Big Picture

Week 10-12: Unit Learning Outcomes (ULO): At the end of the unit, you are expected
to
a. Understand notes payable including its initial and subsequent measurement;
b. Apply accounting for fair value option of measuring notes payable;
c. Apply accounting for note payable issued for cash, interest bearing and no
interest bearing note issued for property;
d. Understand the nature, purpose and types of debt restructuring;
e. Apply accounting principle for an asset swap, equity swap and modification
of terms of the old liability.
f. Understand the accounting for operating lease in the books of the lessor;
g. Distinguish operating lease and finance lease;
h. Apply the measurement criteria in accounting for operating and finance
lease;
i. Journalize transactions affecting lease in the books of the lessor under
operating lease and finance lease;

Big Picture in Focus:

ULOa. Understand notes payable including its initial and subsequent
measurement;
b. Apply accounting for fair value option of measuring notes payable;
c. Apply accounting for note payable issued for cash, interest and
non interest bearing note issued for property.

1
Metalanguage and Essential Knowledge
In this section, the most essential terms relevant to the study of notes payable and its
measurement is discussed and to demonstrate ULOa, to c will be operationally defined
to establish a common frame of reference as to how the texts work in your chosen field
or career. You will encounter these terms as we go through the study of notes payable
and its measurement. Please refer to these definitions in case you will encounter
difficulty in the in understanding of this topic.

To perform the aforesaid big picture (unit learning outcomes) for these weeks of the
course, you need to fully understand the following essential knowledge that will be laid
down in the succeeding pages. Please note that you are not limited to exclusively refer
to these resources. Thus, you are expected to utilize other books, research articles and
other resources that are available in the university’s library e.g. ebrary,
search.proquest.com etc.

1. Notes payable. It is an unconditional promise in writing made by one person to another

payable at determinable future time.
2. Initial Measurement: Notes payable not designated at fair value through profit or loss is
measured at fair value minus transaction costs.

When the Notes payable is designated at fair value through profit or loss, transaction cost is
expensed outright. Fair value of notes payable refer to the present value of the future cash
payment to settle the note using market rate of interest.

3. Subsequent measurement: Subsequent to initial recognition, notes payable are

measured at either a. amortized using effective interest method and b. at fair value through
profit or loss.

4. Amortized cost. It represents the amount initially recorded minus the payment for principal
plus the amortization of discount on notes payable or deduct the amortization of premium
on the notes payable.

Otherwise stated, amortized cost is Notes payable at face amount less the unamortized
discount on notes payable or add the unamortized premium on notes payable.

5. Note issued solely for cash. When a note is issued for cash, the proceeds is the present
value and the difference between the face of the note and the cash proceeds is regarded as
discount on notes payable amortized as interest expense over the period of the note.
Illustration: On November 1, 2017, an entity discounted its own note of 5,000,000 at 12%
for one year.
The entry: Cash 5,000,000 – (.12*5,000,000) 4,400,000
Discount on notes payable 600,000
Notes payable 5,000,000

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 To record amount borrowed discounted in advance.

Dec. 31 Interest expense 600,000*2/12 100,000

Discount on notes payable 100,000
To record amortization from 11/1 to 12/31, 2 months.
November 1 Interest expense 600,000 *10/12 500,000
Discount on notes payable 500,000
To record amortization.

Notes payable 5,000,000

Cash 5,000,000
6. Issuance of an interest bearing notes payable for property. The notes payable is
recorded at the face value of the note and interest expense is recognized every end of the
accounting period.
On January 1, 2017, an entity acquired an equipment for 800,000 payable in 5 annual equal
instalments every Dec. 31 of each year. Interest is 10% on the unpaid balance.
Jan. 1, 2017 Equipment 800,000
Notes payable 800,000
To record acquisition of the property.
Dec. 31, 2017 Interest expense 80,000
Notes payable 160,000
Cash 240,000
To record first annual instalment and interest payment.
Dec. 31, 2018 Interest expense 640,000*.10 64,000
Notes payable 160,000
Cash 224,000
To record 2nd instalment and interest payment.
On the 3rd instalment, interest expense will be 48,000 (10% of 480,000 notes payable
balance).
7. Issuance of a non interest bearing notes payable for property with available cash
price. The property acquired through the issuance of a non interest bearing notes payable
is to be recorded equal to the cash equivalent price. The difference between the cash
available price and the face value of the note is regarded as discount on notes payable to
be amortized as interest expense over the period of the note.
On January 1, 2017, an entity acquired an equipment with a cash price 700,000 for
1,000,000, payable in the following terms: 200,000 down payment and the balance in 4
annual equal instalments every Dec. 31 of each year. The entries will be as follows:
Jan. 1, 2017 Equipment 700,000
Discount on notes payable 300,000
Notes payable 800,000
Cash 200,000

12/31/2017 Interest expense 120,000

Discount on notes payable 120,000
Notes payable 200,000

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 Cash 200,000
12/31/2018 Notes payable 200,000
Cash 200,000

Interest expense 90,000

Discount on notes payable 90,000
Table of amortization
Year Notes payable Fraction Amortization
balance
2017 800,000 .8/2*300,000 120,000
2018 600,000 .6/2*300,000 90,000
2019 400,000 .4/2*300,000 60,000
2020 200,000 .2/2*300,000 30,000
2,000,000 300,000

8. Notes payable issued for property and no cash price available: When a notes is issued
for a property, please observe the following concepts:
Cost of property = Down Payment plus present value of the N/P
Discount on N/P = Face value of the N/P less the present value of the N/P
Amortization of discount on N/P = computed using effective interest method
Illustration: On Jan. 1, 2017, an entity acquired a machinery for 1,500,000 payable in 5
annual equal instalments on every Dec. 31 of each year. The prevailing market interest rate
is 10%. The present value of 1 at 10% in an ordinary annuity for 5 years is 3.7908
Entries: 1/1/2017 Machinery 1,,161,424
Discount on N/P 338,576
Cash 100,000
Notes payable 1,400,000

Cost of machinery = 100,000 plus 3.7908 (280,000) = 1,161,424

Discount on N/P = 1,400,000 less 3.7908(280,000) = 338,576

12/31/1017 Interest expense 106,142

Disc. On N/P 106,142

Notes payable 280,000

Cash 280,000

Table of amortization effective interest method

Date Payment Interest = Principal = Present
Carrying Payment - IE value/carrying
amount*ER amount = CA –
principal
Jan. 1,2017 1,061,424
Dec. 31, 2017 280,000 106,142 173,858 887,566
Dec. 31, 2018 280,000 88,757 191,243 696,323

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 Dec. 31, 2019 280,000 69,632 210,368 485,955
Dec. 31, 2020 280,000 48,596 231,404 254,551
Dec. 31, 2021 280,000 25,449 254,551 -
The notes payable is presented as current and noncurrent liabilities as follows:
Current portion: Noncurrent portion
Notes payable 280,000 Notes payable 840,000
Discount on N/P 88,757 Disc. On N/p 143,677
Carrying amount 191,243 Carrying amount 696, 323
9. Fair value option of measuring notes payable: Under the fair value option, transaction
costs directly attributable is expensed outright and the notes payable is subsequently
carried at fair value at every end of the accounting period. The change in fair value
attributable to credit risk is reported through other comprehensive income (OCI) and the
remaining amount is recognized through profit or loss.

Illustration: On Jan. 1, 2017, an entity has a 2,800,000 amount of borrowings from a bank
on 12% interest rate payable in 5 years. The entity received the 2,800,000 and the
transaction cost incurred directly attributable is 70,000 paid for by the entity. The company
elected the fair value option of measuring the note payable. At the end of the year, the fair
value of the note payable is 2,450,000 with change in fair value amounted to 350,000
comprised of 35,000 attributed to credit risk and 315,000 attributed to interest risk.

Journal entries:
1/1/2017 Cash 2,800,000
Notes payable 2,800,000

Transaction cost 70,000

Cash 70,000

12/31/2017Notes payable 350,000

Gain from change in FV 315,000
Gain from credit risk –OCI 35,000

Interest expense .12(2,800,000) 336,000

Cash 336,000

KEYWORDS INDEX
This section lists down the keywords that help you for recall the discussions.

Amortization Fair Value Cash equivalent price

Amortized Cost Carrying Amount Interest bearing
Discount on note payable Gain from change in fair value Non - interest bearing
Premium on note payable Gain from credit risk

5
Self-Help: You can also refer to the sources below to help you further
understand the lesson:

*VALIX (2019). Financial Accounting: Volume 2. Manila, Philippines: GIC Enterprises & Co

J. David Spiceland, Mark W. Nelson, Wayne B. Thomas Intermediate Accounting 10th edition,
McGrawhill higher education 2019.pdf
https://drive.google.com/file/d/1bZ4wSMaqrIG8OTSwkAplJ2ehwk40MtBB/view retrieved June 1,
2020

https://corporatefinanceinstitue.com/resources/knowledge/accounting/notes-payable/retrieved June 4,
2020

https://www.principlesofaccounting.com/chapter-12/notes-payable/retrieved June 4, 2020

Q&A LIST
Do you have any questions for clarification?

Questions/Issues Answers

1. 1.
2. 2.
3. 3.
4. 4.
5. 5.
Let’s Check
1. The fair value option of recording note payable, amortizes discount at every end of
the year. (True or False)
2. The cost of asset acquired upon the issuance of a noninterest bearing note is equal
to the cash equivalent price, if readily available. (True or False)
3. The cost of the asset acquired by an issuance of a noninterest bearing note does
not include the down payment made on the date of transaction. (True or False)
4. The difference between the cash equivalent price of 540,000 for an equipment
acquired at 600,000 noninterest bearing note is a loss on acquisition of the asset.
(True or False)
5. When a company’s own note is discounted at the bank, the difference between the
face value of the note and the cash proceeds from the bank is amortized as interest
expense over the period of the note. (True or False)
6. When an entity issued a note solely in exchange for cash, the present value of the
note at issuance is equal to its face value. (True or False)

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 7. If the present value of a note issued in exchanged for a property is less than the
face amount, the difference should be included in the cost of the asset. (True or
False)
8. Discount on note payable may be debited when an entity discounts its own note with
the bank. (True or False)
9. The discount on note payable is a deduction from the face amount of note payable.
(True or False)
10. The discount on note payable represents interest charges applicable to past
periods. (True or False)
11. Amortizing the discount on note payable gradually decreases the carrying amount of
the liability over the life of the note. (True or False)
12. The discount resulting from the determination of the present value of a note payable
should be reported as
a. Deferred credit
b. Direct deduction from the face amount of the note
c. Deferred charge
d. Addition to the face of the note
13. When a note payable is exchanged for property, the stated interest rate is presumed
to be fair when
a. No interest rate is stated
b. The stated interest rate is unreasonable
c. The face amount of the note is materially different from the cash sale price for
similar property
d. The stated interest rate is equal to the market rate
14. On October 1, 2019, an entity borrowed cash and signed a three year interest
bearing note on which both principal and interest are payable on Oct. 1,2022. On
Dec. 31, 2021 accrued interest payable should
a. Be reported as current liability
b. Be reported as noncurrent liability
c. Be reported as part of noncurrent note payable
d. Not be reported as liability

Let’s Analyze
1. Assume that on January 1, 2011, an entity acquired an equipment with a cash price of
400,000 for 550,000, 150,000 down and the balance payable in 4 equal annual
instalments. What is the amount to be debited as cost of the Equipment?
2. On January 1, 2019, Mabelle Company acquired a tract of land for 10,500,000. The
entity paid a 2,500,000 down payment and signed a non interest bearing note for the
balance which is due on January 1, 2022.

There was no established exchange price for the land and the note had no ready
market. The prevailing interest rate for this type of note was 12%. The present value of
1 at 12% for 3 periods is .7118.

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 Q1 What is the cost of the land?
Q2 What is the initial carrying amount of the notes payable?
Q3 What is the amount of interest expense for the year 2019?
Q4 What is the carrying amount of the notes payable on Dec. 31, 2019? Q1 What

3. On March 2, 2018, Firefly company borrowed 800,000 and signed a 2-year note
bearing interest at 12% per annum compounded annually. Interest is payable in full at
maturity on Feb. 28,2020.
Q1 What is the amount of interest expense for Dec. 2018?
Q2 What is the amount of interest expense for Dec. 2019?

In a Nutshell
Problem 1. On January 1, 2019,Joanna Company borrowed 1,000,000 8% noninterest bearing note
due in four years. The present value of the note on the date of issuance was 367,500. The entity
elected irrevocable the fair value option in measuring the note payable. On December 31, 2019, the fair
value of the note is 408,150.

Q1 What is the carrying amount of the note payable on December 31, 2019?

Q2 What amount should be reported as interest expense for 2019?

Q3 What amount of gain from change in fair value of the note payable should be reported for 2019?

Q4 At what amount should the discount on note payable be presented on December 31, 2019?

Problem 2 On January 1, 2011 an entity acquired an equipment for 2,000,000 payable in 5

equal annual instalments on every December 31, of each year. The prevailing market interest
rate is 10%. The table of present value shows that the present value factor of an annuity of 1
for 5 years at 10% is 3.7908. Prepare the entries for 2011 and 2012 and show the necessary
solutions.

Problem 3 On January 1, 2011, an entity acquired an equipment for 3,000,000. The entity paid
300,000 down and signed a noninterest bearing note for the balance which is due after three
years on January 1, 2014. The prevailing interest rate is 10%. The present value of 1 for 3
periods is .7513.

Required 1 Prepare the entries for 2011 and 2012.

Required 2 Prepare the amortization table.

8
Big Picture in Focus:
ULOd. Understand the nature, purpose and types of debt
restructuring;
e. Apply accounting principle for an asset swap, equity swap and
modification of terms of old liability;.

Metalanguage and Essential Knowledge

In this section, the most essential terms relevant to the study of debt restructuring is
discussed and to demonstrate ULOd, to e will be operationally defined to establish a
common frame of reference as to how the texts work in your chosen field or career. You
will encounter these terms as we go through the study of debt restructuring. Please
refer to these definitions in case you will encounter difficulty in the in understanding of
this topic.

To perform the aforesaid big picture (unit learning outcomes) for these weeks of the
course, you need to fully understand the following essential knowledge that will be laid
down in the succeeding pages. Please note that you are not limited to exclusively refer
to these resources. Thus, you are expected to utilize other books, research articles and
other resources that are available in the university’s library e.g. ebrary,
search.proquest.com etc.

Debt Restructuring. This usually occurs when the debtor is experiencing financial difficulty
and the creditor grants the debtor some things not normal in business so as to maximize
recovery of amount loaned under a bad situation.
Types of debt restructuring: Asset swap, Equity swap and modification of terms.
Asset swap: The settlement of the liability is by transferring any non cash asset to the creditor
in full payment of the obligation. PFRS accounting accounts for the difference between the
carrying amount of the liability set off and the non cash asset given as gain or loss on
extinguishment of debt.
Illustration: An entity the following balance at year end:
Notes payable 6,000,000
Accrued interest payable 1,200,000

At the end of the year, the entity transferred to the creditor a land with a carrying amount of 4.500,000
and a fair value of 6,600,000.

Entry: Notes payable 6,000,000

Accrued interest payable 1,200,000

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 Land 4,500,000
Gain on extinguishment 2,700,000

Under the USA GAAP, the difference between the Carrying amount of the liability and the Fair
value of the asset given is Gain on debt restructuring while the difference between FV of asset
given and its carrying amount is gain on exchange. This is on the assumption that two
transactions took place; the sale of the asset and the extinguishment of debt.
Notes payable 6,000,000
Accrued interest 1,200,000
Land 4,500,000
Gain on exchange 2,100,000
Gain on extinguishment 600,000
Equity swap. The amount of liabilities is settled through the issuance of share capital by the
debtor in full or partial payment of the obligation. The following order of priority is to be
observed in the measurement of the equity instruments to extinguish the liability: a. Fair Value
of the equity instruments issued b. Fair value of the liability extinguished c. Carrying amount of
liability extinguished. Share capital is credited equal to par and the difference between the
priorities and par value is share premium. When the carrying amount of the liability is used,
there is no gain or loss to be recognized.
The amount of difference between the carrying amount of the liability and these priorities is the
amount of gain or loss on extinguishment reported in profit or loss.
Illustration: An entity provided the following data at year end:
Bonds payable 7,500,000
Accrued interest payable 750,000

The entity issued share capital with a total par value of 3,000,000 and fair value of 6,750,000 in
full settlement of the bonds and accrued interest. On the other hand, the fair value of the bonds
payable is 7,050,000.

Priority 1 CA of liability 8,250,000 FV of shares issued 6,750,000

FV of shares issued 6,750,000 Par value 3,000,000
Gain/loss 1,500,000 Share premium 3,750,000

Entry: Bonds payable 7,500,000

Accrued interest payable 750,000
Share capital 3,000,000
Gain on extinguishment 1,500,000
Share premium 3,750,000

10
Priority 2 CA of liability 8,250,000 FV of B/P 7,050,000
FV of B/P 7,050,000 Par value 3,000,000
Gain/loss 1,200,000 Share premium 4,050,000

Entry: Bonds payable 7,500,000

Accrued interest payable 750,000
Share capital 3,000,000
Gain on extinguishment 1,200,000
Share premium 4,050,000

Priority 3 Bonds Payable 7,500,000

Accrued interest750,000
Share Capital 3,000,000
Share premium 5,250,000

Modification of terms.
Modification of terms can be forgiveness of interest, reduction of principal, extension of due
date. It can be with substantial modification of terms where gain or loss is recognized or non
substantial modification whereby the gain or loss is not to be recognized. The determination
whether substantial or not can be when one of the two tests are met as per IFRS 9 guidance on
Quantitative test and qualitative test.
Under the quantitative test or known as the 10% test, when the gain or loss computed reached
at least 10% of the old financial liability, then there is subtstantial modification of terms.
As for the qualitative test, it is considered substantial when a significant change in the terms and
condition that fundamentally requires the de-recognition of with no additional quantitaive
analysis.
In PFRS 9, accounting for substantial modification, gain or loss is computed as the difference
between the Carrying amount of the old liability and the total present value of the new liability
discounted at the old rate.
The old financial liability is extinguished at the carrying amount while the new liability is credited
at face value with debiting discount on note payable for the difference between face value and
present value. The gain or loss on extinguishment which is at least 10% of the carrying amount
of the old liability is recognized through profit or loss as seprate line item among other
income/expense.
Meanwhile the discount on note payable or new liability shall be amortized by the effective
interest method over the period of the liability.

11
Under USA GAAP, the gain on debt restructure is the difference between the Carrying amount
of the loan and the new note payable computed as the sum of the absolute amount of new
principal and future interest payments.
In accounting for modification of terms, PFRS 9 shall be followed.
When there is no substantial modification of terms, the amount of gain or loss on
extinguishment is not recognized.
Thus the carrying amount of liability is eliminated while the new face value of the note
immediately credited and any difference between carrying amount and the new notes payable is
premium on notes payable or discount on notes payable to be amortized as interest expense
over the period of the note.
Illustration 1: Modification of terms with substantial gain.
On January 1, 2017, an entity showed the following:
Note payable – due Jan. 1, 2017 – 14% 1,000,000
Accrued interest payable 200,000

The creditor granted the entity with the following modifications on January 1, 2017:
a. The accrue interest of 200,000 is forgiven.
b. The principal obligation is reduced to 800,000.
c. The new interest rate is 10% payable every Dec. 31.
d. The new date of maturity is Dec. 31, 31, 2020.

The present value of 1 at 14% for 4 periods is 0.5921 and the present value of an ordinary
annuity of 1 at 14% for 4 periods is 2.9137.
To compute for the present value of the new note:
PV of principal .5921 (800,000) = 473,680
PV of interest payments 2.9137 ( 800,000 * .10) = 233,096
Total 706,776

To compute for the gain or loss:

Carrying amount of note payable – old 1,000,000 + 200,000 = 1,200,000
PV of new note payable 706,776
Gain on extinguishment 493,224

Percentage of modification 493,224/1,200,000 = 41% substantial

Therefore the gain is to be recognized. The entry on the books of the debtor will be:
Note payable 1,000,000
Accrued interest 200,000
Discount on note payable – new 93,224
Note payable – new 800,000
Gain on extinguishment 493,224
To record the extinguishment of debt.

Interest expense 80,000

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 Cash 80,000
To record interest payment on Dec. 31.

Interest expense 18,949

Discount on notes payable 18,949
To record amortization of discount.

Amortization : Effective interest method

Date Interest paid Interest expense Discount Carrying amount

amortization
1/1/2017 706,776
12/31/2017 80,000 98,949 18,949 725725
12/31/2018 80,000 101,602 21,602 747,327
12/31/2019 80,000 104,626 24,626 771,953
12/31/2020 80,000 108,047 28,047 800,000

The entries on the books of the creditor will be:

Note receivable – new 800,000
Loss on debt restructure 493,224
Note receivable –old 1,000,000
Accrued interest receivable 200,000
Unearned interest income 93,224

Cash 80,000
Interest income 80,000

Unearned interest income 18,949

Interest income 18,949

Using the same problem, under USA GAAP, the new restructured loan is to be recognized at
absolute amount of principal and interest and the difference between these absolute amount
and the carrying amount of the liability is a gain or loss on debt restructure.
Hence, the entry under USA GAAP will be:
Notes payable 1,000,000
Accrued interest payable 200,000 Principal Interest
Notes payable –new 1,120,000 = 800,000 + (800,000*.10 *4)
Gain on debt restructure 80,000
Please observe that PFRS is followed in accounting for modification of terms.

Illustration 2: No substantial modification: Assume the following given information:

Note payable – due Jan. 1, 2017 – 10% 4,500,000
Accrued interest payable 900,000
a. The accrued interest of 900,000 is forgiven.
b. The interest rate is 14% payable every Dec. 31.
c. The date of maturity is Dec. 31, 2019.

13
 d. The present value of 1 at 10% for 3 periods is .7513 and the PV of 1 in ordinary
annuity for 3 periods is 2.4869.
Compute for the PV of principal and interest:
PV of principal (4,500,000 * .7513) 3,380,850
PV of interest (4,500,000*.14*2.4869) 1,566,747
Total 4,947,597
Less Carrying amount4,500,000 + 900,000 5,400,000
Gain or loss 452,403/5,400,000=8% not substantial

The gain or loss which is not substantial is to be recognized in profit or loss as per
clarification of PFRS 9 B3.3.6

The entry will then be:

Accrued interest payable 900,000
Gain on modification of terms 452,203
Premium on notes payable 447,597

Present value 4,947,597

Face amount 4,500,000
Premium on note payable 447,597

The recording of the interest payment is taken as follows: Interest expense 630,000
Cash
630,000

To record amortization of the premium on note payable by the effective interest method, the
preparation of the table is necessary:
Date Interest Paid Interest expense Amortization Carrying amount
1/1 year 1 4,947,597
12/31/year 1 630,000 494,760 135,240 4,812,357
12/31/year 2 630,000 481,236 148,764 4,663,593
12/31/year 3 630,000 466,407 163,593 4,500,000

In reference with the table, interest paid is principal of 4,500,000 multiplied by the new interest
rate of 14% while interest expense is carrying amount multiplied by the old rate of 10%.

The difference between interest paid and interest expense is the amortization of the premium
recorded as follows:
Premium on notes payable 135,240
Interest expense 135,240
For additional information, you may read chapter 3 on this material, just click on this site:
https://www.pwc.com/us/en/cfodirect/assets/pdf/accounting-guides/pwc-guide-financing-transactions-
debt-equity.pdf retrieved August 5, 2020

KeyWord Index

14
 Debt restructuring Asset Swap Gain/Loss on Restructuring
Dacion en pago Equity Swap Discount on note payable
Substantial modification Gain/Loss on extinguishment Carrying Amount

Self-Help: You can also refer to the sources below to help you
further understand the lesson:

*VALIX (2019). Financial Accounting: Volume 2. Manila, Philippines: GIC Enterprises & Co

https://www.eycom.ch/en/Publications/20180530-Accounting-for-debt-restructuring-under-the-new-
IFRS-9/download retrieved August 5, 2020

https://www.pwc.com/us/en/cfodirect/assets/pdf/accounting-guides/pwc-guide-financing-transactions-
debt-equity.pdf retrieved August 5, 2020

file:///F:/FINANCIAL%20ACCOUNTING/IFRIC%2019%20-%20Extinguishing%20Financial%20Liabilities
%20with%20Equity%20Instruments.pdf

https://www.principlesofaccounting.com/chapter-11/accounting-for-asset-exchanges/

Let’s Check
1. Under a debt restructuring involving substantial modification of terms, the future cash flows
under the new terms shall be discounted using (a. market rate of interest b. Original effective
interest rate)
2. There is substantial modification of terms of an old financial liability if the gain or loss on
extinguishment is (a. At least 10% of the carrying amount of the old liability b. At least 10% of
the carrying amount of the new liability)
3. The accounting issue on extinguishment of a financial liability by issuing equity instruments is
now well settled under IFRIC 19. (True or False)
4. An asset swap is the issuance of share capital by the debtor to the creditor in full pr partial
payment of an obligation. (True or False)
5. Under PFRS 9, asset swap is recorded as if two transactions have taken place; sale of the asset
and extinguishment of liability. (True or False)
6. The difference between the carrying amount of the liability and the fair value of the asset is gain
or loss from restructuring. (True or False)
7. Maturity value concession involves a reduction of interest rate, forgiveness of unpaid interest or
moratorium on interest. (True or False)
8. Under USA GAAP, the gain or loss on debt restructuring is the difference between the carrying
amount of the old liability and the present value of the new restructured liability. (True or False)
9. When the gain on extinguishment of liability is less than 10% of the carrying amount of the old
financial liability, the amount should be recognized. (True or False)

15
 10. USA GAAP shall be followed in accounting for debt restructuring conceived as modification of
terms. (True or False)

Let’s Analyze
1. During 2019, Shyrill company experienced financial difficulties and is likely to default on a
9,000,000, 15% three year note dated Jan. 1, 2017, Payable to Canque Bank. On Dec. 31,
2019, the bank agreed to settle the note and unpaid interest of 1,350,000 for 2019 for
7,380,000 cash payable on Jan. 31, 2020. The amount that Shyrill company report as gain
from extinguishment of debt in its 2019 income statement is ________________ and the
entry in connection with the settlement is____________________.
2. Sunset Company showed the following data with respect to a matured obligation:
Mortgage payable 6,400,000
Accrued interest payable 480,000

The entity is threatened with a court suit if it could not pay its maturing debt. Accordingly, the
entity entered into an agreement with the creditor for the issuance of share capital in full
settlement of the mortgage.
The agreement provided for the issue of 35,000 shares with par value of 80. The share is
currently quoted at 104. The fair value of the liability is 3,600,000.

Required: Prepare the journal entry to record the equity swap on the books of Sunset
Company.

3. Seal company is experiencing financial difficulty and is negotiating debt restructuring with its
creditor to relieve its financial stress. Seal has a 2,000,000 note payable to United Bank. The
bank is considering acceptance of an equity interest in Seal company in the form of 200,000
ordinary shares valued at 9.6 per share. The par value is 8 per share. How much share
premium should be recognized from the debt restructuring?

4. Land costing 480,000 and building costing 3,520,000 with accumulated depreciation of
960,000, were mortgaged to secure a bank loan of 2,400,000. Data regarding the loan are:

Face of the loan 2,400,000

Accrued interest 240,000
Legal fee and bank service charges 40,000
Total 2,680,000

Subsequently, the land and building were given in full settlement of the liability.

Required: Prepare the entry of this Dacion en Pago transaction.

5. An entity shows the following balances on December 31, 2010:

Note payable 3,200,000

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Accrued interest 640,000
Total liability 3,840,000

On December 31, 2010, the entity transfers to the creditor land recorded at cost of 2,400,000
with fair value of 3,520,000.

Required: Prepare the entry to record the asset swap under PAS 39 and US GAAP.

In a Nutshell
Problem 1 Green Company has an overdue 8% note payable to City Bank at 6,400,000 and
recorded accrued interest of 512,000. As a result of a settlement on January 1, 2017, City Bank
agreed to the following restructuring arrangement:
a. Reduced the principal obligation to 5,600,000.
b. Forgave the 512,000 accrued interest.
c. Extended the maturity date to December 31, 2018.
d. Annual interest of 10% is to be paid on December 31, 2017 and 2018.
The present value of 1 at 8% for two periods is 0.8573, and the present value of an ordinary
annuity of 1 at 8% for two periods is 1.7833.
Required: Prepare the entries for 2017 and 2018 to record the modification of terms and show
all the necessary solutions.

Problem 2 Sandara Company showed the following data with respect to a

matured obligation:
Mortgage payable 3,200,000
Accrued interest payable 240,000

The entity entered into an agreement with the creditors for the issuance of capital in full settlement of
the mortgage.

The agreement provided for the issue of 35,000 shares with par value of 80. The shares is currently
quoted at 104. The fair value of the liability is 3,600,000.

Required: Prepare journal entry o record the equity swap on the books of Sandara Company:
1. If the fair value of the share capital is used for the equity swap.
2. If the fair value of the liability is used for the equity swap.
3. If the carrying amount of the liability is used for the equiy swap.

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Big Picture in Focus:
ULOf. Understand the accounting for operating lease on the books of
the lessor;
g. Distinguish operating and finance lease; h. Apply the measurement
criteria in accounting for operating and finance lease;
i. Journalize transactions affecting lease in the books of the lessor
under operating and finance lease.

In this section, the most essential terms relevant to the study of operating leaseand its
measurement is discussed and to demonstrate ULOf, to i will be operationally defined
to establish a common frame of reference as to how the texts work in your chosen field
or career. You will encounter these terms as we go through the study of operating lease
and its measurement. Please refer to these definitions in case you will encounter
difficulty in the in understanding of this topic.

To perform the aforesaid big picture (unit learning outcomes) for these weeks of the
course, you need to fully understand the following essential knowledge that will be laid
down in the succeeding pages. Please note that you are not limited to exclusively refer
to these resources. Thus, you are expected to utilize other books, research articles and
other resources that are available in the university’s library e.g. ebrary,
search.proquest.com etc.

Operating Lease – A lease that does not transfer substantially all risks and rewards of the
ownership of an asset is accounted for as operating lease ( IFRS 16.62).

Finance lease. IFRS 16.63-65 enumerates the circumstances and indicators for a lease to be
classified as a finance lease. Hence, a lease that contains any one of the following is
accounted for as a finance lease.
a. Transfer of ownership at the end of the lease term.
b. There is bargain purchase option which is expected to be sufficiently lower than the fair
value of the asset at the date it becomes exercisable.
c. The lease term is for the major part of the economic life of the asset. By the USA
GAAP, major part is 75% of its economic life.
d. The present value of the lease payments is substantially all of the fair value of the asset
at the inception of the lease. By the USA GAAP, substantial is at least 90%.

Other criteria for finance lease classification:

a. The asset is of specialized nature that only the lessee can use it without major
modifying.
b. Losses on cancelation of the lease are borne by the lessee.
c. Gains or losses in changes in fair value accrue to the lessee.

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d. The lessee has ability to continue the lease for a secondary period at rental substantially
lower than market rent.

Thus, a lease that does not meet any one of those mentioned indicators is operating lease.

Accounting for operating lease – lessor. The asset under lease is presented in the
statement of financial position of the lessor as required by IAS 17.49.

IAS 17.50 provides that any periodic rental received for over the period of the lease is
recorded as rent income on a straight line basis or other systematic basis.

Even if there is unequal rental payments, the total rental received shall be uniformly
recognized as income over the lease term.

It is to be noted that part of the lessor’s responsibility is to bear all ownership costs such as
depreciation, real property taxes insurance and maintenance.

Initial direct cost by the lessor is debited as deferred initial direct cost and added to the
carrying amount of the underlying asset and recognized as expense over the lease term.

Any security deposit refundable upon the expiration of the lease is a liability of the lessor.

Additionally, any lease bonus paid for by the lessee, is recognized as unearned rent income
by the lessor and amortized as earned over the lease term.

Illustration 1: On January 1, 2017, Summer company purchased a machinery for

1,950,000 cash for the purpose of leasing it. The machine is expected to have a 10-year
life with no residual value. A lease bonus was also received on this date amounting to
78,000.

On April 1, 2017, Summer company leased the machine to another entity for 3 years at a
monthly rental of 32,500 payable at the beginning of every month.

In addition, Summer company received a security deposit 390,000 to be refunded at the

lease expiration.

On the same date, Summer paid initial direct cost of 195,000.

At the end of the year, Summer company paid repair and maintenance totalling 13,000.

The entries:

Applying the concept mentioned above, the following are the entries for the transactions of
Summer company.

January 1, 2017 Machinery 1,950,000

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 Cash 1,950,000
To record purchase of the machine.
Cash 78,000
Unearned rent Income 78,000
To record lease bonus.
April 1, 2017 Cash 390,000
Liability for rent deposit 390,000
To record refundable deposit.

Deferred Initial direct cost 195,000

Cash 195,000
To record directly attributable cost incurred.
April 1- Dec. 31 Cash 292,500
Rent Income 292,500
To record rent received for 9 months.
Dec.31, 2017 Depreciation expense 1,950,000/10 195,000
Accumulated depreciation 195,000

Repairs and Maintenance 13,000

Cash
To record repairs incurred.

Unearned rent income 19,500 78,000/3*9/12

Rent income 19,500
To record 9 months earned of unearned rent.

Amortization of deferred initial direct cost 48,750

Deferred initial direct cost 48,750
195,000/3 * 9/12

Illustration 2. Unequal rental payments

Ivory company leased office building to another entity for 3 years to begin Jan.1, 2017.
Under the terms of agreement, rent for the first year is 1,800,000 and rent for the next two
years is at 2,250,000 annually. However, Ivory granted the lessee lease free period for the
first 6 months.
Total payments received = 900,000 + 2,250,00 + 2,250,000 = 5,400,000
Divided by Lease term 3
Average annual rental per year = 1,800,000
st
Entries: 1 yearCash 900,000
Rent receivable 900,000
Rent Income 1,800,000

2nd year Cash 2,250,000

Rent income 1,800,000

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 Rent receivable 450,000

3rd year Cash 2,250,000

Rent income 1,800,000
Rent receivable 450,000

Discolures: IAS 17.35 provides for the disclosures of the following:

1. Minimum amounts of lease paymentsfor the next year, years 2 through 5 and 5 years beyond
at balance sheet date for non cancellable lease
2. contingent rent recognized as income
3. Description og general lease arrangements

KEYWORDS INDEX
This section lists down the keywords that help you for recall the discussions.

Finance lease Initial Direct Cost Straight line

Operating Lease Lease Bonus Deferred initial direct cost
Purchase option Security Deposit Carrying Amount

Self-Help: You can also refer to the sources below to help you
further understand the lesson:

*VALIX (2019). Financial Accounting: Volume 2. Manila, Philippines: GIC Enterprises & Co

J. David Spiceland, Mark W. Nelson, Wayne B. Thomas Intermediate Accounting 10th edition,
McGrawhill higher education 2019.pdf
https://drive.google.com/file/d/1bZ4wSMaqrIG8OTSwkAplJ2ehwk40MtBB/view retrieved June 1,
2020

Intermediate Financial Accounting Volume 2, Glenn Arnold & Suzanne Kyle file:///F:/Accounting
%206/ArnoldKyle-IntermFinAcct-Vol2-2020A.pdf

https://leasequery.com/blog/capital-lease-accounting-finance-lease-accounting-
example/retrieved June 4, 2020

https://www.iasplus.com/en/standards/ias/ias17retrieved June 4, 2020

https://ifrscommunity.com/knowledge-base/ifrs-16-lessor-accounting/retrieved June 4, 2020

Q&A LIST

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 Do you have any questions for clarification?

Questions/Issues Answers

1. 1.
2. 2.
3. 3.
4. 4.
5. 5.

Let’s Check
____________ 1. It is defined as an agreement whereby the lessor conveys to the lessee in
return for a payment or series of payments the right to use an asset for an agreed period of
time.
____________ 2. and ___________ 3. What are the two types of leases?
____________ 4. It is the type of lease whereby periodic rental is simply recognized as rent
expense on the part of the lessee and also called the rental approach.
____________ 5. It is an amount paid by the lessee to the lessor in addition to periodic rental
and amortized as rent expense over the lease term.
____________ 6. It is often incurred by the lessor and includes amounts such as commissions,
legal fees and internal costs that are incremental and directly attributable to negotiating and
arranging the lease.
____________ 7. It is refundable upon the lease expiration and accounted for as a liability by
the lessor.
____________ 8. These refers to ownership costs and expenses usually born by the lessor
such as depreciation of leased property, real property taxes, insurance and maintenance.
____________ 9. What PAS covers the accounting for operating lease?
____________ 10. The balance of the deferred initial direct cost shall be presented as an
addition to the carrying amount of machinery. (True or False)

Let’s Analyze
Problem 1. On Oct. 1, 2017, Dean company leased office space at a monthly rental of 600,000
for 10 years expiring Sept. 30,2027. As an inducement for Dean to enter into the lease, the
lessor permitted Dean to occupy the premises rent free from Oct. 1 to Dec. 31, 2017. For the
year ended Dec. 31, 2017, Dean should record rent expense amounting to _______________.

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 Problem 2. Ramzel company leased a new machine to Marlon company on Jan. 1, 2017. The
lease expires on Jan. 1, 2022. The annual rental is 900,000. Additionally, on Jan. 1, 2017,
Marlon paid 500,000 to Ramzel as a lease bonus and 250,000 as a security deposit to be
refunded upon expiration of the lease. In Ramzel’s 2017 income statement, the amount of
rental revenue should be ______________.
Problem 3 Rod Company purchased a tractor on Jan 1,2017 at a cost of P1,600,000 for the
purpose of leasing it. The tractor is estimated to have a useful life of 5 years with residual value
of P100,000. Depreciation is on a straight line basis. On April 1,2017, Rod entered into a lease
contract for the lease of the tractor for a term of two years up to March 31,2019. The lease fee
is P50,000 monthly and the lesee paid P600,000, the lease fee for one year. Rod paid P120,000
commission associated with negotiating the lease, P15,000 minor repairs, and P10,000
transportation of the tractor to the lessee during 2017. Rod Company should report net rent
revenue for the year 2017 at _____________.
Problem 4. Roche Company, lessor, leases its equipment under an operating lease. The lease
term is for 5 years and the lease payments are made in advance on January 1 of each year as
shown in the following schedule:
January 1, 2017 800,000
January 1, 2018 800,000
January 1, 2019 1,120,000
January 1, 2020 1,360,000
January 1, 2021 1,520,000
On December 31, 2018, what amount should be reported as rent receivable? And what is the entry
on December 31, 2019?
Problem 5 On May 1, 2019, Huggies company leased equipment to Raven company which expires
on May 1, 2020. Raven could have bought the equipment from Huggies for 4,160,000 instead
of leasing it.
Huggies accounting records showed a carrying amount for the equipment on May 1, 2019 for
3,640,000. Huggies depreciation on the equipment in 2019 was 468,000.
During 2019, Raven paid 936,000 in rentals to Huggies for the 8-month period. Huggise incurred
maintenance and other related costs under the terms of the lease of 83,200 in 2019.
After the lease with Raven expires, Huggies will lease the equipment to another entity for two years.
What is the pretax income derived by Huggies for 2019?

In a Nutshell
The explorer company hired you as part time employee in their accounting office. One
transaction you encountered in the office is the recording in connection with the
following lease agreement:

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Explorer company purchased a machine on January 1, 2019 for 3,000,000 for the
purpose of leasing it.
The machine was expected to have a 10-year life with no residual value and the straight
line method of depreciation is used.

On March 1, 2019, Explorer company leased the machine to Anne company for 720,000
a year for 4 years ending Feb. 28, 2023.

Explorer company paid a total of 36,000 for maintenance and received 720,000 from
Anne company on March 1, 2019.

Explorer company retains title to the property and plans to lease it to someone else after
the 4 year lease period.

Required:
1. Prepare journal entries on the books of Explorer company.
2. Determine the net rent income of Explorer company

Course Schedule

Submission of Let’s Check – week 10 Wednesday of week 10

Submission of Let’s Analyze – week 10 Friday of week 10
Submission of In a Nutshell – week 10 Saturday of week 10
Submission of Let’s Check – week 11 Wednesday of week 11
Submission of Let’s Analyze – week 11 Friday of week 11
Submission of In a Nutshell – week 11 Saturday of week 11
Submission of Let’s Check – week 11 Wednesday of week 12
Submission of Let’s Analyze – week 12 Friday of week 12
Submission of In a Nutshell – week 12 Saturday of week 12
Submission of In a Nutshell – week 12

5th Formative Assessment

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