment for other long term liabilities
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Long-Term Liabilities
• Consists of present obligations not payable within the operating cycle of the business, or a year whichever is longer. • Long-term creditors have no vote in management affairs and only receive a stated rate of interest regardless of the level of earnings. • Covenants or restrictions, for the protection of both lenders and borrowers, are stated in the bond indenture or note agreement • Example: Bond payable, Long-term notes payable, Long-term loans, mortgages payable
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FINANCIAL LIABILITY MFRS 132 defined as any liability that is: (a) a contractual obligation: i. or 4 . to deliver cash or other financial asset to another entity. or ii. to exchange financial assets or financial liabilities with another entity under conditions that are potentially unfavourable to the entity.

or 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 entity’s own equity instrument. ii. a non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own instrument.FINANCIAL LIABILITY FINANCIAL LIABILITY (b) a contract that will or may be settled in the entity’s own equity instruments and is: i. 5 .

▫ convertible bonds & commodity-backed bonds. ▫ secured and unsecured bonds. Stice & Stice. 2005. 2010(p696)) 6 . serial bonds. ▫ registered and coupon bonds. Represents a promise to pay the principle(face value) at maturity and periodic interest based on the stated interest rate and the face value of the bond • the different types of bonds such as: ▫ term bonds.Bonds Payable • Arises from a contract known as a bond indenture. ▫ Callable bond ▫ deep discount bonds ▫ Junk bonds (Keiso&Weygandt.

Represents a promise to pay: (1) sum of money at designated maturity date.000 face value. Purpose is to borrow when the amount of capital needed is too large for one lender to supply. plus (2) periodic interest at a specified rate on the maturity amount (face value). Paper certificate.Bonds Payable Bond contract known as a bond indenture. Interest payments usually made semiannually. typically a RM1. 7 .

Bond Conventional 1) 2) 3) 4) Cagamas MBS Berhad Petronas Capital Limited AmBank (M) Berhad Asian Development Bank 8 .Bursa Malaysia.

Paka Capital Ltd Khazanah Nasional Berhad 9 . GE Capital Sukuk Ltd. 2. Cagamas MBS Berhad Petronas Global Sukuk Ltd. 7.Bursa Malaysia: Islamic Bond . 8. 5. 4.Sukuk 1. 3. 6. CIMB Islamic Bank Berhad Rafflesia Capital Limited Cherating Capital Ltd.

Dr.Accounting for the Issuance of Bonds 1. The face value of the bond is always reflected in the Bond Payable account. Cash Cr. Bond Payable (issue at par) xx xx 10 .

Bond Payable 11 .Accounting for the Issuance of Bonds (cont.  This is a contra-account to Bonds Payable. xx xx xx Dr. When a bond sells at a discount. Discount on Bond Cr. the difference between the sales price and the face value is debited to Discount on Bonds Payable.) 2. Cash Dr.

the difference between the sales price and the face value is credited to Premium on Bonds Payable. When a bond sells at a premium. ▫ This is an adjunct account to Bonds Payable. Bond Payable xx xx Cr.) 3. Cash Cr.Accounting for the Issuance of Bonds (cont. Dr. Premium on Bond xx 12 .

Bonds sold between interest dates: i.Accounting for the Issuance of Bonds (cont. The accrued interest is credited to Bond Interest Expense.) 4. The price includes the interest accrued since the last interest payment. 13 . ii.

Example 1: Bonds Payable CINB Bhd issued RM200. Compute the issue price at (as a percentage of face value): a) 100 b) 97 c) 105 Prepare journal entries for CINB Bhd. with interest payable each 1 July and 1 Jan. 14 . The bonds are due on 1 Jan 2015.000 of 8% bonds on 1 Jan 2010.

Solution (‘000): at 100 (at par) at 97 (at discount) at 105 (at premium) Dt Cash Kt Bonds Payable 200 200 Dt Cash 194 Dt Disc. bonds 6 Kt Bonds Payable 200 Dt Cash 210 Kt Bonds Payable 200 Kt Premium Bonds 10 15 .

000 of 9% bonds.  16 . Compute the issue price of the bonds. At the time of issue. with interest payable semiannually.Issuance of Bonds- Price of bond is based on present value of bond  Occur when rate employed by buyer is differs from stated rate. Example 2: RHD Bhd issues RM300. due in 10 years. the market rate for such bonds is 10%.

sell at a premium. c) the stated rate > the market rate. sell at a discount.Valuation of Bonds Payable • A bond's price is equal to the sum of the present value of the principle and the present value of the periodic interest. sell at par. If a) the stated rate = the market rate. b) the stated rate < the market rate. • The price of a bond is determined by the interaction between the bond's stated interest rate and its market rate. • Term: • Stated rate = contract rate • Market rate = yield/effective interest rate 17 .

Valuation of Bonds Interest Rates Stated. 18 . Market rate or effective yield = rate that provides an acceptable return on an investment commensurate with the issuer’s risk characteristics. coupon. Rate of interest actually earned by the bondholders. or nominal rate = The interest rate written in the terms of the bond indenture.

000 x PVn=20.307 19 .240 281.Solution for Example 2: n = 10 x 2 i = 10%/2 113.500 x Price of bond 12.37689) PVOA of interest payable: [(9% x 300.067 PV of the principal: 300. i=5% 13.000)/2] x PVAn=20.46221 168. i=5% (0.

Straight-line method ◦ may be used if the results are not materially different from those produced by the effective interest method. Effective interest method ◦ is the preferred procedure used to calculate periodic interest expense. . 20 2. The carrying amount of the bonds at the start of the period is multiplied by the effective interest rate to determine the interest expense.Amortization of bond discounts and premiums Two methods: 1.

or = Face Value .Discount  Interest Payable = Stated Rate x Face Value of Bonds  Interest Expense= Effective Rate x Carrying Value of Bonds  If a premium exists: Dr Interest Expense XX Dr Premium on Bonds Payable XX Cr Interest Payable XX   If a discount exists: Dr Interest Expense XX Cr Discount on Bonds Payable Cr Interest Payable XX XX 21 .Effective interest method Carrying Value of Bonds = Face Value + Premium .

at 102. Interest is payable semiannually on 1 July and 1 Jan. Prepare the journal entries to record: a)The issuance of the bonds b)The payment of interest on 1 July c)The accrual of interest on 31 Dec 22 . 20-year bonds on 1 Jan 2012.Example 3: Amortization of Bond Premium BIMD Bhd issued RM600. BIMD Bhd uses straight-line method of amortization for bond premium/discount.000 of 10%.

Solution for Example 3 a) Issuance of bonds Dr Cash (600.02) Cr Bonds Payable Cr Premium on bond b) 612.700 300 Payment of interest on July 1 Dr Interest expense Dr Premium on Bond Cr Cash 30.000 12.000 29.000 600.000 23 .000 x 1.

000 24 . Interest payable 29.Solution for Example 3 (cont.700 300 30.) c) Accrual interest on 31 Dec Dr Interest expense Dr Premium on Bond Cr.

20-year bonds on 1 Jan 2012. Interest is payable semiannually on 1 July and 1 Jan.5% Prepare the journal entries to record: a)The issuance of the bonds b)The payment of interest on 1 July c)The accrual of interest on 31 Dec 25 .Example 4: Amortization of Discount Bonds PMB Bhd issued RM600. PMB Bhd uses effective interest method of amortization for bond premium/discount.000 of 10%. Assume an effective rate yield of 11.

n=20x2 PV 600.000 26 .10685 PVOA 30.100 69.5330 Price on 1 Jan Dr Cash Dr Discount on bond Cr Bonds payable = 64.110 = 465.990 = 530.100 530.5/2.900 600.000 x 15.Solution for Example 4 a) Issuance of bonds i=11.000 x 0.

000 30538 538 531.581 27 .100 530.627 a: 11.089 1/7/12 1/1/13 30.481a 30.Solution for Example 4 (cont.000 1/7/13 30.000 30.481 – 30. 30.100 + 481 = 530.) Cash Interest exp.000 = 481 c: 530.100 x 6/12 = 30.508 Amort.581c 531.481 b: 30. Disc 481b 508 Balance of Bonds 530.5% x 530.

000 28 .) b) Interest expense on 1 July 2012 Dr Interest expense Cr.481 481 30. Interest payable 30.Solution for Example 4 (cont. Cash 30. Discount on Bond Cr.508 508 30.000 c) Interest expense on 31 December 2012 Dr Interest expense Cr Discount on Bond Cr.

administrative expense (printing doc/prospectus).   These costs do NOT represent an asset Methods of recognition: 1) As an expense – charge to income statement immediately 2) Capitalized & amortized – debited to a deferred charge account & amortize over bond period 29 . underwriting fees.Cost of Bonds Issue  The issue of bonds involve numerous costs: ◦ Legal and accounting expense.

Costs of issuing the bond.000. totaled RM1.Example 5: Cost of Bond Issue Assume that Cyber Bhd issued a RM40. The costs were capitalized as a deferred charge and amortized on the straight line method. Show the entries to (a) record the issue of bond on 1 Jan 2012 (b) recognize the amortization of the bond issue cost and interest expense 30 .000. The bond carries a coupon interest of 10% and interest is payable on 31 Dec each year.000 five-year bond at its par value on 1 January 2012. which included underwriting fees.000.

000.000.000 Dt Deferred bond issue cost 1.000.000 to recognize interest expense Dt Interest expense Kt Cash 4.000 Kt Bonds Payable 40.000 31 .000 b) 31/12/12 : to recognize amortization of deferred charge Dt Amortization expense 200.000 4.000.Solution for Example 5 a) 1/1/12: to record the issuance of the bond Dt Cash 39.000 Kt Deferred bond issue cost 200.000.

Bonds Issued between Interest Dates  When bonds are issued between interest dates. 32    . Cash paid by buyer is the price of the bonds together with the accrued interest. the purchase price is increased by an amount equal to the interest earned on the bonds since the last interest payment date. Price of bonds is the present value of the bond at the date of issue. Buyers will pay the seller the interest accrued from the last interest payment date to the date of issue.

 33 . the amount of interest expense to the issuing corporation is the difference between the interest payment and the amount of interest prepaid by the purchaser. However. the bondholder will receives the entire interest payment.Bonds Issued between Interest Dates  On the next interest payment date.

2014 Date of selling the bond Date of interest payment Stated interest rate Face value of bond Sept 1.000 Prepare journal entries on 1 Sept and 31 Dec 34 .Example 6 Cumi Bhd purchased bond from Ciki Bhd. Date of bond Maturity date June 30. 2009 Dec 31 and June 30 9% RM200. The following is the information on the bond. 2009 June 30.

000 35 (-) Cash paid for interest from 30/6 – 1/9 [200.000] Present Value on 30 June 2009 (+) Increment of bond’s value from 30/6 – 1/9 [200.000 203.91272 x 9.000 = 7.000 3.000 x 9% x 2/12] PRICE OF BOND AT 1/9/2009 .Solution for Example 6 Issued at par: Effective interest rate = 9% Price of bond at 30/6/2009: Face value [PV4.000] Interest [PVOA4. 10 200. 10 9.214 200.000 = 0.5%.000) 200.64393 x 200.786 71.000 x 9% x 2/12] 128.5%.000 (3.

200.0001 9.Solution for Example 6 (cont.0001 3.000 36 .000 3.000 (interest) 2.000 x 9% x 2/12 Dec.000 + 3. 200.0002 200.000 6.000 x 9% x 4/12 1. 31 Dr Interest Payable Interest Expense Cr Cash 1.) Journal entries Sept 1 Dr Cash Cr Interest Payable Bonds Payable 200. 203.

5%.Solution for Example 6 (cont.58543 x 200. 10 200.315 37 .390 188.925 3.315 (3.000) 185.086 67.000 x 9% x 2/12] PRICE OF BOND at 1/9/2009 117.000 = 0.000 = 7.925 x 11% x 2/12] (-) Cash paid for interest from 30/6 – 1/9 [200. 10 9.53763 x 9.000] Present Value (+) Increment of bond’s value from 30/6 – 1/9 [184.5%.000] Interest [PVOA5.839 184.) Issued at discount: Effective interest rate = 11% Price of bond at 30/6/2009: Face value [PV5.

000 185. 2.315 200.Solution for Example 6 (cont.000 x 9% x 2/12 38 . 3.) Journal entries Sept 1 Dr Cash Disc on Bond Cr Interest Payable Bonds Payable 1.000 (interest) 200.6852 3.0003 200.315 + 3.000 – 185. 188.3151 14.

235 184.171 1.171 10.096 187.235 1.000 10.925 186.) Amortisation of discount schedule Date Cash Interest Paid Expense Amortisation Carrying of discount amount of bond 30/6/09 31/12/09 30/6/10 9.Solution for Example 6 (cont.331 39 .000 9.

Solution for Example 6 (cont. 31 Dr Interest Expense Interest Payable Cr Disc on Bonds Cash 1.000 10.171 x 4/6 40 . 6.171 x 4/6 1.7811 3. 2.) Journal entries Dec.000 7812 9.

Convertible Bond 3. Refunding 2. Callable Bond At the maturity date  If bond is retired at the maturity date. no profit or loss is recorded Carrying Amount of Bond = Face Value of Bond  Journal entry for payment made at the maturity date: Dr Bonds Payable XX Interest expense XX Cr Cash XX Discounts on Bonds Payable XX 41 .RETIREMENT OF BONDS Before the maturity date  Examples of bonds retirement: 1.

 42 . all records on bonds and any related records to the old bond will be eliminated. Interest expense and amortisation of discount/premium needs to be recorded in advance until the retirement date.  At the retirement.Refunding  Bond is retired by issuing new bond.

Example 7 On January 1. 2012. 10-year bond at par and with stated interest rate of 5% paid every 30/6 and 31/12. the buyer agreed to receive bond of RM90. 43 . 2008. Prepare journal entries for issuance of bond and refunding. Wira Bhd issued RM100.000. On January 1. Market interest rate is 8%. with stated interest rate of 8% paid at the same dates.000. 20-year.

000 Cr Gains from retirement 10.Solution for Example 7  At the issuance of the bond: 1/1/08 Dr Cash 100.000 Cr Bonds Payable 100.000 (at par) 1/1/12 Dr Bonds Payable.5% 100.000 44 .8% 90.000 Cr Bonds Payable.000  At refunding Value of new issuance of bond = RM90.

• At the callable date.Callable Bonds • Normally the bond is repaid at the maturity date. the company should record all interest expense and amortise the discount/premium until that date. Thus. 45 . • CAN be repaid at any time if it is called up. all record of the bonds and any related to it will be eliminated. • When the bond is callable. • Normally the bond is callable when the market interest increase due to lower callable price. it is retired.

Bond issue cost totalling RM16.000 at 97.Example 9 On 1 January 2004. 46 . the entire issue is called at 101 and canceled. Discount on bond payable and bond issue cost are amortized using straight-line basis. due in 20 years.000 were incurred. Eight years after the issuance. Beztax Bhd issued bonds with a par value of RM800.

000 47 .Solution for Example 9 Reacquisition price (RM800.400) Unamortized issue cost 16.000 32.000 Unamortized discount 24.000 x 12/20 (14.01) 808.000 x 1.000 Net carrying amount of bonds redeemed: Face value 800.000 x 12/20 (9.600) Loss on redemption 776.

000 14.000 48 .600 808.400 Deferred bond issue cost Cash 9.000 32.Solution for Example 9 Journal entry: Bond Payable Loss on redemption Discount on Bond 800.

Compound Financial Instruments

Hybrid Securities:
◦ Securities or financial instruments that have characteristic of both debt and equity. ◦ They often combine traditional and derivative financial instruments

Hybrid instruments consist of two parts:
◦ A debt security referred to a (host security) ◦ An option to convert to shares of ordinary shares (embedded derivative)

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Compound Financial Instruments
Compound Financial Instruments

Are classified by the issuer according to substance of contractual arrangement and the definition of a financial liability and an equity instrument. Their components are classified separately as financial liabilities, financial assets or equity instruments. Example: Covertible bond payable

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Convertible Bonds
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Bonds can be converted into shares Reasons for conversion: ◦ to increase the equity capital without giving up more ownership control. ◦ to make the bond marketable Purchased by investors who desire the security of a bond holding-guaranteed interest-plus the added option of conversion if the value of the shares appreciates significantly.
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such an instrument comprises two components: • a financial liability (a contractual arrangement to deliver cash or another financial asset) and • an equity instrument (a call option granting the holder the right. • From the perspective of the entity. for a specified period of time. require separate recognition of the equity and liability component • A bond or similar instrument convertible by the holder into a fixed number of ordinary shares of the entity is a compound financial instrument. to convert it into 52 a fixed number of ordinary shares of the entity .Convertible Bonds • Entries for issuing of the bonds –MFRS 132 para 29.

000). Par value of Tania Bhd share is RM1.000 shares of Tania Bhd at any time after 2 years of bond issued. Half of the discount/premium has been amortised at the exchange date. Every RM1. The is expected to be sold at the rate of 96 if there is no conversion privilege. Record the journal entries: a) On issuance date b) Exchange date 53 .Example 8: Converted Bonds Tania Bhd sold RM500. All bonds are exchanged to shares.000 bond can be exchanged to 1.000 bonds. 8% at 105 (RM525.

000) Discount on bonds payable Price of bond with conversion privilege: Cash received from the sale of bonds Selling price without conversion Total can be used for conversion 525.000 .000 480.Solution for Example 8 At issuance date: Price of bonds without conversion privilege Face value of bond Selling price of bond without conversion privilege (0.000 .96 x 500. 20.000 (480.000 54 500.000) 45.

Solution for Example 8 At issuance date: Journal entry: Dr Cash 525.000 Cr Bonds payable 500.000 Premium on shares 45.000 Discounts on bonds payable 20.000 55 .

000) 500.000 56 .000 Sharee premium 10.000 Cr Discounts on bonds payable 10.000 Ordinary shares (RM1x500.Solution for Example 8 At exchange date: Dr Bonds payable 500.

Redeemable preference shares  Issued with the condition that the company can buy back the shares at a specified date in the future The terms of redemption will be stated in the Articles of Association If it provide a mandatory redemption or where the option of redemption is exercisable by the shareholders SHOULD be classified as a financial liability.   57 .

The present value of the redemption value is a liability.  58 . the unwinding of the interest is expense. dividends paid relate to the equity are recognised as distribution of equity.Redeemable Preference Share with Discretionary Dividends  Redeemable preference share on which dividends are non-cumulative and at the discretion of the issuer are compound instruments.

Other Instrument for Long Term Liabilities 1. Warrants (Transferable Subscription Rights) • Gives the holder right to subscribe specific number of shares at the pre-determine exercise price and within a specified period of time . Convertible Bonds (CULS) • Debt securities that are exchangeable into ordinary shares at the option of the holder and under specified terms and conditions 2.

Irredeemable Convertible Loan Stocks (ICULS) ◦ Quasi-debt – pay annual coupon over their tenure but ‘irredeemable’ in future. means there will be no repayment of principle at maturity ◦ Mandatory converted ◦ Faced value of ICULS will be converted into new ordinary shares based on stipulated conversion ratio .Other Instrument for Long Term Liabilities (cont.) 3.

00 per ICULS.00.Exercise: ICULS On 1 Jan 2008. par)  Prepare journal entries at issuance and conversion? . The five-year ICULS paid 7. This ICULS can be converted into ordinary shares based on conversion ratio of RM5 ICULS for one new shares (RM1.5% coupon per year. DRG Bhd issues RM1 million ICULS 2008/2012 value at RM1.

Solution: At Issuance DR Cash CR ICULS 1.000 5 = 200.000.000.000 1.000 units shares DR ICULS 1.000.000 .000 At Conversion (maturity date) RM1 million ICULS = # shares? New shares = 1.000.000 CR Premium on shares 800.000 CR Ordinary shares 200.

losses and gains depend on whether the items are related to liability or equity. If they relate to liability.Treatment of interest. losses and gains  The accounting treatment and presentation of interest. they should be recorded directly to the statement of changes in equity. they should be reported in the income statement as expense or income such interest on bonds If they relate to equity instrument.   BKAF3063 Financial Accounting & Reporting 3 63 . dividends. dividends.

◦ Premiums and discounts on liability are charged in the income statement. ◦ Dividend on redeemable preference shares is an expenses to be disclosed in the income statement. losses and gains  Charges to Income Statement: ◦ Interest on borrowing ◦ Gains or losses associated with redemption or refinancing of liability are expenses in the income statement.Treatment of interest. dividends. BKAF3063 Financial Accounting & Reporting 3 64 .

BKAF3063 Financial Accounting & Reporting 3 65 . ◦ Transaction cost on equity transactions such as registratin and professional fees. losses and gains  Changes in equity: ◦ Dividends on equity shares are disclosed in the statement of changes in equity.Treatment of interest. dividends. stamp duties and printing costs on the issue or share buy back are deducted from equity.

Disclosure of Financial Instruments  Purpose: ◦ To enhance understanding of the significance of financial instrument to the entity’s financial position. performance and cash flows. timing and certainty of future cash flows associated with those instruments ◦ Provide information to the extent of risk related to financial instrument BKAF3063 Financial Accounting & Reporting 3 66 . ◦ To assist in assessing the amounts.

. and f) financial liabilities measured at amortised cost.Disclosure of Financial Liabilities Statement of Financial Position  Categories of financial liabilities (para 8) ◦ The carrying amounts shall be disclosed either on the face of the balance sheet or in the notes: e)financial liabilities at fair value through profit or loss. showing separately (i) those designated as such upon initial recognition and (ii) those classified as held for trading in accordance with MFRS 139.

in the fair value of the financial liability that is attributable to changes in the credit risk of that liability (b) the difference between the financial liability's carrying amount and the amount the entity would be contractually required to pay at maturity to the holder of the obligation. .Disclosure of Financial Liabilities Statement of Financial Position  Financial liabilities at fair value through profit or loss (para 10) (a) the amount of change. during the period and cumulatively.

Disclosure of Financial Liabilties Statement of Comprehensive Income An entity shall disclose the following items of income. showing separately those on financial assets or financial liabilities designated as such upon initial recognition. . expense. gains or losses either on the face of the financial statements or in the notes: (para 20) (a) net gains or net losses on: (i) financial assets or financial liabilities at fair value through profit or loss. (v) financial liabilities measured at amortised cost. and those on financial assets or financial liabilities that are classified as held for trading in accordance with MFRS 139.

): (b) total interest income and total interest expense (calculated using the effective interest method) for financial assets or financial liabilities that are not at fair value through profit or loss. fee income and expense (other than amounts included in determining the effective interest rate) arising from: (c) (i) financial assets or financial liabilities that are not at fair value through profit or loss. and ..Disclosure of Financial Liabilities Para 20 (cont.

END OF TOPIC 1 71 .

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