JPIA-HAU

FINANCIAL ACCOUNTING
Debt Restructuring and Lease Accounting Fair Value 1,100,000
Carrying amount 600,000
Overview of the Handouts: Gain on exchange 500,000
1. Debt Restructuring – theories; sample
problem Note Payable 1,000,000
2. Lease Accounting – accounting for lessee; Accrued Interest Payabe 200,000
accounting for lessor; sample problem Carrying amount of Liab 1,200,000
Less: Fair value of patent 1,100,000
DEBT RESTRUCTURING Gain on debt restructuring 100,000
- is a situation where the creditor grants the debtor
concession that would otherwise be granted in a b. Equity Swap
normal business relationship. - Transaction whereby debtor and creditor
- its main objective is to make the best of a bad renegotiate terms of financial liability with the
situation or maximize recovery of investment result of fully or partially extinguishing the
liability by debtor issuing equity instruments to
Types of Debt Restructuring creditor
a. Asset Swap
b. Equity Swap Initial Measurement of Equity Instrument
c. Modification of Terms - at fair value of equity instruments issued
- If fair value cannot not be reliably measured,
a. Asset Swap liability will be measured in the order of priority:
- transfer by debtor to creditor of any asset in a. Fair value of equity instrument issued
full payment of an obligation b. Fair value of liability extinguished
- the difference between Carrying amount and c. Carrying amount of liability extinguished
consideration given shall be recognized in profit
or loss SAMPLE PROBLEM
The Leaky Cauldron showed the following
Dacion en pago Accounting - accounted for as an data with respect to a mature obligation:
asset swap form of debt restructuring; Loss or gain Mortgage Payable 4,000,000
on extinguishment is recognized for the difference Accrued Interest Payable 300,000
between carrying amount and balance of obligation The entity is threatened with a court suit if it
could not pay its maturing death. Accordingly, the
Dacion en pago - arises when mortgaged property entity entered into an agreement with the creditor
is offered by the debtor in full settlement of debt for the issuance of share capital in full settlement of
the mortgage.
SAMPLE PROBLEM The agreement provided for the issue of
Weasley’s Wizard and Wheezes showed 35,000 shares with par value of P100. The share is
the following balances on December 31, 2020 currently quoted at P130. Fair value of liability is
Note Payable- due Dec. 31,2020 1,000,000 P4500,000.
Accrued Interest Payable 200,000
Prepare journal entries if
The entity is in financial distress and 1. Fair Value for share capital is used for
negotiates with the creditor for the settlement of the Equity swap
note. 2. Fair Value of liability is used for equity swap
Consequently, the entity transferred patent 3. If carrying amount of liability is used for
to the creditor in full satisfaction of the note equity swap
payable.
The patent has carrying amount of Solution
P600,000 and a fair value of P1,100,000. 1.Mortgage Payable 4,000,000
Prepare journal entry to record asset swap on Accrued Interest Payable 300,000
the books of Weasley’s Wizard and Wheezes. Loss on Extinguishment 250,000
1. Under IFRS Share Capital 3,500,000
2. Under GAAP Share Premium 1,050,000
Solution: 2.Mortgage Payable 4,000,000
1.Note Payable 1,000,000 Accrued Interest Payable 300,000
Accrued Interest Payabe 200,000 Loss on Extinguishment 20,000
Patent 600,000 Share Capital 3,500,000
Gain on Extinguishment 600,000 Share Premium 1,000,000
2.Note Payable 1,000,000 3.Mortgage Payable 4,000,000
Accrued Interest Payabe 200,000 Accrued Interest Payable 300,000
Patent 600,000 Share Capital 3,500,000
Gain on Exchange 500,000 Share Premium 3,000,000
Gain on Extinguishment 100,000

Financial Accounting 2 – Debt Restructuring and Lease Accounting


c. Modification of Terms
- Modification may involve either the interest,
maturity value or both
- Substantial modification of terms (gain or loss
is at least 10% of old liability) shall be
accounted for as an extinguishment of old
financial liability and recognition of a new
financial liability
Interest concession - may involve a reduction of
interest rate, forgiveness of unpaid interest or
moratorium on interest
JPIA-HAU
LEASE ACCOUNTING
Lease- defined as a contract or part of a
contract that conveys the right to use the
underlying asset for a period of time in
exchange for consideration.
Lessee- entity that obtains the right to use an
underlying asset
Lessor- entity that provides the right to use an
underlying asset

Maturity Value - may involve extension of maturity Finance Lease- a lease that transfers substantially
date or reduction of principal amount all of the risks and rewards incidental to ownership
of an underlying asset
Gain or loss on extinguishment – the difference
between the carrying amount of the old liability and Operating Lease- a lease that allows the use of an
the present value of the new or restructured liability underlying asset but does not convey the
ownership rights of the asset.
SAMPLE PROBLEM
Flourish and Botts had an overdue 8% note Lease term- the non-cancelable period for which
payable to Gringotts bank at P8,000,000 with the lessee has the right to use the underlying asset
accrued interest of P640,000. As a result of a
settlement on January 1, 2020, Gringotts bank “Right to Control Asset” there is a right to:
agreed to the following restructuring arrangement: 1. Obtain substantially all of the economic
1. Reduced the principal obligation to P7,000,000 benefits from use of the identified asset
2. Forgave the P640,000 accrued interest 2. Direct use of the identified asset
3. Extended the maturity date to December 31,
2021 LESSEE ACCOUNTING
4. Annual interest of 10% is to be paid on - At commencement date, a lessee shall
December 31,2020 and 2021 recognize a right of use asset and a lease
Prepare journal entries for 2020 and 2021 to liability
record modification of terms.
A. Operating Lease
Solution: - Under the new standards, all leases shall be
PV of principal (7Mx .8573) 6,001,100 accounted for by the lessee as a finance lease.
PV Interest (700k x1.7833) 1248,310 However, the company may elect for operating
PV of new Liability 7249,410 lease under two optional exemptions:
1. Short term lease- lease that has a term
Note payable 8,000,000 of 12 months or less
Accrued interest 640,000 [NOTE: A lease that contains a
CA of liability 8,640,000 purchase option is NOT a short-term
PV of new liability 7,249,410 lease.]
Gain on Extinguishment 1,390,590 2. Low value lease- no quantitative
threshold in the new lease standard.
2020 Professional judgement may be used.
01/01 N/P- old 8,000,000 (example: personal computers, office
Accrued Interest Payabe640,000 furniture)
N/P-new 7,000,000
Premium on N/P 249,410 B. Finance Lease
Gain on extinguishment 1,390,590 - lessee shall recognize a right of use asset and
lease liability
12/31 Interest Expense 700,000 - a lease that transfers substantially all of the
Cash 700,000 risks and rewards incidental to ownership of an
underlying asset
Premium on N/P 120,047
Interest Expense 120,047 Right of Use Asset- represents the right of a lease
(700 000 – 579 953) to use an underlying asset
2021
12/31 Interest Expense 700,000 Initial Measurement of Right of Use Asset
Cash 700,000 - must be measured at cost, which includes the
following:
Premium on N/P 129,363
a. Present value of lease payments
Interest Expense 129,363
b. Lease payments to lessor such as lease
Note payable 7,000,000 bonus, less any lease incentives received
Cash 7,000,000 c. Initial direct cost

Financial Accounting 2 – Debt Restructuring and Lease Accounting


d. Estimated dismantling cost when there is
a present obligation
Subsequent Measurement of Right of Use Asset
-IFRS 16, paragraph 29 provides that a lessee
shall measure the right of use asset using a cost
model (cost less accumulated depreciation and
impairment loss)
Other Measurement Models
a. Fair Value Model - is used if lessee
measures investment property at fair value
b. Revaluation Model - is used to assets that
relates to that class of Property, Plant and
Equipment
Depreciation of Right of Use Asset
- Lessee shall apply normal depreciation for right of
use asset over whichever is lower of:
Useful life of asset- if:
a. there is transfer of ownership and
b. reasonably certain to exercise purchase
option; or Useful life of lease term
Measurement of Lease Liability
- measured at present value of the lease payments
- lease payments are discounted using:
a. implicit interest rate, or
b. incremental borrowing rate of the
lessee
Components of Lease Payment
a. Fixed payments – payments made by the
lessee to the lessor for the right to use an
underlying asset during the lease term
b. Variable payments – payments made by
the lessee during the lease term that may
vary because of circumstances occurring
after the commencement date
c. Exercise Price of a purchase option if the
lessee is reasonably certain to exercise
the option
d. Ammount expected to be payable by the
lessee under a residual value guarantee
e. Termination penalties if the lease term
reflects the exercise of a termination option
Guaranteed Residual Value - included in
computing cost of right of use asset and lease
liability (Present Value)
Unguaranteed Residual Value - not included in
computing cost of right of use asset and lease
liability; also ignored in computing depreciable
amount
Executory cost - expensed immediately
LESSOR ACCOUNTING
- Lessor shall classify leases as either operating
or finance lease depending on the substance of
the transaction
A. Operating Lease
- does not transfer substantially all the risks and
rewards incidental to ownership of an
underlying asset
Financial Accounting 2 – Debt Restructuring and Lease Accounting
JPIA-HAU
- periodic rental is simply recognized as
rent income
Initial Direct Cost – if incurred by lessor added
to the carrying amount of underlying asset and
expensed over lease term
Security Deposit - refundable upon lease
expiration; liability by lessor
Lease Bonus – if received by the lessor from
the lessee it is recognized as unearned income to
be amortized over lease term
Unequal Rental Payments – in an operating
lease, in case of unequal cash payments the total
cash payment for the lease term is amortized using
a straight line basis
B. Finance Lease
- to be classified as finance lease, any of the
following situation should be present
a. there is transfer of ownership to the
lessee
b. lessee has an option to purchase the
asset
c. lease term is a major part (75%) of the
economic life of the asset
d. PV of lease payment amounts to
substantially all (at least 90%) of the fair
value of the asset at the inception
- other criteria (suggestive in nature)
a. Only the lessee can use the asset
without major medication
b. Losses due to cancellation of lease are
borne by the lessee
c. Gains or losses accrue to the lessee
d. Lessee has the ability to continue the
lease at rent substantially lower than
market rent
Classification of Finance Lease
1. Direct Financing Lease
2. Sales Type Lease
A. Direct Financing Lease - income of lessor is
only in the form interest income
Gross Investment - is equal to gross rentals for
entire lease term plus absolute amount of residual
value, both guaranteed and unguaranteed.
Net Investment - cost of asset plus initial direct
cost by lessor
Unearned Interest Income- difference between
gross and net investment
Additional Notes:
1. When computing for Direct Financing Lease
with initial direct cost, a new implicit rate
must be determined through trial and error
approach
[ The implicit rate has an indirect
relationship with the present value. That is,
the higher the rate, the lower the present
value and vice versa]
 JPIA-HAU
2. For Direct Financing Lease with residual Solution:
value, the present value of the residual A. Books of Lessor
value is deducted to the cost of asset if the Gross Investment:
asset will revert to the lessor at the end of Gross Rentals (900k x 8) 7,200,000
lease term otherwise, the residual value is Unguaranteed RV 600,000
completely ignored Total P7,800,000
Net Investment
B. Sales Type Lease - recognizes interest income Cost of Equipment 5,250,000
and gross profit on sale Unearned Interest Income 2,550,000

Gross Rentals- same with that of Direct Financing 2020

Lease 01/01 Lease Receivable 7,800,000
Equipment 5,250,000
Net Investment - PV of gross rentals plus PV of Unearned Interest Income 2,550,000
residual value, whether guaranteed or
unguaranteed 01/01 Cash 900,000
Lease Receivable 900,000
Unearned Interest Income - difference between
Gross and Net investment 12/31 Unearned Interest Income 522,000
Interest Income 522,000
Sales - equal net investment or FV of asset,
whichever is lower 2021
01/01 Cash 900,000
Cost of Goods Sold - cost of asset sold minus PV Lease Receivable 900,000
of unguaranteed residual value plus initial direct
cost paid by lessor 12/31 Unearned Interest Income 476,640
Interest Income 476,640
Gross Profit - sales minus COGS
2027
Additional Notes: 01/01 Cash 900,000
1. When the asset will revert to the lessor? Lease Receivable 900,000
a. Guaranteed Residual Value - PV of
residual value is included in sales 12/31 Unearned Interest Income 63,646
revenue Interest Income 63,646
b. Unguaranteed Residual Value- PV is
NOT included in sales revenue; PV is 2028
deducted from cost of underlying asset 01/01 Equipment 500,000
in computing COGS Loss on finance lease 100,000
2. When asset will NOT revert to lessor? Lease Receivable 600,000
- Residual value is completely ignored by
lessor in computation of Unearned Interest B. Books of Lessee
Income and Gross Profit on Sale 2020
01/01 Right of Use Asset 5,007,381
SAMPLE PROBLEM Lease Liability 5,007,381
Borgin and Burkes Industries is in the (900,000 x 5.563756539)
business of new sophisticated equipment. As
lessor, the company expects a 12% return on the 01/01 Lease Liability 900,000
net investment. Cash 900,000
All leases are classified as direct financing.
At the end of the term, equipment will revert 12/31 Interest Expense 492,886
to Borgin and Burkes Industries Accrued Interest Payable 492,886
An equipment is leased on January 1, 2020
with the following information. 12/31 Depreciation 625,923
Cost of equipment 5,250,000 Accum. Dep’n 625,923
Unguaranteed Residual value 600,000 (5,007,381/8)
Annual rental payable in advance 900,000
Useful life and lease term 8 years 2021
Implicit rate 12% 01/01 Lease Liability 900,000
Required: Cash 900,000
1. Prepare journal entries for 2020, 2021 in the
books of lessor and lessee 12/31 Interest Expense 444,032
2. Prepare journal entries for 2027 (lessor Accrued Interest Payable 444,032
only)
3. Prepare journal entry on Jan. 1, 2028 to 12/31 Depreciation 625,923
record return of the equipment from lessee. Accum. Dep’n 625,923
Fair value on this date is 500,000 (lessor (5,007,381/8)
only)

Financial Accounting 2 – Debt Restructuring and Lease Accounting