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Notes Payable
1. A short-term, non-trade, note payable with no stated rate of interest issued in a
transaction that contains a significant financing component should be
a. recorded at maturity value.
b. recorded at the face amount.
c. discounted to its present value.
d. reported separately from other short-term notes payable.

2. On August 1, 20x1, an entity acquired a new machine that it does not have to
pay for until September 1, 20x5. The total payment on September 1, 20x5 will
include both principal and interest. The initial measurement of the note and the
machine is equal to the
a. payment for the principal multiplied by PV of ₱1
b. payment for interest multiplied by PV of ordinary annuity of ₱1
c. a plus b
d. total payment on the note multiplied by PV of ₱1

3. On January 1, 20x1, BLATANT NOISY Co. acquired a piece of equipment by paying

cash of ₱400,000 and issuing a noninterest-bearing note of ₱4,000,000 due on
January 1, 20x4. There is no cash price equivalent for the equipment. The
effective interest rate on the note is 12%. How much is the carrying amount of
the note on initial recognition?
a. 2,847,120 c. 3,247,120
b. 2,000,000 d. 2,786,309

*(4,000,000 x PV of 1 @12%, n=3) = 2,847,121

4. On January 1, 20x1, Sunday Calm Co. issued a ₱4,800,000, 3-year, noninterest-

bearing note due in equal semi-annual payments starting July 1, 20x1. The
effective interest rate is 10%. How much interest expense should Sunday Calm
Co. recognize in 20x1?
a. 203,028 c. 350,780
b. 279,830 d. 376,207

Solution:
Initial measurement:
(4,800,000 ÷ 6 semiannual payments) = 800,000 x PV of ordinary annuity @5%, n=6 = 4,060,554

Subsequent measurement:
Date Payments Interest expense Amortization Present value
Jan. 1, 20x1 4,060,554
July 1, 20x1 800,000 203,028 596,972 3,463,582
Dec. 31, 20x2 800,000 173,179 626,821 2,836,761

Interest expense in 20x1: (203,028 + 173,179) = 376,207

5. On January 1, 20x1, Beautiful Morning Co. acquired a machine in exchange for a

₱4,800,000 noninterest-bearing note due as follows:
Date Amount
December 31, 20x1 ₱ 2,400,000
December 31, 20x2 1,600,000
December 31, 20x3 800,000
Total ₱ 4,800,000
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The effective interest rate is 10%. How much is the carrying amount of the note on
initial recognition?
a. 4,105,184 c. 3,980,134
b. 4,100,341 d. 3,086,394

Solution:

Cash flows PV of 1 @10% PVF PV

Dec. 31, 20x1 2,400,000 n=1 0.909091 2,181,818
Dec. 31, 20x2 1,600,000 n=2 0.826446 1,322,314
Dec. 31, 20x3 800,000 n=3 0.751315 601,052
4,105,184

6. On January 1, 20x1, Unforgiven Co. purchased an inventory with a list price of

₱4,400,000 and a cash selling price of ₱4,000,000 in exchange for a ₱4,800,000
noninterest-bearing note due on December 31, 20x3. The effective interest rate
on the note is most approximately equal to
a. 5.2659%. b. 6.2695%. c. 8.7893%. d. 9.2625%.

Solution:
Choice (a): 4.8M x PV of 1 @ 5.2659%, n=3 = 4,115,078
Choice (b): 4.8M x PV of 1 @ 6.2695%, n=3 = 3,999,589
Choice (c): 4.8M x PV of 1 @ 8.7893%, n=3 = 3,728,058
Choice (d): 4.8M x PV of 1 @ 9.2625%, n=3 = 3,679,831

7. On January 1, 20x1, DWINDLE DECREASE Co. acquired a vehicle in exchange for

cash of ₱400,000 and a noninterest-bearing note of ₱4,000,000 due in 4 equal
annual installments starting on December 31, 20x1. The prevailing rate of
interest for this type of note is 12%. How much is the current portion of the note
on December 31, 20x1?
a. 613,409 c. 814,342
b. 711,780 d. 718,324

Solution:
Initial measurement: (1,000,000 x PV of ordinary annuity @12%, n=4) = 3,037,349

Subsequent measurement:
Date Payments Interest expense Amortization Present value
Jan. 1, 20x1 3,037,349
Dec. 31, 20x1 1,000,000 364,482 635,518 2,401,831
Dec. 31, 20x2 1,000,000 288,220 711,780 1,690,051

8. On January 1, 20x1, VELVETY SMOOTH Co. acquired an intangible asset by

paying cash of ₱400,000 and issuing a noninterest-bearing note payable of
₱4,000,000 due in 4 equal annual installments. The first installment is due on
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January 1, 20x1. The prevailing rate of interest for this type of note is 12%. How
much is the interest expense in 20x1?
a. 0 c. 334,357
b. 288,220 d. 432,000

Solution:
Initial measurement: (1,000,000 x PV of an annuity due @12%, n=4) = 3,401,831

Subsequent measurement:
Date Payments Interest expense Amortization Present value
Jan. 1, 20x1 3,401,831
Jan. 1, 20x1 1,000,000 - 1,000,000 2,401,831
Dec. 31, 20x1 1,000,000 288,220 711,780 1,690,051

9. STUNTED Co. issued a 3-year, noninterest-bearing note of ₱4,000,000 to

DWARFISH, Inc., a related party. The proceeds from the issuance of the note
were ₱2,847,120. The note matures on December 31, 20x3. The prevailing
interest for similar type of obligation is 12%. The entry on initial recognition of
the note includes a
a. credit to notes payable for ₱2,847,120.
b. debit to discount on notes payable for ₱1,152,880.
c. credit to discount on notes payable for ₱1,152,880.
d. a and b

Solution:
Future cash flow 4,000,000
Multiply by: PV of ₱1, @12%, n=3 0.71178
Present value 2,847,120

Jan. 1, Cash 2,847,120

20x1
Discount on N/P (4M – 2,847,120) 1,152,880
Note payable 4,000,000

10. On January 1, 20x1, SHABBY WORN OUT Co. acquired a machine by issuing a
3-year, 3%, ₱4,000,000 note payable. Principal and interest are due on January
1, 20x4. The prevailing interest rate for this type of note is 12%. How much is
the carrying amount of the note on initial recognition?
a. 3,114,884 c. 3,111,126
b. 4,370,908 d. 3,114,879

Solution:
 (PV = Future cash flows x PV factor)
 Future cash flows (principal plus compounded interest) = (4,000,000 x 103% x 103% x 103%) =
4,370,908
 PV = 4,370,908 x PV of 1 @12%, n=3 = 3,111,126

Bonds Payable & Other Concepts

1. Which of the following is the least relevant consideration when evaluating
whether to derecognize a financial liability?
a. Whether the obligation has been discharged.
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b. Whether the obligation has been canceled.

c. Whether the obligation has expired.
d. Whether the obligation has a potential to cause inflows of economic benefits
to the issuer. (inflows relate to assets not liabilities)

2. When bonds are redeemed by the issuer prior to their maturity date, any
material gain or loss on the redemption, is
a. amortized over the period remaining to maturity and reported as an
extraordinary item in the income statement.
b. amortized over the period remaining to maturity and reported as part of
income from continuing operations in the income statement.
c. reported in the income statement as an extraordinary item in the period of
redemption.
d. reported in the income statement as part of income from continuing
operations in the period of redemption.

3. On January 1, 20x1, SMUDGE BLUR Co. issued 1,000, ₱4,000, 12%, 3-year bonds
for ₱4,198,948. Principal is due on December 31, 20x3 but interests are due
annually every year-end. The effective interest rate is 10%. How much is the
unamortized discount or premium on bonds payable as of December 31, 20x1?
a. 198,948 c. 138,843
b. 135,204 d. 143,134

Solution:
Interest
Date payments Interest expense Amortization Present value
Jan. 1, 20x1 4,198,948
Dec. 31, 20x1 480,000 419,894 60,106 4,138,842

4,000,000 face amount – 4,138,842 = 138,842

4. On January 1, 20x1, SLOPPY UNTIDY Co. issued 10%, ₱4,000,000 bonds at face
amount. SLOPPY paid underwriter’s commission of ₱192,147. The bonds mature
on December 31, 20x3. Interest is due annually. The effective interest on the
bond issue is approximately equal to
a. 9.2659% c. 12%
b. 11.3692% d. 13.5%

Solution:
Initial measurement: (4,000,000 – 192,147) = 3,807,853

Trial using 12%:

F (4M x PV of ₱1 @ 12%, n=3) + [400,000 x PV of an ordinary annuity of ₱1 @ 12%, n=3] =
3,807,853
F (2,847,120 + 960,733) = 3,807,853 is equal to 3,807,853s
 The effective interest is 12%.

5. On March 1, 2002, Pyne Furniture Co. issued ₱700,000 of 10 percent bonds to

yield 8 percent. Interest is payable semiannually on February 28 and August 31.
The bonds mature in ten years. Pyne Furniture Co. is a calendar-year corporation.
How much is the issue price of the bonds?
a. 792,335 c. 802,336
b. 795,132 d. 809,667
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Solution:
F (700,000 x PV of 1 @4%(a), n=20(b)) + (35,000(c) x PV ordinary annuity @4%, n=20) =
F 319,471 + 475,661 = 795,132

(a)
8% ÷ 2 = 4%
(b)
10 yrs. x 2 payments in a year = 20
(c)
700,000x 10% x ½ = 35,000

6. On January 1, 20x1, SPITEFUL MALICIOUS Co. issued 1,000, ₱4,000, 10%, 3-year
bonds for ₱3,807,852. Principal is due on December 31, 20x3 but interests are
due annually every year-end. The effective interest rate is 12%. SPITEFUL Co.
incorrectly used the straight line method instead of the effective interest method
to amortize the discount. What is the effect of the error on the carrying amount
of the bonds on December 31, 20x1? (over) understated
a. 7,107 c. 6,341
b. (7,107) d. (6,341)

Solution:
Erroneous amortization of discount using straight line:
The erroneous straight-line amortization of the discount on bonds payable is computed as follows:
4,000,00
Face amount of bonds
0
(3,807,852
Cash proceeds
)
192,14
Discount on bonds payable - Jan. 1, 20x1
8
Divide by: Term of bonds (in years) 3
64,04
Annual amortization (straight line method)
9

Interest expense for 20x1 recognized under straight-line method:

400,00
Interest paid (4,000,000 x 10%) 0
64,04
Amortization of discount (see computation above) 9
464,04
Interest expense under straight-line method 9

Carrying amount of bonds on Dec. 31, 20x1 under straight-line method:

Carrying amount - Jan. 1, 20x1 3,807,852
Amortization of discount (see computation above) 64,049
Carrying amount - Dec. 31, 20x1 3,871,901

Amortization of discount under effective interest method:

Amortization table:
Interest Interest Amortizatio Present
Date payments expense n value
Jan. 1, 20x1 3,807,852
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3,864,79
Dec. 31, 20x1 400,000 456,942 56,942 4

Effect on carrying amount of bonds as of Dec. 31, 20x1

Carrying amounts on Dec. 31, 20x1:
Straight-line 3,871,901
Effective interest rate 3,864,794
Difference - overstatement under straight-line 7,107

The carrying amount of the bonds on December 31, 20x1 under the straight line method is overstated
by ₱7,107.

7. On April 1, 20x1, SQUALID FILTHY Co. issued 12%, ₱4,000,000 bonds dated
January 1, 20x1 at 97 including accrued interest. The bonds mature in ten years
and pay interest annually every year-end. How much is the initial carrying
amount of the bonds?
a. 3,760,000 d. 3,812,341
b. 3,880,000 c. 4,000,000

Solution:
Cash proceeds including accrued interest (4M x 97%) 3,880,000
Accrued interest sold (4M x 12% x 3/12) (120,000)
Carrying amount of the bonds, April 1, 20x1 3,760,000

8. On January 1, 20x1, POTENT POWERFUL Co. issued 12% bonds with face amount
of ₱4,000,000 for ₱4,303,264. The bonds mature in five years and pay annual
interest every year-end. The effective interest rate is 10%. On July 1, 20x3,
POTENT called-in the entire bonds and retired them at 102, which is inclusive of
payment for accrued interest. How much is the gain (loss) on the extinguishment
of the bonds?
a. 328,897 c. (118,948)
b. (328,896) d. 118,948

Solution:
Interest
Date payments Interest expense Amortization Present value
Jan. 1, 20x1 4,303,264
Dec. 31, 20x1 480,000 430,328 49,672 4,253,592
Dec. 31, 20x2 480,000 425,360 54,640 4,198,948
July 1, 20x3 240,000 209,948 30,052 4,168,896

Carrying amount of bonds retired: (see table above) 4,168,896

Retirement price (Call price):
Retirement price including payment for
accrued interest (4M x 102%) 4,080,000
Accrued interest (4M x 12% x 6/12) (240,000) 3,840,000
Gain on extinguishment of bonds 328,896

9. On January 1, 20x1, TIPSY UNSTEADY Co. issued 10%, ₱12,000,000 bonds for
₱11,601,220. Principal on the bonds matures in three equal annual installments.
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Interest is also due annually at each year-end. The effective interest rate on the
bonds is 12%. How much is the carrying amount of the bonds on December 31,
20x1?
a. 7,844,635 c. 7,683,343
b. 7,793,366 d. 7,543,341

Solution:
Principal Interest on outstanding
Date payments principal balance Interest payments Total payments
Dec. 31, 20x1 4,000,000 12,000,000 x 10% 1,200,000 5,200,000
Dec. 31, 20x2 4,000,000 8,000,000 x 10% 800,000 4,800,000
Dec. 31, 20x3 4,000,000 4,000,000 x 10% 400,000 4,400,000

Date Total payments Interest expense Amortization Present value

Jan. 1, 20x1 11,601,220
Dec. 31, 20x1 5,200,000 1,392,148 3,807,852 7,793,368

10.On December 31, 20x1, CONFLAGRATION LARGE FIRE Co. agreed to the following
modification of its existing liability:
 The principal remained unchanged at ₱20,000,000.
 The repayment of the accrued interest of ₱600,000 was waived.
 The maturity date was extended from December 31, 20x2 to December 31,
20x4.
 The stated rate was reduced from 12% to 10%.

Interest is payable annually at each year-end. The original effective interest rate is
12%. CONFLAGRATION Co. incurred costs of ₱200,000 which were directly
attributable to the restructuring. The costs were paid to third parties. How much is
the gain (loss) on the extinguishment of the debt?
a. (1,360,732) c. (200,000)
b. 1,360,732 d. 0

Solution:
The modification is analyzed as follows:
Old terms New terms
Principal 20,000,000 20,000,000
Accrued interest 600,000 -
Remaining term ('n') 3 years
Nominal rate 12% 10%
Direct costs of modification 200,000

Future cash flows PV factors @12%, n=3 Present value

Principal 20,000,000 0.711780 14,235,600
Interest 2,000,000 2.401831 4,803,662
Present value of the modified liability 19,039,262

Carrying amt. of old liability (20M + 600K accrued int.) 20,600,000

Present value of modified liability 19,039,262
Difference 1,560,738

Difference 1,560,738
Divide by: Carrying amount of old liability 20,600,000
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7.58%

 The modification is NOT substantial. The old liability is not extinguished and NO GAIN OR
LOSS on extinguishment is recognized. The direct costs of modification are treated as an
adjustment to the carrying amount of the existing liability.

11.On December 31, 2011, Cey Company had outstanding 10%, P1,000,000 face
amount convertible bonds payable maturing on December 31, 2014. Interest is
payable on June 30 and December 31. Each P1,000 bond is convertible into 40
shares of P10 par value. On December 31, 2011, the unamortized premium on
bonds payable was P60,000. On December 31, 2011, 400 bonds were converted
when Cey’s share had a market price of P24. Cey incurred P4,000 in connection
with the conversion. No equity component was recognized when the bonds were
originally issued. What is the share premium from the issuance of shares as a
result of the bond conversion on December 31, 2011?

Solution:
Bonds payable 1,000,000
Premium on BP 60,000
Carrying amount 1,060,000

Carrying amount converted 4/10 x 1,060,000 424,000

Par value of shares 400 x 40 x 10 160,000
Share premium 264,000
Conversion expenses 4,000
Net share premium 260,000

12.Clay Company had P600,000 convertible 8% bonds payable outstanding on June

30, 2011. Each P2000 bond was convertible into 10 ordinary shares of P50 par
value. On July 1, 2011, the interest was paid to bondholders, and the bonds were
converted into ordinary shares, which had a fair value of P75 per share. The
unamortized premium on these bonds was P12,000 at the date of conversion. No
equity component was recognized when the bonds were originally issued. What
is the increase in share premium as a result of the bond conversion?

Solution:
Bonds payable 600,000
Premium on BP 12,000
Carrying amount 612,000
Par value of ordinary shares issued 3000 shares x 50 150,000
Share premium 462,000

13.Spare company had outstanding share capital with par value of P50,000,000 and
a 12% convertible bond payable in the face amount of P10,000,000. Interest
payment dates of the bond issue are June 30 and December 31. The conversion
clause in the bond indenture entitles the bondholders to receive 40 shares of P25
par value in exchange for each P1000 bond. On June 30, 2011, the holders of
P5,000,000 face value bonds exercised the conversion privilege. The market
price of the bonds on that date was P1,100 per bond and the market price of the
share was P30. The total unamortized bond discount at the date of conversion
was P500,000. The share premium from conversion privilege has a balance of
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P2,000,000 on June 30, 2011. What amount of share premium should be

recognized by reason of the conversion of bonds payable into share capital?

Solution:
Bonds payable 10,000,000
Discount on bonds payable (500,000)
Carrying amount 9,500,000

Carrying amount converted 5/10 x 9,500,000 4,750,000

Applicable share premium from 5/10 x 2,000,000 1,000,000
conversion privilege
Total consideration 5,750,000
Par value of shares issued 5,000 x 40 = 200,000 shares x 25 5,000,000
Share premium from conversion 750,000

14.Susan company issued 5,000 convertible bonds on January 1, 2011. The bonds
have a 3-year term and are issued at 110 with a face value of P1,000 per bond.
Interest is payable annually in arrears at a nominal rate of 5% interest rate.
Each bond is convertible at anytime up to maturity into 100 ordinary shares with
par value of P5. When the bonds are issued, the prevailing market interest rate
for similar debt instrument without conversion option is 9%. What is the equity
component of the issuance of the convertible bonds on January 1, 2011? (Carry 2
decimal places only of the present value factors).

Solution:
PV of 1 at 9% for 3 periods 0.77
PVOA at 9% for 3 periods 2.53

PV of principal 5,000,000 x 0.77 3,850,000

PV of annual interests 250,000 x 2.53 632,500
Total PV of bonds 4,482,500

Issue price of convertible 5,000,000 x 110% 5,500,000

bonds
PV of bonds 4,482,500
Equity component 1,017,500

15.On March 1, 2011, Case Company issued P5,000,000 of 12% nonconvertible

bonds at 103 which are due on February 28, 2016. In addition, each P1,000 bond
was issued with 30 detachable share warrants, each of which entitled the
bondholder to purchase, for P50, one ordinary share of Case Company, par value
P25. On March 1, 2011, the quoted market value of each warrant was P4. The
market value of the bonds ex-warrants at the time of issuance is 94. What
amount of the proceeds from the bond issue should be recognize as an increase
in shareholders’ equity?

Solution:
Issue price of bonds with warrants 5,000,000 x 103% 5,150,000
Market value of bonds without warrants 5,000,000 x 94% 4,700,000
Residual amount allocated to warrants – equity component 450,000
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16.Due to extreme financial difficulties, Armada Company has negotiated a

restructuring of its 10%, P5,000,000 note payable due on December 31, 2011.
The unpaid interest on the note on such date is P500,000. The creditor has
agreed to reduce the face value to P4,000,000, forgive the unpaid interest,
reduce the interest rate to 8% and extend the due date three years from
December 31, 2011. How much is the amortized portion of the discount related
to the new liability for 2012? (Carry 2 decimal places only of the present value
factors)

Solution: