_ CHAPTER 14 suttertack Non-Current Liabilities LEARNING OBJECTIVES aterstudying this chapter, you should be able 1, Describe the nature of bonds and indicate the accounting for bond issuances. 2. Explain the accounting for long-term notes 4, Indicate how to present and analyze non-current payable. liabit 3. Explain the accounting for the extinguishment. of non-current liabilities. PREVIEW OF CHAPTER 14 As the following opening story indicates, governments ad companies are increasingly relying on long-term borrowing to yet the resources needed ‘oroperations. In this chapter, we explain the accounting issues related to non-current libil tes The content and organization of the chapter are as follows. Me eed Poel Cemoiny Sours Cees PYOR ae ee ek [Bonds Payable Long-Term Notes Extinguishment of Presentation and Types of bonds Payable Non-Current Liabilities | | Analysis |+ Issuing bonds + Notes issued at face it + Fairvalue option | + Valuation and accounting | | value enbecreceaty) + Off-balance-sheet | | | forbonds payable + Notes not issued at face financing + Eletve.interest vain) exchanging assets or ||. presentation of non- | notes payable secures current liabilities |, method + Spe e ; | situations + Extinguishment with + Analysis of non- modification of terms, ys yon-current l + Mortgage notes payable liabilities Going Long Gacinments issue debt when their expenditures exceed their tax receipts. This is often the ‘xen governments want to stimulate their economies either directly via spending or 1S through a reduction in taxes. While this is a reasonable policy, many governments sat! Practice operated at substantial deficits for a number of years, relying on borrowing to “PP0R their spending, — Scanned with CamScanner142 CHAPTER 14 Non-Current Liabilities ¢s the $69 trillion total government debt sider chart (a), which shows the St aver that the United States and Japan have the largest arma nt of outstanding debe ne : es that of the United States, ‘ an’s debt to GDP ratio is over two times t States bo 1 (), total debe ou ces, As can been seen in ch have triggered record bond issuances, As can ng i rs recenly increased in every region of the world, For example, total debt outsang in 10 years ©) wo — Percentage of World Government Total Corporate Debt Outstanding itn Debe ($69 Trillion) % sur Otheradranes | econenies | other counties “em Other develo ses | 588 | India and rae china Japan | China este Ege hay, Germany, | Franceyand saa United Kingdom | Uoteastaes | United States 2007 20132017 suaiCapitalstcom | | Source: Data from McKinsey Global stitute, 59 Corporate Deb: Prior Promise? (June 2018) Companies such as PayPal (USA), Air Liquide (FRA), and To URSIN qui )- and Toyota Motor (PS) all sold long-term bonds recently. Increases in the issuance of these bonds suggest have a strong appetite for issuing the bonds because they provide substantial nat a relatively low interest rate. The hope ig e beneicil# - The hope is that the trend will prove bene! both the investor and the company in the long ruin : infu Review and Practice Go to the Review and Practice section uth d a nail exercises aa practice probltn with solutions ate abo aaltlc aoe —_—_—_— Scanned with CamScannerBonds Payable 14-3 Bo! LeARNIN esc pe the nature of bonds and indicate the accounting for bond issuances. — pcrent abilities (Sometimes referred toas long term debt) consist ofan expected outflow sans esarising from present obligations that are not payable within a year or the operating oes pote company. ope, pension liabili rane pany usual requires approval by the board of di whichever is longer. Bonds payable, long-term notes payable, mortgages id lease liabilities are examples of non-current liabilities. ctors and the shareholders before ee notes can be issued. The same holds true for other types of long-term debt arrangements. ‘General long-term debt has various covenants or restrictions that protect both lenders od TEN rest at, vers The indenture or agreement often includes the amounts authorized to be issued, due date(s), call provisions, property pledged as security, sinking fund requirements, ‘eejingcaptal and dividend restrictions, and limitations concerning the assumption of additional ex Companies Should describe these features in the body of the financial statements or the notes, $fnporant fora complete understanding ofthe financial postion and the results of operations. though it would seem that these covenants provide adequate protection to the long- tem debiholder, many bondholders suffer considerable losses when companies add more debuto the capital structure. Consider what can happen to bondholders in leveraged buyouts (1803), which are usually led by management. In an LBO of RR Nabisco (USA), for ex anpe, solidly rated 9% percent bonds plunged 20 percent in value when management an- tounced the leveraged buyout. Such a loss in value occurs because the additional debt added tothe capital structure increases the likeli Types of Bonds 00d of default. Although cover folders, they can still suffer losses when debt levels get too high. ts protect bond- \edefine some of the more common types of bonds found in practice as follows. D5 Secured and Unsecured Bonds. Secured bonds are backed by ‘pledge of some sort of collateral. Mortgage bonds are secured by ‘chim on real estate, Collateral trust bonds are secured by shares 4nd bonds of other companies. Bonds not backed by collateral are ‘unsecured. A debenture bond is unsecured. A “junk bond” is un- secure and also very risky, and therefore pays a high interest rate. Companies often use these bonds to finance leveraged buyouts. Tem, Serial Bonds, and Callable Bonds. Bond issues that atu ona single date are called term bonds; issues that mature ‘ninsaliments are called serial bonds. Serially maturing bonds 2: fequenly used by school or sanitation districts, muniipali- & orcther local axing bodies that receive money through a spe fully. Callable bonds give the isuer the right to call and retire bonds prior to maturity. RMertibe Bonds. bonds are convertible into er secur US the company for a specified time afer issuance, they are vertble bonds Sad of bonds have been developed in an attempt to attract en! 0a tight money market—commodity-backed bonds and Sk2dicount bonds. Commodity-backed bonds (also called inked bonds) are redecmable in measures of commodity such as barrels of oil, tons of coal, or ounces of rare metal. To illus- trate, Sunshine Mining (USA). a silver-mining company, sold bonds that were redeemable with either $1,000 in cash or $0 ‘ounces of silver, whichever was greater at maturity, and that had stated interest rate of 8% percent. The accounting problem was, fone of projecting the maturity value, especially since silver has yctuated between $4 and $40 an ounce since issuance Deep-discount bonds, also refered to as zero-Interest deben: ture bonds, are sold ata discount that provides the buyer's total interest payolf at maturity, with no periodic interest payments, Registered and Bearer (Coupon) Bonds. Honds issue in the name of the owner are registered bonds and require surrender of the certificate and issuance of a new certificate to complete a sale. A bearer or coupon bond, however, is not recorded in the me of the owner and may be transferred from one owner to an- ‘other by mere delivery Income and Revenue Honds. Income bonds pay no inter ext unless the issuing company Is profitable, Revenue bonds, so called because the Interest on them Is pald fom specified revenue sources, are mast frequently Isued by airports, school districts, counties, tll road authorities, and governmental bodies. Scanned with CamScanner14-4 CHAPTER 14 Non-Current Liabilities Issuing Bonds a asa bond indenture. A bond represents A ond aries fom acon rat, pls 2 erode ey, pay ida sm of money ale), nial bond are evidenced by pe realy have a €1,000 face value. Companies usually make bond ine eg y have a €14 aime though the interest rate is generally expressed a an annual ae Thee’ purpose of bonds isto borrow forthe longterm when the amount of capital nei large for one lender to supply. By issuing bonds in €1 0, £1.00, oF £10.00 deen ‘a company can divide a large amount of long-term inde! Ps ie into many smal} inven unis, thus enabling more than one lender participate inthe oan, : ‘A company may sell an entire bond issue {0 an investment bank, which acts aya, ty agent inthe process of marketing the bonds. In such arrangements, investment banigent underwrite the entire issue by guaranteeing a certain sum to the company, thus taking ty of selling the bonds for whatever price they can get (firm underwriting). Or, the underneg ould sel the bond issue fora commission on the proceeds ofthe sale (best-ffons undone ing), Alternatively the issuing company could sell the bonds directly to a large insane financial or otherwise, without the aid of an underwriter (private placement), How do investors monitor their bond investments? One way is toreview the bond listings found in the newspaper or online, Com- pany bond listings show the coupon (interest) rate, maturity date, However, because company bonds are more actively titutional investors, the listings also indicate the eld. Company bond listings would look as follows. Issuer Coupon Maturity Price Yield Rating Vodafone Group 6.15% 2/17/2037 128.81 3.69% BBB Telecom Italia Sp.A 7.20% 7/18/2036 116.24 5.65% BB+ ‘The companies issuing the bonds are listed in the first column, in this case, two telecommunications companies, Vodafone Group, (GBR) and Telecom Italia S.p.A (ITA), In the second column is the interest rate paid by the bond as a percentage of its par value, followed by its maturity date. The Vodafone bonds, for example, pay 6.15 percent and mature on February 17, 2037. The Telecom Italia bonds pay 7.20 percent. The Vodafone bonds have a current yield of 3.89 percent, hased on the price of 128.81 per £1,000. In contrast, the Telecom Italia bonds selling at 116.24 yield 5.65 percent, The final column gives the bond rating. Vodafone, witha rating of BBB, What Do the Numbers Mean? All About Bonds {s viewed as more creditworthy than Telecom Italia, which epi, why Vodafone's bonds sel at a higher price and lower yield ‘Also, as indicated in the chapter, interest rates and the bends term fo maturity have a real effect on bond prices. For eagle an increase in interest rates will lead to a decline in bond values Six: ‘arly, a decrease in interest rates will lead to a rise in bond vals. ‘The following data, based on three different bond funds, demonstra these relationships between interest rate changes and bond values, ‘Bond Price Changes in 9binterest —1slnteret Response to Interest Rate pate Rate Changes: Increase _Decrense Short-term fund 2-5 years) ~25% ae Intermediate-term fund (5 years) 5% +58 Long-term fund (10 years) 10% 0% ‘Source: The Vanguard Group, Another factor that affects bond prices is the call featur. which decreases the value of the bond, Investors must be rev ced for the risk that the issuer will call the bond if interest decline, which would force the investor to reinvest at lower Ft Valuation and Accounting for Bonds Payable ‘The issuance and marketing of bonds ‘weeks or even months, First, the issui ‘market and sell the bonds. Then, audits, and issue a prospectus (a d financial information), Finally, the ‘0 the public does not happen overnight. It usually ing company must arrange for underwriters wich wil ‘Must obtain regulatory approval of the bond isu ue locument that the features of the bond and Scanned with CamScanner4 at the present value of its expected future cash flows, which consist of ave 8 and 2) principal. The rate used to compute the present value ofthese cash flows Is uimeteerate that provides an acceptable return on an investment commensurate with the eine ekcharacterstics. ne {terest rate written in the terms of the bond indenture (and often printed on the mficate) known as the stated, coupon, oF nominal rate. The issuer ofthe bonds piste. The stated Tate is expressed as a percentage of the face value ofthe bonds (also separ valos pinelpal amount, oc maturity valu), gonds issued at Par spoerteemployed by the investment community (buyers) is the sume asthe stated rate, the ‘selbat par. Tht is, the par value equals the present value of the bonds computed by the es cand the current purchase price). To illustrate the computation of the present value abond issue, assume that Santos SA issues RS100,000 in bonds dated January 1, 2022, due otgveyeas with 9 pereent interest payable annually on January 1. At the time of issue, the feviet rate for such bonds is 9 percent. The time diagram in IMustration 14.1 depicts both seinterest and the principal cash flows, — ” £5100,000 Pineal | = 996 rrox___R83000" __S5(00 "$3,000 __R59,000__RS9,000Interest. | en ¢ t 2 3 * 5 [seo 900.09 ssshown in Mustration 14.2. Present value ofthe principal: | $100,000 x 64983 (Table 6.2) RS 64.993 | Present value of the interest payments: | 9,000 x 3.86965 (Table 6.4) 35,007 l Present value (selling price) of the bonds ae ee | paying RS100,000 (the par value) at the date of issue, investors realize an effective rate “veld of 9 percent over the five-year term of the bonds. Santos makes the following entries ‘athe first year of the bonds. ree Lc “January 1, 2022 (issue bonds) | cash 100,000 Bonds Payable 100,000 Theactual principal and interest cash flows are discounted at a 9 percent rate for five periods, | | Interest Expense (100,000 x.08) 9,000 \ | Docu 0,2 eieed are open |_“oecaee a January 1,2023 (record the frst int ‘meres Payable Cash _ Bonds Payable 14-5 SUE Time Diagram for Bonds Issued at Par Mune Present Value Computation of Bond Selling at Par Scanned with CamScanner146 CHAPTER 14 Non-Current Liabilities Time Diagram for Bonds ued sts Dosoune (RULED Present Value Computation of Bond Selling at a Discount Bonds Issued at Discount or Premium : Joyed by the investment community Couyers) ifers fom the sted IF the rate empl ponds computed by the buyers (and the current Purchse price yi Ponstel of {ference between the face value and the pre value ofthe bonds. The di ; ind the presen ore ond determines the actual price that buyers pay for the bonds. This difference g,* a discount or premium. «Ifthe bonds sell for less than face value, they sell at 2 discoun they sell ata premium. iscount. + If the bonds sell for more than face value, ly earned by the bondholders is called the effective yey, market rate. if bondssell ata discount, the effective yield exceeds the stated rate. Conrengy if bonds sel ata premium, the effective yield is lower than the stated rate. Several vars affect the bond's price while it is outstanding, most notably the market rate of interest isan inverse relationship between the market interest rate and the price of the bond, “To illustrate, assume now that Santos issues R$100,000 in bonds, due in five years 9 percent interest payable annually at year-end. At the time of issue, the market rate frst bonds is 11 percent. The time diagram in Ilustration 14.3 depicts both the intrest andi ‘The rate of interest actuall principal wv $100,000 Principat 5 19% | Pv.oa 9,000 3,000 $3,000 $9,000 __RS8,000 Interest ° 1 2 3 *R$100,000.x.05, i ‘The actual principal and interest cash flows are discounted at an 11 percent rate for fi periods, as shown in Mustration 14.4, Present value ofthe principal | 'R5100,000 x 59345 (Table 6.2) 559,345 | Present value ofthe interest payments: | $9,000 x 3.69580 (Table 6.4) 33,263 | Present value (selling price) of the bonds 592,608 | By paying RS92,608 at the date of issue, investors realize an effective rate or vied! 11 percent over the five-year term of the bonds. These bonds would sell at a discout $7,392 (RS100.000 — R$92,608). The price at which the bonds sell is typicaly stated? percentage of the face or par value of the bonds. For example, the Santos bonds so i (s 6% of par). If Santos had received R$102,000, then the bonds sold for 102(! of par). ight bonds sell at less than face value, it means that investors demand arate fit bigher than the stated rate, Usually, this oceurs because the investor can ear 3 highe wise to pay ice ee anda 8k The investors cannot change the sated mH #8 refuse to pay face value for the bonds, Thus, si sted, they ae effective rate of return. The by changing the amount invested Be ‘itis generally the case that the stated rate of in pereent), Companies usually attempt to align thea iret on bol fs set in rather prove devils (8542 ie ated rate closely a pose with the are Scanned with CamScannerBonds Payable 14-7 what DO the Numbers Mean? How About a 100-Year Bond? searge Tor example, Elecriité de France S.A (FRA) in that Disney ised in 1993 fs suppesed to mature sec pts 100 ear bondsin Europe In addon, countries such comypanyean start repaying the bons any and Meso haverecerty sol 100year goverment nds San weal Lt eapicamiecunuieson ijeetonls Aten a au ee have non-current liabilities, The ca gm at ait misatch, Whe ieetng 2g eet against long-duration assets, Thus, this group of indole companies suchas Walt Dimey Somes Aber rane ‘dnanoption that lets the debt issuer partially or fully repay the debt Comeback Tra companies ssve bonds with maturities that exceed a per Jong before the scheduled maturity For example, the 100 yea" bond, that 1,000var bonds also exist. ers, such as the Canadian Pacific Corporation (CAN), ier of investors, such as pension funds and insurance haveissueu such bondsin the past. And, there have also been instane: y need long-duration esof bonds issued with no maturity {suers continue fulfilling the eoupon payments forever. These types struments are commonly referred toas perpetultes Do Compani ell, "EDF's Horrowing Exceeds ‘company(USA)and The Coca-Cola Company (USA), haveissued $12 tillion This Week with 100:Year Bon foyearbonds in the past. Many of these bonds and debenturescon- 2014); and Dara Doyle, “Ireland Sells First 100-Year Bond, S "Bloomberg (March 16, 2016). | {in 2093, but the ime after 30 years (2023), tall, meaning that the debt Issue 100-Year Bonds?” Bloomberg Ganuary 17. ying On Effective-Interest Method ssdiscussed eatlier, by paying more or lessat issuance, investors earn a rate different than the coupon rate on the bond. Recall that the issuing company pays the contractual interest rate verte term of the bonds but also must pay the face value at maturity. Ifthe bond is issued atadiscount, the amount paid at maturity is more than the issue amount, If issued at a pre~ nium, the company pays less at maturity relative to the issue price. ‘The company records this adjustment to the cost as bond interest expense over the life sfihehonds through a process called amortization. Amortization of adiscount increases tond interest expense. Amortization of a premium decreases bond interest expense. Therequired procedure foramortization of adiscount or premiumistheeffective-interest ‘ethod (also called present value amortization). Under the effective-interest method, com- panies [1] (See the Authoritative Literature References section near the end of the chapter.) Compute bond interest expense first by multiplying the carrying value (book value) of the bonds atthe beginning of the period by the effective-interestrate.? 2 Determine the bond discount or premium amortization next by comparing the bond in- terest expense with the interest (cash) to be paid. Nuustration 14.5 depicts graphi ly the computation of the amortization, ‘Bond interest Paid ‘Sond Interest Expense Canngvaae Effectve- FaceAmount Stated ‘Amortization StBendsat x Interest | ~ or % interest |= | Amount etiningof Period Rate Bonds Rate per ffctiventerest method produces a periode interest expense equal toa constant 'nlage of the carrying value of the bonds.” Teng ale she face amount las any unarortize count ous any Unamorted ee value is synonymous with book value. el eee a en gl nd cm prnson 2th smiarehages These oat should be corded as feetion ofthese mount othe ect '¢ and then amortized into expense over the life of the bond, through an adjustment to the ince tee Fate (sce Underlying Concepts). [2] For example, i the fae vale ofthe bond is C100,000, Seatac C1000, then the bond payable (nto the bon issue costs) is recorded at €99.00, Thus, a ny OE EL Bond Discount and Premium Amortization Computation Underlying Concepts Because bond issue costs do not meet the definition of an asset, some argue they should be expensed at issuance, Scanned with CamScanner148 CHAPTER 14 Non-CurrentLiabilities Bonds Issued at a Discount .e amortization of a discount under the effective-interest method, assume: t Se Caaaoneh aires nuary 1, 2022, due on fangs ter AG issued €100,000 of & percent I 22, de on SaaS \With interest payable each July 1 and January 1. Because the investors required an, interest rate of 10 percent, they paid €92,278 for the €100,000 of bonds, creating ‘count, Evermaster computes the €7,722 discount as shown nn Maturity value of bonds payable ‘Computation of Discount on Present valve of €100,000 due in years at 10%, interest payable feone Pavalte ‘semiannually (Table 6:2); FM(PUF gy) (€100,000 61391) es139 Present valve of €4,000 intrest payable semiannually for 5 years at 1055 annually Table 64); FUPUF OA} (€8,000 7.72173) 30887 Proceeds from sale of bands tam Discounton bonds payable tm | inet Mlustration wg! 2s a 109%) ‘The five-year amortization schedule appeats in Iustration 14.7, ond Discount Amortization Schedule a Galeator station or Schedule of Bond Discount Amortization j 1 Prosentvalve tfective-Interest Method—Semiannual Interest Payments | caerene ‘Year 8% Bonds Sold to Veld 10% | Corning o cosh Interest Discount Amount oate ad Expense Amortized Bonds mm eam \ fi mhz € 4000" aus € out szan mans Sas co oom ma asm or eae | mrs m1 oaans 2 an ; anys 783 ase inns sam [pt] 0% that xn = mrs saoss , mar 109000 | . reaene= e276 10% Evermaster records the iss cash Bonds Payable ince ofits bonds at a discount on J 92.278 It records the fitst interest payment on July 1, 2022, a follows. Interest Expense Bonds Payable cash tet records the interest expense accrued at December 3 amortization of the discount as follows, Interest Expense Interest Payable Bonds Payable 635 “tecause companies pay in est erlannuslly. the interest rate used $4 (10x Yah The nundroo 1s 10(8 yearsx2), rate use 9 $4 (10 Ya The us Scanned with CamScannergsissued at a Premium a asume hat forthe bond issue described above, investorsare willing toacceptan effective- sen ate of 6 percent. In that case, they would pay €108,530 or a premium of €8,530, 0 jesshown in Ilustration 14.8, x sty valve ofbonds payable amie | ramtat value of €100,000 due in 5 years at 6%, interest payable “Sriannualy Table 62); FVPYF sn) (€100,000 x 74408) vale of €4,000 interest payable semiannually for years “es annually (Table 6.4); RUPYE OAs (4,000 8.53020) raceedstrom sate of bonds ‘reniumonbonds payable ‘pefive year amortization schedule appears in IMlustration 14.9, [EET nnd premium Amortization Schedule i Schedule of Bond Premium Amortization Effective-nterest Method—Semiannual interest Payments S.vear, 8% Bonds Sold to Yield 6% corning cash Interest Premium ‘Amount Date, Paid Expense Amortized of Bonds | ina ‘€108,530, | min € 4000" 3,256" € maa 1o7zast wp 4,900 334 166 107,020 mp3 4,900 32u 169 106,231 mae 4,000 3187 a3 105,418, aur 4,000 36a 37 104581 ans 4,000 3137 863 103.718 | maps 4,000 3an 388 102,830 | m6 4,000 3,085 15 101915 | maps 4,000 3087 8 100972 snat 4,000 3.029 on 100,000 £40,000 un es “4000 = 000% 08x64 sera = (4000 ~ 2356 “eon =€108500- E744 “eaass = ous 06x tain ee Exermaster records the issuance of its bonds at a premium on January 1, 2022, as follows. cash 108,530 Tonds Payable Exermaster records the first interest payment on July 1, 2022, and amortization of the Fenium as follows 108,530 Interest Expense 3.256 Bonds Payable ma Cash 000 ___ Eetmaster should amortize the discount or premium as an adjustment to interest ex- ‘seiner helifeof the bond in such a way a8(0 result ina constant rate of interest when lied wo the carrying amount of debt outstanding at the beginning of any given period.* ‘cruing interest ‘oe Previous examples, the interest payme' n Were essentially the same, For example, when Evermast statements were premium unt datesand thedate the finan fer sold bonds in dae. Thal feature gives the fun seany Pantage of lower Interest rates. Whether bands over the bond’ lifeto maturity Pein Sere DAY cal we bonds at a stated price after acetal ually to reduce its bonded indebtedness of take adv Be. acomnpany must amortire any premiam or disor '¥edempeion (all f the bond) Is nota certainty Bonds Payable 14-9 ILLUSTRATION 14.8 ‘Computation of Premium on Bonds Payable ay et nese ae Inputs Answer Scanned with CamScanner24-10 CHAPTER 14 Non-Current Liabilities bwo interest payment dates coincided with the financial reporting dates. Howerey yp, pens if Evermaster prepares financial statements atthe end of February, 20227 nig Mlustration 14.10 shows, the company prorates the premium by the appropriate pi“ months to arrive at the proper interest expense. (OT ao a ee Interest accrual (64,000 x?) 133333 a umber Computation of Interest Premium amortized (€744 24) 248.00) | Expense Interest expense Jan-Feb) 005.33 {2 Evermaster records this accrual as follows Interest 1,085.33, Bonds P 248.00 Interest Payable 1333.33 If the company prepares finan ements six months later, it follows the same pr. dure, That is, the premium amortized would be as shown in Illustration 14.11, Se eae | E een ea arcane Computation of Premium Premium amortized (July-August) (€766 x 24} 255.33 | Amortization: Premium amortized (March-August 2022) (751.33 i Bonds Issued Between Interest Dates ‘Companies usually make bond interest payments semiannually, on dates specified in the tnt indenture. When companies issue bonds on other than the interest payment dates, bond vestors will pay the issuer the interest accrued from the last interest payment tt to the date of issue. The bond investors, in effect, pay the bond issuer in advance for tt portion of the full six-month’ interest payment to which they are not entitled because ty have not held the bonds for that period. Then, on the next semiannual interest paymea! date, the bond investors will receive the full six-months' interest payment. sume that instead of issuing its bonds on Janay! ape Bonds Issued at Par To illustrate, 2022, Evermaster issued its five-year bonds, dated January 1, 2022, on May 1 (€100,000). Evermaster records the issuance of the bonds between interest dates fol May 1, 2022 h 100,000 Bonds Payable 10,000 (To record issuance of bonds at par) cash 2,667 Interest Expense (€100,000 x 08 x (To record accrued interest; Interest Payable might be credited instead) soe he Because Evermaster issues the bonds between interest dates, it records the bo! at par (€100,000) plus accrued interest (€2,667). That is, the total amount paid bs" nvestor includes four months of accrued interes On July 1, 2022, two months after the date of purchase, Everm: ‘months’ interest, by making the following entry. e ver pays te ave Interest Expense Suay 12022 ——_Tsniaz 2,067" ee nee Ise (€100,000 08 ¥/i2) 4,000 ro pz sgoo*| (to record first interest payment) lance 1.383 - “accrue intrest tee ‘The Interest Expense wecount now eontalnsa debit balance of €1,333 (€4,000 — 2.467 “Cash paid represents the proper amount of interest expense—two months at percent on €12 Scanned with CamScannerBonds Payable 14-11 jssued at Discount or Premium The illustration above was simplified by hav- ean 1s 2022, bonds issued on May 1, 2022, at par, However if the bonds reissued ef quntor premium between interest dates, Evermaster must net only aecount for the sat eash interest payment but also the amount of effective amortization for the jal period. pal rate asume thatthe Evermaster8-percent bonds wer isd on May 1, 2022 gaseercent. Thus, the bonds are issued at a premium; in this case, the price fs €108,039." sero the fsuane ofthe bonds between interes dates a OWS. May 1, 2022 108,039 108,039 h flows) cash 2.667 Interest Expense (€100,000 X.08 x 4/2) 2.667 (To record accrued interest; Interest Payable might be credited instead) Inthis case, Evermaster receives a total of €110,706 at issuance, comprised of the bond srs of €108,039 plus the accrued interest of €2,667. Following the effective-interest proce- Aires, Evermaster then determines interest expense from the date of sale (May 1, 2022), not fom the date of the bonds (January 1, 2022). Illustration 14.12 provides the computation, ‘sng the effective-interest rate of 6 percent, The bond interest expense therefore for the two ronths (May and June) is €1,080. Interest Expense ILLUSTRATION 14.12 CCatryingvalue of bonds 108,038 Partial Period Interest Effective interest rate (06 x2) 1% Amortization Inerest expense fortwo months © 1,980 ‘The premium amortization of the bonds isalso for only two months. ILis computed by tak- 'sgthe difference between the net cash paid related to bond interest and the effective-interest ‘7ense of €1,080, IMlustration 14.13 shows the computation of the partial amortization, ‘wing the effective-interest rate of 6 percent. Less Cash interest eceived on May 1, 2022 208T Partial Period Interest Net cash paid 41333 Amortization | Bondintrest expense (atthe elective ate) fortwomonths 1,080) ‘inde, both dhe bond intrest expense and amortization reflect the shorter two-month Fd between the iste date and the first interest payment. Evermaster therefore makes the ngentries on July 1, 2022, to record the interest payment and the premium amortization, July 1,2022 Interest Expense mer Expense 4.000 ~Tsiraa 2.007" ‘ah 4.000 THz _ 4,000"| 7/1/22" 253° (record fest interest pay Tatance 080 PO Bonds Payable 253 ‘Accrued interest evened Interest Expense 283 Cash pat (To record two months’ premium amortization) “Sino anna, agg Expense account now contains a debit balance of €1,080 (€4,000 ~ €2,667 ~ Anny) P'ch represents the proper amount of interest expense—two months at an effective etest rate of 6 percent on €108,039. em ‘exaltation o the price of a bond between Interest payment dates generally requlres use of «financial igre the me wt many ses show his ato mt se ofr al compounding homework purposes, te price ofa br sol between Interet dates wl be proved, — Scanned with CamScanner14-12 CHAPTER 14 Non-Cur Liabilities TTT TY, Long-Term Notes Payable LEARNING OBJECTIVE 2 Explain the accounting for long-term notes payable. TT ‘The difference between current notes payable and long-term notes payable isthe muy, date. As discussed in Chapter 13, short-term notes payable are those that companies apg pay within a year or the operating eyele—whichever is longer. Long-term notes are sing, substance to bonds in that both have fixed maturity dates and carry either a stated or pig, interest rate, However, notes do not trade as readily as bonds in the organized publiseevig markets. Small companies commonly issue notes as their long-term instruments. Largereos sue both long-term notes and bonds ‘Accounting for notes and bonds is quite similar, Like a bond, a note is valued a the present value of its future interest and principal cash flows. The company amortin Any discount or premium over the life of the note, just as it would the discount or pe ‘mium on a bond. Companies compute the present value of an interest-bearing note, reed suance, and amortize any discount or premium and accrual of interest inthe same wy that they do for bonds. ‘As you might expect, accounting for long-term notes payable parallels accountng fx long-term notes receivable, as Chapter 7 demonstrated. Notes Issued at Face Value In Chapter 7, we discussed the recognition of a €10,000, three-year note Scandinavian lx ports issued at face value to Bigelow ASA. In this transaction, the stated rate and theeflte rate were both 10 percent. The time di and present value computation in Chap’? (See Iustration 7.12) for Bigelow would be the same for the issuer of the note, Seandinxisa Imports, in recognizing a note payable, Because the present value ofthe note and itsfacevabe are the same, €10,000, Scandinavian would recognize no premium or discount. I recodsthe issuance of the note as follows. cash 10,000 Notes Payable 10,000 Notes Not Issued at Face Value Zero-Interest-Bearing Notes {fa company issues a zero-interest-bearing (non-interest-bearing) note” solely foresshlt sures the note's present value by the cash received. The implicit interest rate is the Fate! a equates the cash received with the amounts to be paid in the future, The iste Dany records the difference between the fuee amount and the present value (cash rece) iscount and amortizes that amount to intere the not . ount to interest expense over the life o 0 __ An example of such a transiction fs Beneficial coronation (USA) offering of ie tnillion of zero-coupon notes (deep-discount bonds) having an eightyear life. With value of $1,000 eich, these nots sold for $327—-a deep of The pr although we we the term "note" thro equally to other Fong vere ow ts dcuon th base pps Scanned with CamScannerLong-Term Notes Payable 14-13 efeach note is the cash proceeds of $327. We can calculate the interest rate by deter- sneer tat esis the stout the investor crn pay wth the amount oe anes in the future. Thus, Beneficial amortizes the discount over the eight-year life of the Saingan efective-interest rate of 15 percent.* “illustrate the entries and the amortization schedule, assume that Turtle Cove Company the three-year, $10,000, 2er0-interest-bearing note to Jeremiah Company illustrated in aeoier7 ates receivable). The implicit rate that equated the total cash to be paid ($10,000 Suiy) to the present value of the future cash lows ($7,721.80 cash proceeds at date of ean) was 9 percent. (The present value of $1 for three periods at 9 percent is 0.77218.) sajation 14.14 shows the time diagram forthe single cash flow. i Sgn prio ‘Time Diagram for ; ‘Ture Cove amortizes the discount and recognizes interest expense annually using the tfective interest method. Illustration 14.15 shows the three-year discount amortization aad interest expense schedule. (This schedule is similar to the note receivable schedule of Jeremiah Company in Illustration 7.14.) ILLUSTRATION 14.15 Schedule of Note Discount Amortization Schedule of Note Discount Effective-Interest Method o% Note Discounted at 996 Amortization Coming cash Interest Discount Amount Paid Expense, Amortized,-—«—«_of Note Dateotissue $7721.86 Endotyeart $-0- $694.96" $694.96" 8,416.76" Endotyear2 =O 15151 15151 917427 Endolyesr3 —_-0- 925.73 925.73 10,000.00 yaare20 $2,278.20 53,721.80 + $60496 = $8416.76 spe asunimenttocompeasate for round ng ‘S572140 x 09 = $694.96 ‘Se 96 $0= 59496 TunleCove records interest expense at the end ofthe ist year sing the effe ‘ethod as follows. Interest Expense ($7,721.80 x09) GA nto he Notes Payable Cie amount of the discount, 2.27820 In this case, repre Company will incur on the note over the three years sents the expense that Turtle ‘ne = Seoneyr,) Ph, ._$07 ean me 194 (in Table 62, locate 32690) _ peer eee eae Scanned with CamScannerRURCLEET Schedule of Note Discount Amortization ies Interest-Bearing Notes “The zero-interest-earing note above isan example ofthe extreme difference betwen g rate and the effective rate. In many cases, the difference between these rates is notqy Consider the example fom Chapter 7 where Marie Co. issued for cash a iggy year note bearing interest at 10 pereent to Morgan Group. The market rateof interes yr of similar risk is 12 percent. Illustration 7.15 shows the time diagram depicting the qartt”* z f shin andthe computation of the present value of this not. In tis case, because the ety of interest (12%) is greater than the stated rate (108 4), the present value of the the face value. That is, the note is exchanged at a discount, Marie Co, record: the note as follows, Hoteislena Ss thesia cash 9,520 Notes Payable 9,520 Marie Co. then amortizes the discount and recognizes interest expense annual effective-interest method, lustration 14.16 shows the three-year discount a and interest expense schedule. 1 using be IMortatn ‘Schedule of Note Discount Amortization Effective-interest Method | 20% Note Discounted at 129% | Canying i cash Interest Discount ‘Amount Paid Expense Amortized otNote | Date of ssue € 9520, i Endofyearl —€1,000"—€1,aaa® ena’ esr | Endofyear2 1,000 159 9g Endotyear3 _1,000 179 10000 | 289 fe1.42— 1000-4182 e920 C142 ~€9662 Marie Co. records payment of th first year as follows (amounts per amortization schedule), nual interest and amortization of the discount forte Interest Expense 1a Notes Payable 142 Cash 1,000 ‘When the present value exceeds the face value, Marie Co. issues the note ata premium. does so by recording the premium as a credit to Notes Payable and amortzing it using effective-interest method over the life of the note as annuial reductions in the amountef i est expense recognized. jan the amount I ‘Starting around 2014, a numberof debt sec paid a negative intrest rate. Most of us understand that interest ft traditional (positive interest rte) debt offering, where the ‘amount received over the I What Do the Numbers Mean? _ Negative Interest Rates—Is That Even Possible? vies were ssued that 2, Who would issue this kind of debt? The most common’ sets have been central banks, Central hanks are cummpens®® Pates rise and fall, but negative interest rates are something alto OF affiliates of the central governments of various count frie differen. The presence of debt securities paying negative Sad rep For xcmpfe Reuse Bundesbank (DEL) Fics ress numberof questions tecerattnko th Fer Rei Geman 1, What Is a negative interest rate? Ina negative interest rate 'y, the European Central Hank (ECB) is the central 8 ihe Investor provides money tothe borrower, fe European Union, Central banks have awaiety of hie lated to ermploynent and economic growth Hanese FE the majority of negative interest rate borrowings a Si by central banks, mall number of businesses 3 fetime of the Investment i Scanned with CamScannertvwat (FRA), Sanofi (FRA), and Henkel (DEU), have is- sued debt that has traded a zero and/or negative rate) ror example, in the years following the economic ct af 2008-2008, the economies of countries in the European Unian began to recover and for several years showed healthy owth. However, during 2014, the growth began to slow Jd overall growth in the EU lagged behind many ofthe oth. «reconomies around the world. Typically, uring this kind of period, central banks will reduce interest rates with an capectation that making funds “cheaper” will stimulate the economy. However, the ECB, like many other central banks, had already reduced its rates. For example, by the end of oll, the ECB rate was at .25 percent, which was then eut in 2012 0 2er0. In 2014, still hoping to stimulate the lagging {European economy, the ECH lowered rates again, Since rates were already at zero, this meant that the rates were reduced toa negative rate: frst to ~.10 percent and then to ~.20 per- cent, The ECB has continued to cut rates to this current rate set at ~.50 percent. This strategy was not limited to Europe alone. For example, the yield on Japanese 10-year government bonds was negative in 2016 and again in 2019, 3, Who would invest in negative interest rate debt? While a varity of investors purchase debt, a subset of debt investors tend Long-Term Notes Payable 14. to be the primary investors in negative interest rate debt, The ‘most prominent investors tend tobe in the financial services in- dustry, such as banks, mutual funds, and insurance companies. ‘The reason they are willing to accept this negative return has 10 do with regulatory requirements and business practices, such as banks that have a regulatory requirement to hold a portion Of their assets in very low risk and highly liquid securities. To full this requirement, banks have almost always invested in debts from central banks since they are backed by these banks" national governments and are viewed as essentially risk-free. What does the future hold? Will we continue to sce debt is- sued with negative yield? Will t continue to be common practice fora central bank to reduce interest rates to stimulate the econo- my, even when cutting rates means lowering them to below zero? Numerous questions accompany this recent phenomenon and remain to be answered in full, Sources: Jonathan Soble, “Japan's Negative Interest Rates Explained.” The New York Times (September 20, 2016); Brian Blackstone, "Neyative Rates, Designed as a Short-Term Jolt, Have ecome an Adlcton,” Will Set Journal (May 20,2019); and James “Mackintosh “There's Too Much Negativity About Negative Rates.” Wall Soret Journal, (September 10, 2019), Special Notes Payable Situations Notes Issued for Property, Goods, or Services Sometimes, compa may r e property goods, or services in exchange for: note payable \When exchanging the debt instrument for property, goods, or services in a bargained transac ‘on entered into at armn’s length, the stated interest rate is presumed to be fair unless: interest rate is stated, oF 2 The stated interest rate is unreasonable, or 3 Thest ‘sles price for the same or similar ed face amount of the debt instrument is materially different from the current cash emsor from the current fair value of the debt instrument, Ihthese circumstances, the company measures the present value of the debt instrument by the value ofthe property, goods or services or by amount that reasonably appro nates the ttalie ofthe note, [3] If there is no stated rate of interest, the amount of interest is "difference between the face amount of the note and the fair valuc of the property. sorexample, assume th 90.000 to Health Spa Sei ae 1 Scenic Development AS sells land having ices. In exchange for the land, Health Spa gives a sh sale price year, i166, 26¢0-interest-bearing note. The €200,000 cash sale price represents the present not the €293,866 note discounted at 8 percent for five years. Should both parties record the "MSction on the sale date at the face amount of the note, which is €293,866? No—it ‘20/4id Health Spa's Land account and Scenic’s sales would be overstated by €93,866 (the teres 1 angie! five years at an effective rate of 8 percent). Simil nistest expense to Health Spa for the five-yea ly, interest revenue to. period would be underst cenic ted by €93,866, sng Ue the difference between the cash sale price of €200,000 and the €293,866 face ni 4 of the note represents interest | yt seaservcesuyery __ 700,000 Notes Receivable Sales Revenue Notes Payable 200,000 an effective rate of 8 percent, the "ecorded at the exchange date as shown in Illustration 14.17, Scenle Development aS (Seller) mpante Pe Bntrles for Non-Cash, 200000 | Note Transaction Scanned with CamScanner26-16 CHAPTER 14 Non-Current Liabilities ILLUSTRATION) ‘Time Diagram for Interest-Bearing Note Computation of Imputed Fair Value and Note Discount During the five-year life of the note, Health Spa amortizes annually a por ea te discount of €93,866 as a charge to interest expense. Scenic Development records revenue totaling €93,866 over the five-year period by also amortizing the discoun, yin" Ltsngae terest method. ceffectiv Choice of Interest Rate In note transactions, the effective or market interest rate is either evident or deter by other factors involved inthe exchange, such as the far value of what is given ore But, if'a company cannot determine the fair value of the property, goods, services, rane rights, and if the note has no ready market, determining the present value of the nots ‘Hite. To estimate the present value of a note under such circumstances, a company mt Spproximate an applicable interest rate that may differ from the stated interest rat. This earner interest-rate approximation is called imputation, and the resulting interest ry called an imputed interest rate. “The prevailing rates for similar instruments of issuers with similar credit ratings ay the choice of a rate, Other factors, such as restrictive covenants, collateral, payment sta. tole, and the existing prime interest rat, also play a part. Companies determine the inpze interest rate when they issue a note; any subsequent changes in prevailing interest resax ignored ‘To illustrate, assume that on December 31, 2022, Wunderlich ple fsued a promisty ase and to Brown Interiors Company for architectural services. The note has face valueof £00 4 due date of December 31,2027, and also bears a stated interest rate of 2 percent, payable at bx tend of each year. Wunderlich cannot readily determine the fair value of the architecture tices, nor isthe note readily marketable. On the basis of Wunderlich’s credit rating, the bent of collateral, the prime interest rate at that date, and the prevailing interest on Wundediis other outstanding debt, the company imputes an 8 percent interest rate as appropit ints circumstance, Hlustration 14.18 shows the ime diagram depicting both cash flows. vv sssooopinciat | . ~ a | prion 14000" __exyg00 e1o00 _ 1.900 exec0imeest | | | o 1 2 3 4 s | aes “£590.000%.02 IMlustration 14.19 shows the calculation ofthe present value of the note andthelae! fair value ofthe architectural service Facevalueol the note ‘sane | Present value of £550,000 de in years at Stinterest payable annually (Table 6.2); FV(PYF ssa) (£550,000 x 68058) T4319 | Present value of £13,000 intrest payable annually fr S years a 65; | -(PVF-OFs (E1000 3.99271) 43920 9'| Present value of the note us) Discount on notes payable us sco Wunderlich records Issuance of the note in payment for the architectural" follows. December 31,2022 ‘uildings (or Consteustion in Process) 418.239 Notes Payable 162 9 — Scanned with CamScannerme motets Eval 1 in mena beng BA NemeaOdE UE Duncenenh Numeadcinaion Suing tenpsetad Hateenes Bate Eatentaton sonitinn for rman Fae Faie vation of Samra weouee Senin Em Mebe Dncewrmed oP mye oh eee eee” eee ake co 2M nye ) ens heer Descenniber 52 2IS3, termmwn nats Se the tase ama i te ty yes moetgape ng foe a ew plat It wu tecenve & pervent sap usu SM st! ane Montiel Savings: dentate € 31 8 Mae Da. oan Sane sl Ae Src Fi eMC ateneae fue se aaURA te Og percent oe he eee muett af fanatical gran Barcelo yw tie sa ag “erga Shanes Dau” ot srpmery gli hatetity HO opium bang antenity dot eg 46 14 a oe Scanned with CamScanner14-18 CHAPTER 14 Non-Current Lia warrants showing it as a current liability. If itis payable current installments due as current liabilities, with the remainder a ders have partially replaced the traditional fixed-rate mortgage with morgage arrangements. Most Tenders offer varinble-rate mortgages (also clip ingrateor adjustable-rate morigages) Featuring interes rates tied tochangesin the Muga market ate, General, the varable-rate lenders adjust the interest rate at eitheron. rt year intervals, pegging the adjustments to changes in the prime rate or the London int “Offering rate (LIBOR)."” installments, Harrick, Showa, a Ua Alera Extinguishment of Non-Current Liabilities eae cc ie LEARNING OBJECTIVE 3 Explain the accounting for extinguishment of non-current liabilities. $$ How do companies record the payment of non-current liabilities—often referred to 25 extinguishment of debt? Ifa company holds the bonds (or any other form of debt seu) to maturity, the answer is straightforward: The company does not compute any gainsorloves twill have fully amortized any premium or discount at the date the bonds mature, Asaresit the carrying amount, the maturity (face) value, and the fair value of the bond are the sine ‘Therefore, no gain or loss exists In thisseetion, we discuss extinguishment of debt under three common additional situatias 1. Extinguishment with cash before maturity, 2. Extinguishment by transferring 3. Extinguishment with modifc or securities. ion of terms, Extinguishment with Cash Before Maturity Im some cases, a company extinguishes debt before its maturity date." The amount pide® extinguishment or redemption before maturity, including any call premium and expense reacquisition iscalled the reaequisition price, On any specified date, the carrying mous! of the bonds is the amount payable at maturity, adjusted for unamortized premium or & count, Any exces of the net carrying amount over the reacquisition price i. ain 0 finguishment. The excess of the reacquisition price over the carrying amount isa lss fe extinguishment. At the time of reacquisition, the unamortized premium or disc#t ‘must be amortized up to the reacquisition date. To illustrate, we use the Evermaster bonds issued at a. iscount on January’ 1 2022-THE bonds are due in five years. The bonds havea par value of €100,000, a coupon rate of SRT "ne ofthe many changes tht osu in the at oe inthe termath ofthe franca rss 0-938 that LINOK was not reliable mesure of intro rata betwen banie asa eal cneasb meses ma saly tu scam eras ees ans Sas the GH n revocable trust. The company pledes die peel interest of te SUH ed fm pinay obit th e oahwier a calngubhment of deb is pte fs nt cos extinguishment of debt, an wut record gal of loss. 4] ———— ad Scanned with CamScannerExtinguishment of Non-Current Liabilities 14-19 4 emiannually, and were sold to yield 10 percent, The amortization schedule forthe Ever- pide ponds is presented in Mlustration 14.21, as [Schedule ofBond Discountamortzation SEE ‘Bond Discount Amortization Effective-Interest Method—Semiannual interest Payments Bond Premium S-Year, 8% Bonds Sold to Yield 10% Amortization Schedule, canning Bond Extinguishment | cash Interest Discount ‘Amount pate Paid Expense ‘of Bonds | na €oa78 mma € 4000" aust o2eo7 wns 4000, 4645 93537 | 4000, asm oat | ips 4000 am 942s | ame 4,000 aug | mins 4900 4783 mins = 4,000 493 ns 8000, 4964 mp6 4000 4907 4,952 gm On January 1, 2024, two years after the issue date, Everm: issue at 101 andcancelsit. As indicated in the amortization schedule, the earrying value of the bonds on January 1, 2024, is €94,925. Mlustration 14.22 indicates how Evermaster computes the loss cntedemption (extinguishment). TCU Eve) ‘Computation of Loss on Redemption of Bonds Reacquisition price (€100,000 x 1.01) €103,000 Carryingamount of bonds redeemed (941925) Loss on extinguishment LASS MIN. eee LW Sprinter an | Evermaster records the reacquisition and cancellation of the bonds as follows, Bonds Payable 94925 {Loss on Extinguishment of Debt 6.075 Cash 101,000 ang Neth is often advantageous forthe issuer to acquire the entire outstanding bond issue Rdteplace it with a new bond issue bearing a lower rate of interest. The replacement of an exist- ‘suance with a new one is called refunding. Whether the early redemption or other ext ‘ibhment of outstanding bonds is a non-refunding or a refunding situation, a company should yen the difference (gain or loss) between the reacquisition price and the carrying amount * redeemed bonds in income (in other income and expenses) of the period of redemption. Et Inguishment by Exchanging Assets or Securities M addition, set ey 2 Using cash, setting a debt obligation can involve elther a transfer of non-cash estate, receivables, or other assets) or the issuance of the debtor's shares, In the: he lay qt lable bonds mus generally exercise hell on an set at he amortization (Onn Or premium willbe up todate, an Here willbe noaccrued interest. However. ctly extinguish Praag pitba8es of bonds in the open market are more likely tobe on other that an interest date, If the Prablemyg at Made on an interest date, the discount or premium must be wmrortzed, and the Interest accrued from the last interest dae to the date of purchase — Scanned with CamScanner34-20 CHAPTER 14 Non-Current Liabilities situations, the ereditor should account for the non-cash assets or equiy be received at their fair value. | The debtor must determine the excess of the carving AMOUR! Of the Paya fie valve of theses or egulty transferred (gun)! The deblor recognizes gineggt smount of the excess, n addition, the debtor recognizes gain oF loss on disposgat tte i nf. totheextent that the fair value of those assets difes from thei earrying amount (hn i , ‘Transfer of Assets ‘Assume that Hamburg Bank foaned €20,000.00 to Bonn Mortgage Company: Ron, iy invested these monies in residential apartment buildings. However, because of oye fates iteannot meet itstoan obligations. Hamburg Bank agrees to accep teal este yah) value of €16,00.00 from on Mortgage in ful settlement ofthe €20.00.0 ogg tion. The realestate hasa carrying vale of €21,000,000 on the books of Bonn Morigage "ee (debtor) records this transaction as follows. Notes Payable (to Hamburg Bank) 20,000,000, oss on Disposal of Real Estate (€21,00,000 ~ €16,000,000) 5,000,000 Real Estate 2100.00 Gain on Extinguishment of Debt (€20,000,00 ~ €16,000,000) 4,000,000 Honn Mortgage has a loss on the disposition of realestate in the amount of €5,00000 (te difference between the €21,000,000 book value and the €16,000,000 fair value). In addon g has again on settlement of debt of €4,000,000 (the difference between the €20,000.00 ey ing amount of the note payable and the €16,000,000 fair value of the real estate), Granting of Equity Interest Now assume that Hamburg Bank agrees to accept from Bonn Mortgage 320,000 onan shares (€10 par) that have a fair value of €16,000,000, in full settlement of the €20,00000 loan obligation, Bonn Mortgage (debtor) records this transaction as follows. Notes Payable (to amburg Bank) Share Capital—Ordinary (320,000 x €10) 3.200000 Share Premium—Ordinary (€16,000,000 ~ €3,200,000) 12800.00 Fain on Extinguishment of Debt 4,000,000 20,000,000 W records the ordinary sha the par value and the fair va ‘ssued in the normal manner. It records the difference betwet 1 of the shares as share premium, Extinguishment with Modification of Terms Practically every day, the Wall Street Journal or the Financial Times runs a story about oo company in financial difficulty, such as Japan Display (JPN) or Bayer AG (DEU). In = of these situations, a ereditor may grant a borrower concessions with respect to setlemet® ‘The creditor offers these concessions to ensure the highest possible colletion onthe laa. example, creditor may offer one of a combination of the following modifications: 1, Reduction of the stated interest rate, 2, Extension of the maturity date of the face ‘Amount of the debt. 3. Reduction of the fi Amount of the debt, 4. Reduction or deferral o Wy accrued interest, "Likewise, the creditor must determing thee equity interests transferred. Accounts. Creditor seu ’cewvaf the receivable over the fale value of those 8 ey Rarmally charges the exces os) ages Allowance FM for theve transactions iadressed In Chaper Scanned with CamScannerExtinguishment of Non-Current Liabilities 14-21 swith other extinguishments, when a creditor grants favorable concessions on the ff loan, the debtor has an economic gain. Thus, the that for other extinguishments. That i, the ' goa to that eae : rc pable is recorded at fair value, and a gain is recognized forthe difference inthe fair fejeof the new obligation and the carrying value ofthe old obligation. ‘illustrate, assume that on December 31, 2022, Morgan National Bank enters into a debt ication agreement with Resorts Development Group, which is experiencing financial diff- ‘ies Thebank restructures a¥10,500,000 loan receivable issued at par (interest paid to date) b accounting for modifications is inal obligation is extinguished, the «Reducing the principal obligation from ¥10,500,000 to ¥9,000,000; «ending the maturity date from December 31, 2022, to December 31, 2026; and «_ Reducing the interest rate from the historical effective rate of 12 percent to 8 percent. Giv- en Resorts Development's financial distress, its market-based borrowing rate is 15 percent. IFRS requires the modification to be accounted for as an extinguishment of the old note and isvance of the new note, measured at fair value. [6] IMustration 14.23 shows the calculation athe fair value of the modified note, using Resorts Development's market discount rate of Aspeteent. Present value of restructured cashflows: Present value of ¥9,000,000 due in 4 years a 15%, interest payable annually (Table 6.2), PVF ssa), (¥9,000,000 x 57175) 5,145,750 Present value of ¥720,000" interest payable annually for 4 years a 15% (Table 6.4); RIPVF-OA sa (720,000 x 2.85488) Firvalue ofnate 79000000 x.08 The gain on the modification is ¥3,298,664, which is the difference between the prior carry- ingvalue (¥10,500,000) and the fair value of the restructured note, as computed in Illustra~ ‘ion 14.23 (¥7,201,336). Given this information, Resorts Development makes the following ‘airy to record the modification. Notes Payable (old) 10,500,000 Gain on Extinguishment of Debt Notes Payable (new) Mustration 14.24 shows the amortization schedule for the new note, following the edification, tue Cosh Paid Interest Expense Amortization Carrying Valve Dna? opel ion eae TT ete! ¥7,201,336 Riayes——_¥720,000* 1,080,200" 17561,536¢ apipaore "720,000 13134,230 7975.766 aAapors “720,000 196,365 8.452.131 2rypa006 ‘720,000 11267/820 9,000,000 “93,000200~ v720000 “a9 agjstment or ounding 7.301.296 + 9960200 Ase ibstantlal. A substantial tion to the general rule occurs when the modification of terms is not su ene meant ea own het ew tg ee ut We interest rate) lffer by at least 10 percent of the carrying value of the original debt, or (2) there ix an eae iF conditions ofthe new borrowing compared to the on ot rodent Malang Jnterest rte. [5} In the case of a non-substantlal i '8 life of the debt at the (historical) effective-intere tstonncaenes te ewe acannon of test Te china ee mere ale ILLUSTRATION 1 Fair Value of Restructured Note Schedule of Interest and Scanned with CamScanner14-22 CHAPTER 14 Non-Current Liabilities i se on this Note Using the effec ecognizes interest expen e : ae eee rnemiber 3, 2023 (date of fist interest payment afer sito percent. Thus, sorts Development makes the following entry. December 31,2023 1,080,200 Interest Expense or Notes Payable Pao Cash Resorts Development makes sim Payable and debits to Interest Expense) ‘opment makes the following entry, entry (except for different amounts for eres tog, ch year until maturity. At maturity, Reson poe December 31, 2026 Notes Payable 9,000,000, Cash 9,000,000 In summary, following the modification, Resorts Development has extinguished the old pg with an effective rate of 12 percent and now has anew loan with a much higher effete of 15 percent. ee Presentation and Analysis eo LEARNING OBJECTIVE 4 Indicate how to present and analyze non-current liabilities. Se a ae Fair Value Option As indicated earlier, non-current liabilities such as bonds and notes Payable are generlly measured at amortized cost (face valu of the payable, adjusted for any payments and amt zation of any premium or discount). However, companies have the option to record fairy their accounts for most financial assets and liabilities, including bonds and notes payable As discussed in Chapter 7, the LASB believes that fair value measurement for financial i= Siruments, including financial liabilities, provides more relevant and understandable ft ‘mation than amortized cost. It conside se it reflectsthe current cash equivalent value of finan ts fair value to be more relevant bet al instruments, Fair Value Measurement {i SomPanies choose the fair value option, non-current liabilities such as bondsandt® payable are recorded at fair value, with unrealized hol losses reported 35 of net income. An unrealized hol Foe aa Ine Ets oF losses report Y ding gain or loss is the net change in the fit al ecard. As result the company reports the list fair value each reporting Ja" adi omi at ePorts the change in value as part of net eo sn Edmore enum SEs Sto of peat fonds fe ae value of the bond a ent Yat option for these bons, At Deemer 31,2022 | ott “The value of the deb so Because interest rates in the marker ines aso t0 8 ; Ne debt securities fell because the bond Paid less than market rate for" ‘ssuries, Under the sr value option, Edmonds rete following ent: Honds Payable S Unt dee 100 AS the journal entry in Hes, the value reduetion in the bond liability anda neve nd exist? lue of the bonds declined. ‘This decline 1489. “resulting unrealized holding gain, which is Scanned with CamScanneret income: The value of Edmonds’ debt declined because interest rates increased. It ute e emphasized that Edmonds must continue to value the bonds payable at fair value sim gubsequent periods. inal e Controversy ® pave Edmonds bonds, we assumed that the decline in value ofthe bonds was due 10 wih rae increase. In other situations, the decline may occur because the bonds be- site likely to default. That is, ifthe ereditworthiness of Edmonds declines, the coe gts debt also declines. If ts creditworthiness decline, its bond investors ae r- valoe a lower rate relative to investors with similar-risk investments, If Edmonds is using, ir value option, changes in the fair value of the bonds payable for a decline in credit- th pes are included as part of income. Some question how Edmonds can record a gain sors ereditworthines is becoming worse. As one writer observed, "It seems counter vere However the IASB notes thatthe debtholders' loss is the shareholders’ gain. inane shareholders’ claims onthe assets ofthe company inerease when the value of Te holders claims declines. In addition, the worsening credit postion may indicate tee asses ofthe company are declining in value as well. Thus, the company may be vet atig losses on the asset side, which will be offeting gains on the lability side. ‘The IASB apparently agrees with this statement and requires that the effects of changes iaavompany’seredit risk should not affect profit and loss unless the liability is hed for trad- ig [8] Therefore, any change in the value ofthe liability due to credit risk changes should reported in other comprehensive income. To illustrate, assume the change in the interest tie uted to the Edmonds bonds described in the previous section changed from 6 percent pbs percent due toa deerease inthe credit quality of these bonds, Under the far value option, Tmonds makes the following entry: Bonds Payable 20,000 Unrealized Holding Gain or Loss—Equity 20,000 pairValu ‘his entry recognizes the decline in the fair value of the liability and a resulting unreal- ined holding gain, which is reported as part of other comprehensive income. The value of ‘he Edmonds bonds declined because of the change in its credit risk, not because of general market conditions. Edmonds then continues to value the bonds payable at fair value in all subsequent periods (see Underlying Concepts). Off-Balance-Sheet Financing What do Air Derlin (DEU), HSBC (GBR), China Construction Bank Corp. (CHN), and Enron (USA) have in common? They all have been accused of using off-balance-sheet financing ‘ominimize the reporting of debt on their statements of financial postion." Off-balance-sheet tuning isan attempt to borrow monies in such a way as to prevent recording the obligations. haskecome an isu of extreme importance. Many allege that Enron, in one ofthe largest cor Ponte failures on record, hid a considerable amount of its debt off the statement of financial posi- Son. Asa result any company that uses off-balance-sheet financing today risks investors dumping shares Consequently, their share price will suffer. Nevertheless a considerabl foance sit fnaneing continues to exist. AS one writer noted, “The b Pog mount of off ic drives of humans are 1d to keep debt off the balance sheet.” enough food, to find shelter, a take different forms: 1 Non-consolidated subsidiary, Under IFRS, a parent company does not have to consol- ‘ate « subsidiary company that is less than 0 percent owned. In such cases, the parent etefore does not report the assets and liabilities of the subsidiary. All the parent reports Sn tthe tex we use the label “statement of finn poslon” rater than "balance sheet in eering reel sateen that reports assets abies, and equ, We ws ofFalanesheet i the present ve 0 Ssuie ofiscommon usage nina markets a Presentation and Analysis 14-23 Underlying Concepts ‘The fair value controversy represents a classic trade-off between relevance and faithful representation. Scanned with CamScanner14:24 CHAPTER 14 Non-Current! ities its nancial position isthe investment in the subsidiary. Ag fete aoe a not understand that the subs HY as consideny for which the parent may ultimately be liable ifthe subsi nso Fane Special purpose entity (SPE). A company ereates a special purpose entity «> factory. 1owevermanagementdoss not want o report the plantor the borovingugd the construction on its statement of financial position. Fae tenet of which tobe plant. (Thisarangementis called project fnancingaangee ‘The SPE finances and builds the plant, In return, Clarke guarantees that i or some net! party will purchase all the products produced by the plant (sometimes referred toasa or-pay contract) As. result, Clarke might not report the asst or lability on is boga Rationale \Why do companies engage in ffbalance sheet financing? A major reason is that may Neve that removing debt enhances the quality ofthe statement of financial pnt, and permits credit to be obtained more readily and at less cost. Sevond, loan covenants often limit the amount of debt a company may have Asa rug the company uses off-balance-sheet financing because these types of commitments mig not be considered in computing debt limits. ‘Third, some argue that the asset side of the statement of financi ‘understated. For example, companies that depreciate assets on an aceclera have carrying amounts for property, plant, values. As an offset to these lower values, Position i sever ated basis wills and equipment that are much lower than thet fir some believe that part of the debt does not have tote Feported. In other words, if companies reported assets at fair values, less pressure vill undoubtedly exist for off-balance-sheet financing arrangements. Whether the arguments above have merit is debatable, The general idea of “out of si ‘out of mind” may not be true in accounting, Many users of financial statements indiestetht they attempt to factor these off-balance-sheet financing arrangements into their compl tions when assessing debt to equity relationships. Similarly, many loan covenants alsoateay {2.account for these complex arrangements. Nevertheless, many companies still believe benefits will accrue if they omit certain obligations from the statement of financial positon As response to off-balance-sheet financing arrangements, the IASB has increase losure (note) requis ments. This response is consistent with an “efficient markets” phils Phy: The important question isnot whether the presentation is ofE-balance-sheet but whe {be items are disclosed at al. In addition, the US, SEC now requires companies hit EE" Nes to disclose (1)all contractual obligations in a tabular format and (2) contingent skis and commitments in cither a textual or tabular for An example of this disclosure app in the following “Evolving Issue” box." We believe that recordin, hhanee financial reportn '8 more obligations on the statement of financial postion wile '& Given the problems with companies such as Enron, Tiger Ait(AUS- Petra Perdana (MYS), 1 ‘market regulators, w ind Washington Mutual (USA), and on-going efforts by the ASB ‘Sexpect that less off-balance-sheet financing will occur in the future! bal (he, consolidated), Specialy etums from its involvement w ‘over the investe, Thus, the p he investee: (2) exposu {ose power over the invesce toa principle is applied in circumstances whe the investee, such as when sist easels and ables) should bon lane 2 Investec when tis exposed op hs ih 8 heabiity to aet thane returs hohiSPO ut he lowing the eaments con "str fom ive wth tenses sft the amount of the investor's etuens. Inge al hes i votlngrghs are not the dominant factor tn desling 9 any voting rights relate ov tasks only and the eteant si mnsolidation accounting procedure ced accounting our Pall yes of off-batance-sheet transactions. ets Developing new financial intrest an investor controls an | the investee and has of control sets or rights, to variable i unlikely that the VAS willbe englncering isthe Holy Grall of secur tosell and market to custo se to sto nancial tes mat gt Scanned with CamScannerPresentation and Analysis, volving Issue _Off-and-On Reporting qe offbalance-sheet world is slowly but surely becoming pire onbalance-sheet. New rules on guarantees and consol Jon of SPES are doing their part to increase the amount of Sex reported on company statements of financial position Se footnote 16 for a discussion of the IASB's consolidation puldance. In addition, companies must disclose off-balance-sheet ar- rangements and contractual obligations that currently have, or are reasonably likely tohave,a material future effect on the companies’ financial condition, Presented below is Novartis Group's (CHE) tabular disclosure ofits contractual obligations, Recause Novartis, listits securities in the United States itis subject to US. SEC rules, [ausO miions) Non current financial debt, including current portion Inereston non-current financial debt, including current portion Operatingleases Unfunded pensions and other post-employment benefit plans Research and development potential milestone commitments Property plant and equipment purchase commitments Tetalcontractual cash obligations Novartis Group Contractual Obligations the flowing table summarizes the Group's contractual obligations and other commercial commitments as well asthe effect these obligations and commitments are expected to have onthe Group's liquidity and cash flow in future periods TheGroupintends to fund the R&D and purchase commitments with interally generated resources. Payments due by period Lessthan ‘after lyear —-2-Byears4-Syears Sears 3,190 aur 4.863 13.490 ‘72 ‘02 75 3,755 an 500 a7 2363 2 254 266 1482 226 1.632 1.663 ‘98 260 Enron's (USA) abuse of off-balance-shect financing ‘hide debt was shocking and inappropriate. One silver lining, in the Enron debacle, however, is that the standard-setting bodies are now providing increased guidance on companies’ reporting of contractual obligations. We believe the U.S, SEC rule, which requires companies to report their obligations over a period of time, will be extremely useful to the investment community. Presentation of Non-Current Liabilities Co 7 "panies that have large amounts and numerous issues of non-current liabiliti Port only one amount in the statement of financial posit the accompanying notes. Long-term debt that matures thin one year should be reported as a current liability. If the company plans to Comaee debt, convert it into shares, or retire it from a bond retirement fund, t ne to Teport the debt as non-current if the refinancing went ee Somments and schedules teh ae ‘the period. [10] cay 2Sclosures generally indicate the nature igh ovsions, conversion privileges, restrictions imp "ed or pledged as security. Companies should show of the liabilities, n al by the eredito ny assets pledged as security for 3 fre n, supported with it should eement is completed by urity dates, interest and ase th ‘engin the assets setion of the statement of financial position, The fal value ofthe long md og tus Yeap a F8dulrements and maturity amounts of lon ‘ug co’S* disclosures aid financial statement users in eval for oa flows. tMustration 14.25 shows an example of the type Noanis Group, ~~ bt should also be disclosed. Finally, companies must disclose future payments for sink term debt during wating the amou ich of the next five and timing of of information provided Scanned with CamScanner 14-2514-26 CHAPTER 14 Non-Current Liabilities Lang-Term Debt Disclosure Novartis Group {in millions) Tottcurent ose $3556 324208 oe nat nae Deteredtotbies Tats sie Priors and other ron-crentbites 19 st Teta nm-curat sien ana 39 Curent antes, Tolepnaies sa Trane deb and dea nancial ntramens ate is Current income tax liabilities Provisions and other current liabilities Total current abilities Total liabilities 19, Non-Current Financial Debt ais 2018207 Balance Fair Balance fi ao = Fairvalue comparison sheet values sheet values stright bonds Sasa8 S288 oon = straight bonds 525285 Uiptities te bnks and other nna Sie 283 oo insutions 285 sas ao Finance lease obigatons 2 er Total see GIS ASN fest Total, including current portion of ron-urrentfinanlal debt 2566023582 Collateralized non-current finan Less current portion of non-current debtand pledged assets 2018 a0 financial debe 0 vision wae | Total non-cutrent financial debts imams 500M | ouimtecnuuec porary, | “average interest rate 0.3% (2017: 0.3%) plant & equipment pledged as { Collateralfornon-current financial debt $98 cy ms. mut The Group's collateralized non-current financial debt consists afloan breakdown by mat 2018 F355 facies at usval market conditions mig, 5 0 aia 2020 20061397 20 aun 294 «the percentage tl jlceane hepercentage of ied rate nancial debt to tots nad mm aes ats ‘80% a December 31,2018, and December 31,201. ‘ater 2023 13490 1,895 + rani debs ningun finances cous tat ae oe erat corenans. The Go sin compan + The average interest rate on total financiat debt in 2018 was 2 asa (2017-2695) down bycurrency USD Fisp68 T1588 eur sons 5.655 apy m sa | ow 1396 Tot 5c 3,503 Analysis of Non-Current Liabilities Long-term creditors and shareholders are imereste in company’s long-run sober lary Its bit to pay interest a it comes due and to repay the fe va of the 8 turity, Debt to assets and times interest earned are Pr matio® earned ate two ratios that provide infor debt: paying ability and long-run solvency. vo ratios that provi Scanned with CamScannerget to Assets Ratio get to assets ratio measures the percent *rput it divide total debt (both current ani mation 14.26 OWS. € of the total assets provided by creditors. id non-current liabilities) by total assets, as Debtto sets = Zeallabities otal Assets SSR TOR Assets en | spe higher the percentage of total copay a" Times Interest Earned ine times interest earned ratio indicates the company’s ability to meet interest payments ssthey come due. As shown in IMustration 14.27, it is computed by dividing the sum of net aoe, interest expense, and income tax expense by interest expense. Dilities to total assets, the greater the risk that the be unable to meet its maturing obligations, Net income + Interest Expense + Income Tax Expense Interest Expense Times interest Earned ‘illustrate these ratios, we use data from Novartis’ 2018 annual report. Novartis has total lutilties of $66,871 million, total assets of $145,563 million, interest expense of $957 million, income taxes of $1,221 million, and net income of $12,614 million, We compute Novartis’ debt to sseisand times interest eamed ratios as shown in Illustration 14.28. $66,871 3145,563 Debt to assets = Times interest earned = © = 155 times Fven though Novartis has a relatively high debt to assets ratio of 46 percent, its high ‘interest coverage of 15,5 times indicates it can meet its interest payments as they come due. — ee Review and Practice Review and Practice 14-27 ILLUSTRATION 14.26 Computation of Debt to Assets Ratio (UU Computation of Times Interest Earned ILLUSTRATION 14.28 ‘Computation of Long-Term Debt Ratios for Novartis Key Terms Review ‘nization 14-7 ceffective-interest method 14-7 refunding was ‘er(coupon) bonds. 14-3 effective yield or market rate 14-6 registered bonds 14-3, "ddiscoum 14.6 extinguishment of debt 1418 revenue bonds 4-3 tindemute ang reeevrprincpalormaturiyvalue 1S securedbomls 143 “Speemium 14.6 fair value option serial bonds 14-3 eben 143 imputation 1416 special purpose entity SPE) 38 ningeue ey Iiputed interest rate M46 ated, coupon, or nominal ate 18 contodity backed bonds 14-3, Income bonds 14:3 substantial modificatlon 14.21 (0) stile bonds 14:3 Tang-ermdebt 143 teembonds. 13 tue bonds 143 tengserm notes payable M12 ties Interestearned 1427 Masts ratio 8-27 mortgage noe payable erotterest debenture bunds 143 "toner ern den) txalancessheet fh Ma — Scanned with CamScanner8 CHAPTER 14 Non-CurrentLiabilties Learning Objectives Review OSS 1 Describe the nature of bonds and indicate the ac- ‘counting for bond issuances. Seaman eon Incurring long-term debt is often a formal procedure, Companies usually require approval by the board of directors and the sharehollers before they can issue bonds or can make other long-term debt arrange ments. Generally, long-term debt has various covenants of restrict ‘The eovenanis and other termsof the agreement between the bortower and the lender are stated in the bond indenture or note agreeine Various types of bond issues are (1) secured and unsecured ‘bonds; (2) term, serial, and callable bonds: (3) convertible, comm backed, and deep-discount bonds; (4) registered and bearer (coupon) ‘bonds; and (5) income and revenue bonds. The variety inthe types of bonds results from attempts to attract capital from different investors And risk takers and to satisfy the cash flow needs ofthe issuers ‘The investment community values a bond at the present value of its future cash flows, which consist of interest and principal. The rate used to compute the present value of these cash flows isthe interest rate that provides an acceptable return on an in vvestment commensurate with the issuer's risk characteristics. The in terest rate written in the terms of the bond indenture and ordinarily ippearing on the bond certificate is the stated, coupon, or nominal rate, The issuer of the bonds sets the rate and expresses it as a percent age of the face value (also called the par vale, principal amount, or ‘maturity value) of the bonds. Ifthe rate employed by the buyers dif fers from the stated rat, the present value of the bonds computed by the buyers will differ from the face value ofthe bonds. The difference between the face value and the present value of the bonds is either a discount or a premium, ‘The discount (premium) is amortized and charged (cred: ited) to interest expense over the life of the bonds. Amortization ‘of a discount increases bond interest expense, and amortization of a premium decreases bond interest expense. The profession's preferred procedure for amortization ofa discount or premium is the effective. thod. Under the effective-interest method, (1) bond ilue of interest m interest expense is computed by multiplying the carrying the bonds atthe beginning of the period by the efective-interest rate: then, (2) the bond discount or premium amortization is determined by comparing the bund interest expense withthe interest tobe paid ee 2 Explain the accounting for long-term notes payable. 2 eee “Accounting procedures for notes and bonds are similar. Like bond, pote Is valued at the present value oft expected future interest and Frincipal cashflows, with any discount or premium being similarly ortiz over the life of the note. Whenever the face amount of th aides not reasonably represent the present value ofthe considera or ae exchange. « company mustevaluate the entre arrangement sioner to propery record the exchange and the subsequent Interest F Explain the accounting for the extinguishment of rnon-current tiabil such as bonds and notes payable, may be ny cash,(2) transferring non-cash assets and ‘and (3) modification of terms, At Non-current Habilities, extinguished by (1) paying Srrranting of am equly Inst the time of extinguishment, any unamortized premium oy rust be amortized up to the reacqulstion date, The reagusr® sa ict pa on extingushnent or eden iaturity, including any call premium and expense of agi” rnany specified date, the carrying amount ofthe debtisteas payable at maturity adjusted for unamortzed pemiumor diye, Poa cess ofthe earring amOUDt over the TacGuslion ers a inuient Thee of he aye fe spe eantying amount isa loss from extinguishment, aig aedire rontnguishments are recognized curently in income. Whenos srsaingushed by transfer of Hon-cAsh 286 OF granting of eps interests debtors Fecord losses and gains on setlements bl fuirvalues, The accounting for debt extinguished with modes, fe similar to that for other extinguishments. That i the rpaz Solgaton is extinguished, the new payable is recorded at ire sind a gin of lose is recognized fr the difference inthe bce ane new obligation and the carying value of the old oblie eee 4 Indicate how to present and analyze non-curret liabilities. ee ons Fair value option. Companies have the option to reco fire in their accounts for most financial assets and lati indo, non lue measurement for fan tment, ineluding financial abilities, provides more relatat=> derstandable information than amortized cos compsie ee the ar value option, non-current Kablites such asbonds 282 payable are recorded at fir value, with unrealized holding as losses reported as part of net income. An unrealized hole losis the net change in the fava ofthe Hiabilty fro eL toanother exclusive of interest expense recognized but nate Off-alance-sheet financing arrangements. OTHE sheet financingisan attempt to borrow fundsin sucha wey sR recording obligations. Examples of oftbalance sheet arranges" (0) non-considted subsidiaries and 2 spol paps 80% Presentation. Companies that have large amounts asl 0 esissuesof non-curent ables frequent repertoniyne2S inthe statement of financial position and support his withee® and schedules inthe accompanying nots. Any ets OLS cay forthe debt should be shown in the asses sexton oi ent of financial position. Langterm debt that ature iE year shouldbe reported a8 current ibility les ee be accomplished with other than current assets. comes to refinance the deb, convert It int shares, or rte Ht ESS siement fd, i should continue to report its on-CEN , sei etinaning comple yee em Dito required of future payments for sinking fan regimen Tuy mounts of longterm debe ding each te Be ‘Analysis, Debt to assets and times interest eam 20 Provide Information about company’s debe ying long-run slveney. Enhanced Review and Practice i ve {Go online for mutuiptechoice questions with sats exeteses with solutons, and afl glossary of al BSS Scanned with CamScannerPractice Problem 14-29 practice Problem ser the follosing independent situations ‘4. On Marci 1, 2022, Helde AG issued at 103 plus accrued interest €3,000,000, 9% bonds. The bonds are dated January 1. 2022, and pay interest semiannually on July 1 and January 1. in addition, Heide incurred €27,000 of bond issuance costs. Compute the net amount of cash received by hieide asa result of the issuance ofthese bonds, On January 1,2022, Reymont SA issued 9% bonds with face value of €500,000 for €469,280 to yield tof. The bonds ae dated January 1, 2022, and pay interest annually, What isthe amount of discount cn the issue date? Prepare the journal entry to record interest expense on December 31,2022. «, Creslaw Building Co. has a number of long-term bonds outstanding at December 31, 2022. These Jong.term bonds have the following sinking fund requirements and maturities forthe next 6 years. SinkingFund Maturities 2023 +€300,000 €100,000 2024 100,000 250,000 2025 100,000 100,000 2026 200,000 = 2027 200,000 150,000 2028 200,000 100,000 Indicate how this information shouldbe reported inthe financial statementsat December 31,2022. Instructions. ‘repare responses foreach item above. Selution ate AG Selling price ofthe bonds (€3,00,000 1.03) €3.0%0.000 Acero interest fom Janbary 1 to February 28, 2022 (€3,000,000 x .09 x 24 ‘Total cash received from issuance of the bonds ess: Bond issuance costs ‘Net amount of eash received Reymomt sa Face value of bonds € 500,000 (469,250) Issue price ond discount on issue date December 31,2022 Interest Expense (€469,280 x 10) ‘Bonds Payable (€46,928 ~ €45,000) Interest Payable (€500,000 x.09) 46,928 45,000 © Creslaw Building Co. "ec atuities and sinking fand requirements on long-term debt for cach ofthe next five years are as follows 2026 €200,000 x 400,000 as 2027 380,000 2ozs 350,000 2025 200,000 Sercises, Problems, Problem Solution Walkthrough Videos, Data Analytics Activities, and Many more assessment tools and resources are available for practice in Wiley’s online “ourseware, Scanned with CamScannerexercises 14°35 ries for Retirement and i ; 1013) Entries Issuance of Bonds) Kobiachi Group had bonds cae sith a maturity value of ¥5,000,000, On April 30, 2023, when these bonds had an unamor- cosa raf 0D000, they were elle nat 104, To py for these bons, Koiach had issue other sh pom eves bearing Tower interest ate. The newly sed bonds ha if of 10 years. The essa on a 103 lace value Soudan, on = tions wag eo.comr en ronan his end ttin settlement of Debt) Strickland Com 2 m 7 wos) (set pany oes $20.00 pus 14000 of acer sur We an Sate Bank. The bs 10 year 10% note, During 202 Sita’ bins detero ie a ring regional economy. On December 31, 2022, Moran Sate Rank agrees 0 acept an ad ne an cael he entre eb, The machine has eos of $3900, accumulate depreciation Free nanet insrtions per joa entries fr Strickland Company to record this debt settee £ stow should Strickland report the gain o loss onthe disposition of machin tet ints 2022 income statement? ind on restructuring of «. asume that, instead of transferring the machine, Strickland decides to grant 15,000 of its ordi tary shares (S10 par), which have a fair value of $180,000, in full settlement of the loan obligation. prepare the entries to record the transaction itis (to 3) (Loan Modification) On December 31, 2022, Sterling Hank enters into a debt ‘Bructuring agreement with Barkley ple, which is now experiencing financial trouble. The bank agrees ‘Rrestrueture a 12%, issued at par, £3,000,000 note receivable by the following modifications: 1. Reducing the principal obligation from £3,000,000 to £2,400,000, 2. Exending the maturity date from December 31, 2022, t January 1, 2026 4. Reducing the interest rate from 12% to 10-. Barkley’ ‘market rate of interest is 15% terest at the end of ich year. On January 1, 202 parkey pays Stelng Bank, Barkley pays £2.400,000 in cash to Instructions. 2. Can Harkley record a gain under the term modification mentioned above? Explain. Prepare the amortization schedule of the note for Barkley after the debt modification, «Prepare the interest payment entry for Barkley on December 31, 202 4 What entry should Barkley make on January 1, 20267 EUA9 (L03)_ (Loan Modification) Use the same information as in E14.18 except that Sterling Bank. reduced the principal to £1, 900,000 rather than £2,400,000, On January 1, 2026, Barkley pays £1,900,000 in «xh to Sterling Bank for the principal Instructions 4 Prepare the journal entries to record the loan modification for Barkley '. Prepare the amortization schedule of the note for Barkley after the debt modification. 6: Prepare the interest payment entries for Barkley on December 31 of 2023, 2024, and 2025. 4 What entry should Barkley make on January 1, 2026? "1420 (103) (Entries for Settlement of Debt) Consider the following independent situations. Instructions | ® Gottlieb stores owes €199,800 to Ceballos SpA. The debt isa 1Oxyear, 11% nate, Because Gotti is | infinancial trouble, Ceballos agrees to accept some land and cancel the entire deb, The land has a > ale of €90,000 and afar value of €140,000, Prepare the journal entry on Gotlie's books for 4b settlement, Vargo Corp, owes $270,000 to First Trust. The debt isa 10-year, 12% note due December 31, 2022. Be~ {24s Vargo Corp. i in finanelal trouble First Trust agrees to extend the maturlty date to December 31,2025, reduce the principal to $220,000, and reduce the interest rate (o $%, payable annually on. December 31, Vargos market rate of interest i 8%. Prepare the Journal entries on Vargo’ books on ember 31, 2022, 2023, and 2024. Re Scanned with CamScanner14-38 CHAPTER 14 Non-Currenttabilties ote: Payable in Insta for zera-interest-earing Not _ a fry on Decernber 31, 2021 paying $50,000 down and ml er Seog payblecach Deetbe 31, Anas ec hy PIA6 (L02) (Entries meties Co. purchased mac! balance in four equal installment js implicit in the purchase price, Instructions Prepare the journal entries that would be recorded the following dates. fa, December 31,2021, b, December 31,2022. fe. December 31,2023. forthe purchase and for he payments ang, 4d, December 31, 2024, fe, December 31, 2025, ance and trent of onds:Income Statement Prey he rnin 20.000 on ane nt ot v2.70 (effective ate of 10) The indentre securing the Aste proved aga out be eal for edema in total but not in part, at any time before maturity a 10 of pee eae cecen nemare di a prove fran sinking in. : aoa ee company bse Hs IT 2e4 Seen BoM a pg Fat oan the peed wet edo em he 9,256 mee aaa ennui ene ste i prove fora shige? eta ctu The onamaeed coun tcc! Ws 1.2388 PI47 (L02,3,4) (Iss Lid issued its 9, 25-year mortgage bonds int Instructions a. Prepare journal entries to record the iss bs. Indicate the income statement treatment of the gain oF loss from retirement and the note ioe required. ince ofthe 11% bonds and the retirement ofthe bey P148 (LO1,3) (Comprehensive Bond Problem) In each of the following independent eas te ‘company closes its books on December 31. 1, Sanford Co, sells $500,000 of 10% bonds 0 and March 1, The due date of the bonds through December 31, 2023. 2, Titania Co, sells $400,000 of 12% bonds on June 1, 2022. The bonds pay interest on December at June 1. The due date of the bondi is June 1, 2026. The bonds yield 10%. On October 1, 2033 Tas buys back $120,000 worth of bonds for $126,000 (includes accrued interest). Give entes thus: December 1, 2024, ‘March 1, 2022. The bonds pay interest on Sepente September 1, 2025. The bonds yield 12%, Giese Instructions For the two eases, prepare all of the relevant journal entries from the time of sale until the date inde (Construct amortization tables where applicable.) Amortize premium or discount on interes desis at year-end, (Assume that no reversing entries were made; round to the nearest dalla.) Pi (L03,3) (Issuance of Bonds Between Interest Dates, Retirement) sete below ate selected transactions on the books of Simonson Foundry. July 1.2022 Bonds payable with a par value of €900,000, which are dated January 1 sold at 112,290 plus accrued interest to yield 10% They are coupon bonds Wat interest at 12% (payable annually at January 1), and mature January 12032 (0 {interest expense account for accrued interest.) ee. Adjusting entries are made to record the accrued interest on the bonds. and amortization of the proper amount of premium, Jan.1,2023 Interest on the bonds is paid. cod Bonds of par value of €360,000 are called at 102 and extinguished. Dee. 31 Adjusting entries are made to record the accrued interest onthe bonds 301% Proper amount of premium amortized, Instructions Prepare journal entries forthe transactions above. Scanned with CamScanner