02 Non-Current Liabilities

14-1
 Characteristics of Bonds
 Debenture bonds. Debenture bonds are bonds that are not secured by
specific property. Their marketability is based on the general credit
rating of the company. Generally, a company must have a long-period
of earnings and continued favorable predictions of future earnings and
liquidity to sell debenture bonds. Debenture bondholders are
considered to be general creditors, with the same rights as other
creditors if the issuer fails to pay the interest or principal and declares
bankruptcy.
 Mortgage Bonds. Mortgage bonds are bonds that are secured by a
lien against specific property of the company. If the company becomes
bankrupt and is liquidated, the holders of these bonds have first claim
against the proceeds of the sale of the assets that secured their debt.
If the proceeds from the sale of pledged assets are not sufficient to
repay the debt, mortgage bondholders become general creditors for
the balance of the unpaid debt.
14-2
 Characteristics of Bonds
 Registered Bonds. Registered bonds are bonds whose ownership
is registered with the company. That is, the company maintains a
record of the holder of each bond. Therefore, on each interest
payment date, interest is paid to the individuals listed on the
corporate records as owners of the bonds. When an owner sells
registered bonds, the issuer or transfer agent must be notified
so that interest will be paid to the proper person.

 Coupon Bonds. Coupon bonds are unregistered bonds on which

interest is claimed by the holder presenting a coupon to the
company. These bonds can be transferred between individuals
without the company or its agent being notified.

14-3
 Characteristics of Bonds
 Zero-Coupon Bonds. Zero-coupon bonds (also called deep-
discount bonds) are bonds on which the interest is not paid until
the maturity date. That is, the bonds are sold at a price
considerably below their face value, interest accrues until
maturity, and then the bondholders are paid the interest along
with the principal at maturity.

 Callable Bonds. Callable bonds are bonds that are callable by the
company at a predetermined price for a specified period. That is,
the company has the right to require the bondholders to return
the bonds before the maturity date, with the company paying
the predetermined price and interest to date.

14-4
 Characteristics of Bonds
 Convertible Bonds. Convertible bonds are bonds that are
convertible into a predetermined number of shares. That is, the
owner of each bond has the right to exchange it for a
predetermined number of shares of the company. Thus, upon
conversion, the bondholder becomes a stockholder of the
company.
 Serial Bonds. Serial bonds are bonds issued at one time, but
portions of the total face value mature in periodic installments
at different future dates. Bonds with several maturities.
 Term Bonds. Term bonds are bonds that pay the entire principal
on one date, i.e. at the maturity date. Bonds with single
maturity.
 Income (Revenue) Bonds. These are bonds whose payment of
interest is conditional on income.
14-5
 Reasons for Issuance of Long-term Debt
Borrowing, which results in a long-term liability, is one of the choices
available to companies seeking to obtain financial resources. There are five
basic reasons why a company might issue long-term debt rather than offer
other types of securities.
1. Debt financing may be the only available source of funds. Many small-
and medium sized companies may appear too risky to investors to attract
equity (i.e., capital stock) investments. Debt securities issued by a company
may be a less risky investment because by law interest is required to be
paid on each interest payment date. Also, some types of debt are secured
by a lien against specific company assets.
2.Debt financing may have a lower cost. Historically, since debt has a lesser
investment risk than stock, it usually has offered a relatively lower rate of
return. In general, investors in equity securities have earned a higher
return. However, because market conditions change, the cost of debt
financing varies, so this advantage depends on the particular market
14-6
conditions.
 Reasons for Issuance of Long-term Debt
3. Debt financing offers an income tax advantage. Interest payments to
debt holders are deductible by a corporation as interest expense for
income tax purposes, whereas dividend payments on equity securities are
not.
4. The voting privilege is not shared. Corporate stockholders may not wish
to share ownership. Thus, by issuing debt, which does not provide voting
rights, ownership interests are not diluted.
5. Debt financing offers the opportunity for leverage. The term leverage (or
trading on the equity) refers to a company’s use of borrowed funds. By
investing these funds, the company expects to earn a return greater than
the interest it will pay for their use and thereby benefit the stockholders.
Earnings in excess of interest charges (net of the applicable income tax
reduction) increase earnings per share. However, if the return falls below
the effective interest rate, earnings per share will decline. Expectations of
current and future earnings, inflation, and the debt/equity relationship
influence the rate of interest needed to issue debt.
14-7
 I. Bonds Payable

Non-current liabilities (long-term debt) consist of an

expected outflow of resources arising from present obligations
that are not payable within a year or the operating cycle of
the company, whichever is longer.

Examples:
► Bonds payable
► Long-term notes payable
► Mortgages payable
► Pension liabilities
► Lease liabilities
Long-term debt has various
covenants or restrictions.

14-8
 Issuing Bonds

 Bond contract known as a bond indenture.

 Represents a promise to pay:
(1) sum of money at designated maturity date, plus
(2) periodic interest at a specified rate on the maturity
amount (face value).
 Paper certificate, typically a €1,000 face value.
 Interest payments usually made semiannually.
 Used when the amount of capital needed is too large for
one lender to supply.

14-9
 II. Types and Ratings of Bonds

Common types found in practice:

 Secured and Unsecured (debenture) bonds.

 Term, Serial, and Callable bonds.

 Convertible, Commodity-Backed, Deep-Discount bonds.

 Registered and Bearer (Coupon) bonds.

 Income and Revenue bonds.

14-10
 Types and Ratings of Bonds

Corporate bond listing.

Company Price as a % of par

Name
Interest rate based on price
Interest rate paid as Creditworthiness
a % of par value

14-11
III. Valuation of Bonds Payable @ Issuance

Issuance and marketing of bonds to the public:

 Usually takes weeks or months.

 Issuing company must

► Arrange for underwriters.

► Obtain regulatory approval of the bond issue, undergo

audits, and issue a prospectus.

► Have bond certificates printed.

14-12
 Valuation of Bonds Payable

Selling price of a bond issue is set by the

 supply and demand of buyers and sellers,

 relative risk,

 market conditions, and

 state of the economy.

Investment community values a bond at the present value of

its expected future cash flows, which consist of (1) interest and
(2) principal.

14-13
 Valuation of Bonds Payable

Interest Rate
 Stated, coupon, or nominal rate = Rate written in the
terms of the bond indenture.

► Bond issuer sets this rate.

► Stated as a percentage of bond face value (par).

 Market rate or effective yield = Rate that provides an

acceptable return commensurate with the issuer’s risk.

► Rate of interest actually earned by the bondholders.

14-14
 Valuation of Bonds Payable

How do you calculate the amount of interest that is actually

paid to the bondholder each period?

(Stated rate x Face Value of the bond)

How do you calculate the amount of interest that is actually

recorded as interest expense by the issuer of the bonds?

(Market rate x Carrying Value of the bond)

14-15
 Valuation of Bonds Payable
Assume Stated Rate of 8%

Market Interest Bonds Sold At

6% Premium

8% Par Value

10% Discount

14-16
 Bonds Issued at Par

Illustration: Santos Company issues R$100,000 in bonds

dated January 1, 2015, due in five years with 9 percent interest
payable annually on January 1. At the time of issue, the market
rate for such bonds is 9 percent.

14-17
 Bonds Issued at Par

14-18
 Bonds Issued at Par

Journal entry on date of issue, Jan. 1, 2015.

Cash 100,000
Bonds payable 100,000

Journal entry to record accrued interest at Dec. 31, 2015.

Interest expense 9,000

Interest payable 9,000

Journal entry to record first payment on Jan. 1, 2016.

Interest payable 9,000

Cash 9,000
14-19
 Bonds Issued at a Discount

Illustration: Assuming now that Santos issues R$100,000

in bonds, due in five years with 9 percent interest payable
annually at year-end. At the time of issue, the market rate for
such bonds is 11 percent.

14-20
 Bonds Issued at a Discount

14-21
 Bonds Issued at a Discount
Journal entry on date of issue, Jan. 1, 2015.
Cash 92,608
Bonds payable 92,608

Journal entry to record accrued interest at Dec. 31, 2015.

Interest expense ($92,608 x 11%) 10,187
Interest payable 9,000
Bonds payable 1,187

Journal entry to record first payment on Jan. 1, 2016.

Interest payable 9,000
Cash 9,000
14-22
 Bonds Issued at a Discount

When bonds sell at less than face value:

► Investors demand a rate of interest higher than stated rate.

► Usually occurs because investors can earn a higher rate

on alternative investments of equal risk.

► Cannot change stated rate so investors refuse to pay face

value for the bonds.

► Investors receive interest at the stated rate computed on

the face value, but they actually earn at an effective rate
because they paid less than face value for the bonds.

14-23
IV. Bond Discount & Premium Amortization

Bond issued at a discount - amount paid at maturity is more

than the issue amount.

Bonds issued at a premium - company pays less at maturity

relative to the issue price.

Adjustment to the cost is recorded as bond interest expense over

the life of the bonds through a process called amortization.

Required procedure for amortization is the effective-interest

method (also called present value amortization).

14-24
 Effective-Interest Method

Effective-interest method produces a periodic interest

expense equal to a constant percentage of the carrying value
of the bonds.

14-25
 Effective-Interest Method

Bonds Issued at a Discount [Term Bonds]

Illustration: Evermaster Corporation issued €100,000 of 8%
term bonds on January 1, 2015, due on January 1, 2020, with
interest payable each July 1 and January 1. Investors require an
effective-interest rate of 10%. Calculate the bond proceeds.

14-26
14-27
 Effective-Interest Method

Journal entry on date of issue, Jan. 1, 2015.

Cash 92,278
Bonds Payable 92,278

14-28
 Effective-Interest Method

Journal entry to record first payment and amortization of the

discount on July 1, 2015.

Interest expense 4,614

Bonds payable 614
Cash 4,000
14-29
 Effective-Interest Method

Journal entry to record accrued interest and amortization of the

discount on Dec. 31, 2015.

Interest expense 4,645

Interest payable 4,000
Bonds payable 645
14-30
 Effective-Interest Method

Bonds Issued at a Premium [Term Bonds]

Illustration: Evermaster Corporation issued €100,000 of 8%
term bonds on January 1, 2015, due on January 1, 2020, with
interest payable each July 1 and January 1. Investors require an
effective-interest rate of 6%. Calculate the bond proceeds.

14-31
14-32
 Effective-Interest Method

Journal entry on date of issue, Jan. 1, 2015.

Cash 108,530
Bonds payable 108,530

14-33
 Effective-Interest Method

Journal entry to record first payment and amortization of the

premium on July 1, 2015.

Interest expense 3,256

Bonds payable 744
Cash 4,000
14-34
 Effective-Interest Method

Accrued Interest
What happens if Evermaster prepares financial statements at the
end of February 2015? In this case, the company prorates the
premium by the appropriate number of months to arrive at the
proper interest expense, as follows.

14-35
 Effective-Interest Method

Accrued Interest

Evermaster records this accrual as follows.

Interest expense 1,085.33

Bonds payable 248.00
Interest payable 1,333.33

14-36
 Effective-Interest Method

Bonds Issued between Interest Dates

Bond investors will pay the seller the interest accrued from the
last interest payment date to the date of issue.

On the next semiannual interest payment date, bond investors

will receive the full six months’ interest payment.

14-37
  When companies issue bonds on other than the
interest payment dates, buyers of the bonds will
pay the seller the interest accrued from the
last interest payment date to the date of issue.
 The purchasers of the bonds, in effect, pay the
bond issuer in advance for that portion of the full
six-months’ interest payment to which they are not
entitled because they have not held the bonds for
that period.
 Then, on the next semiannual interest payment
date, purchasers will receive the full six-
months’ interest payment.

14-38
 Effective-Interest Method

14-39
 Effective-Interest Method

Bonds Issued at Par

Illustration: Assume Evermaster issued its five-year bonds,
dated January 1, 2015, on May 1, 2015, at par (€100,000).
Evermaster records the issuance of the bonds between interest
dates as follows.
(€100,000 x .08 x 4/12) = €2,667

Cash 100,000
Bonds payable 100,000
Cash 2,667
Interest expense 2,667

14-40
 Effective-Interest Method

Bonds Issued at Par

On July 1, 2015, two months after the date of purchase,
Evermaster pays the investors six months’ interest, by making
the following entry. ($100,000 x .08 x 1/2) = $4,000

Interest expense 4,000

Cash 4,000

14-41
 Effective-Interest Method

Bonds Issued at Discount or Premium

Illustration: Assume that the Evermaster 8% bonds were issued
on May 1, 2015, to yield 6%. Thus, the bonds are issued at a
premium price of €108,039. Evermaster records the issuance of
the bonds between interest dates as follows.

Cash 108,039
Bonds payable 108,039
Cash 2,667
Interest expense 2,667

14-42
 Effective-Interest Method

Bonds Issued at Discount or Premium

Evermaster then determines interest expense from the date of
sale (May 1, 2015), not from the date of the bonds (January 1,
2015).

14-43
 Effective-Interest Method

Bonds Issued at Discount or Premium

The premium amortization of the bonds is also for only two
months.

14-44
 Effective-Interest Method

Bonds Issued at Discount or Premium

Evermaster therefore makes the following entries on July 1,
2015, to record the interest payment and the premium
amortization.

Interest expense 4,000

Cash 4,000
Bonds payable 253
Interest expense 253

14-45
 V. Long-term Notes Payable

Accounting is Similar to Bonds

 A note is valued at the present value of its future interest

and principal cash flows.

 Company amortizes any discount or premium over the

life of the note.

14-46
 Notes Issued at Face Value

BE14-9: Coldwell, Inc. issued a €100,000, 4-year, 10% note at

face value to Flint Hills Bank on January 1, 2015, and received
€100,000 cash. The note requires annual interest payments each
December 31. Prepare Coldwell’s journal entries to record (a) the
issuance of the note and (b) the December 31 interest payment.

(a) Cash 100,000

Notes payable 100,000

(b) Interest expense 10,000

Cash 10,000
(€100,000 x 10% = €10,000)

14-47
 Notes Not Issued at Face Value

Zero-Interest-Bearing Notes
Issuing company records the difference between the face
amount and the present value (cash received) as
 a discount and
 amortizes that amount to interest expense over the life
of the note.

14-48
 Zero-Interest-Bearing Notes

Illustration: Turtle Cove Company issued the three-year,

$10,000, zero-interest-bearing note to Jeremiah Company. The
implicit rate that equated the total cash to be paid ($10,000 at
maturity) to the present value of the future cash flows ($7,721.80
cash proceeds at date of issuance) was 9 percent.

14-49
 Zero-Interest-Bearing Notes

Illustration: Turtle Cove Company issued the three-year,

$10,000, zero-interest-bearing note to Jeremiah Company. The
implicit rate that equated the total cash to be paid ($10,000 at
maturity) to the present value of the future cash flows ($7,721.80
cash proceeds at date of issuance) was 9 percent.

Turtle Cove records issuance of the note as follows.

Cash 7,721.80
Notes Payable 7,721.80

14-50
 Zero-Interest-Bearing Notes

14-51
 Zero-Interest-Bearing Notes

Turtle Cove records interest expense for year 1 as follows.

Interest Expense ($7,721.80 x 9%) 694.96

Notes Payable 694.96
14-52
 Interest-Bearing Notes

Illustration: Marie Co. issued for cash a €10,000, three-year

note bearing interest at 10 percent to Morgan Corp. The market
rate of interest for a note of similar risk is 12 percent. In this case,
because the effective rate of interest (12%) is greater than the
stated rate (10%), the present value of the note is less than the
face value. That is, the note is exchanged at a discount.

14-53
 Interest-Bearing Notes

Illustration: Marie Co. issued for cash a €10,000, three-year

note bearing interest at 10 percent to Morgan Corp. The market
rate of interest for a note of similar risk is 12 percent. In this case,
because the effective rate of interest (12%) is greater than the
stated rate (10%), the present value of the note is less than the
face value. That is, the note is exchanged at a discount.

Marie Co. records the issuance of the note as follows.

Cash 9,520
Notes Payable 9,520

14-54
 Interest-Bearing Notes

14-55
 Interest-Bearing Notes

Marie Co. records the following entry at the end of year 1.

Interest Expense 1,142

Notes Payable 142
Cash 1,000
14-56
 Accounting for Serial Bonds

At the beginning of 2006; a company issued $500,000 of

ten-year, 10% serial bonds, to be repaid in the amount of
$50,000 each year. The bond issue costs were $25,000.
Assume that interest payments are made annually and
that the bonds are issued to yield:
Case 1 9% p.a.
Case 2 11% p.a.

14-57
 Accounting for Serial Bonds
Case 1: Bonds are issued to yield 9%
a. Proceeds of bond issue = PV (I) + PV (P)
A B A+B A+B (1+i)-n
Interest Principal Total Discount Present
End of Due Due Amount Due Factor (9%) value
2006 50,000 50,000 100,000 0.917 91,700
2007 45,000 50,000 95,000 0.842 79,990
2008 40,000 50,000 90,000 0.772 69,480
2009 35,000 50,000 85,000 0.708 60,180
2010 30,000 50,000 80,000 0.650 52,000
2011 25,000 50,000 75,000 0.596 44,700
2012 20,000 50,000 70,000 0.547 38,290
2013 15,000 50,000 65,000 0.502 32,630
2014 10,000 50,000 60,000 0.460 27,600
2015 5,000 50,000 55,000 0.422 23,210
Totals 275,000 500,000 775,000 519,780
Proceeds of Serial Bond issue @ 9% yield 519,780
14-58
 Accounting for Serial Bonds
b. Premium on bond issue
Total proceeds……………………………………$519,780
Face value……………………………………………500,000
Premium…………………………………………......19,780

c. Journal entry for the issuance of the serial bonds

Cash……………………………………519,780
Bonds payable…………………………………….519,780

d. Premium amortization table for the serial bonds using the

interest method

14-59
 Accounting for Serial Bonds
d. Premium amortization table for the serial bonds using the interest method
A B C D
Year Carrying Interest Interest Premium Bond Cumulative
Amount Expense Payment Amortization Premium Bal. Principal
(9%*CV) (10%*FV) (C-B) (BB-D) Payment
Issue 519,780 - - - 19,780 -
2006 466,560 46,780 50,000 3,220 16,560 50,000
2007 413,550 41,990 45,000 3,010 13,550 100,000
2008 360,770 37,220 40,000 2,780 10,770 150,000
2009 308,239 32,469 35,000 2,531 8,239 200,000
2010 255,981 27,742 25,000 2,258 5,981 250,000
2011 204,019 23,038 20,000 1,962 4,019 300,000
2012 152,381 18,362 15,000 1,638 2,381 350,000
2013 101,095 13,714 10,000 1,286 1,095 400,000
2014 50,194 9,099 5,000 901 194* 450,000
2015 - 4,517 483* - 500,000
*Rounding up difference

14-60
 Accounting for Serial Bonds
Journal entry to record the retirement of the first serial bond and
the payment of the first interest for 1996:
Bonds payable……………………….53, 220
Bond Interest Expense…………….46,780
Cash 100,000
Case 2: Bonds are issued to Yield 11%
a. Proceeds of bond issue = PV (I) + PV (P)

14-61
 Accounting for Serial Bonds
A B A+B (1+i)-n A+B (1+i)-n
Interest Principal Total Amount Discount Present
End of Due Due Due factor (11%) value
1996 50,000 50,000 100,000 0.901 90,100
1997 45,000 50,000 95,000 0.812 77,140
1998 40,000 50,000 90,000 0.731 65,790
1999 35,000 50,000 85,000 0.659 56,015
2000 30,000 50,000 80,000 0.593 47,440
2001 25,000 50,000 75,000 0.535 40,125
2002 20,000 50,000 70,000 0.482 33,740
2003 15,000 50,000 65,000 0.434 28,210
2004 10,000 50,000 60,000 0.391 23,460
2005 5,000 50,000 55,000 0.352 19,360
Totals 275,000 500,000 775,000 481,380
Proceeds of Serial Bond issue @ 11% yield 481,380

14-62
 Accounting for Serial Bonds

b. Discount on bond issue

Face value……………………………………………500,000
Total proceeds……………………………………$481,380
Discount ………………………………………….......18,620
c. Journal entry to record the issuance of the bonds
Cash ………………………………………….481,380
Bonds Payable…………………………………..481,380

d. Discount amortization table using the interest method

14-63
 Accounting for Serial Bonds
Year Carrying Interest Interest Discount Bond Cumulative
Amount Expense Payment Amortization Discount Principal
(11%) (10%) Balance Payment
Issue 481,380 - - - 18,620 -
1996 434,332 52,952 50,000 2,952 15,668 50,000
1997 387,109 47,777 45,000 2,777 12,891 100,000
1998 339,691 42,582 40,000 2,582 10,309 150,000
1999 292,057 37,366 35,000 2,366 7,943 200,000
2000 244,183 32,126 25,000 2,126 5,817 250,000
2001 196,043 26,860 20,000 1,860 3,957 300,000
2002 147,608 21,565 15,000 1,565 2,392 350,000
2003 98,845 16,237 10,000 1,237 1,155 400,000
2004 49,718 10,873 5,000 873 282* 450,000
2005 - 5,469 496* - 500,000
*Rounding up difference
e. Journal entry to record the retirement of the first serial bond and
the payment of the first interest for 1996:
Bonds payable [50000-2952]……47048
Bond Interest Expense…………..52,952
Cash………………………………… 100,000
14-64
 Accounting for Serial Bonds
The following diagram shows how the book values of bonds are different between the
straight-line and effective interest methods for both a premium and a discount:

14-65
 VI. Special Issues Related To
Non-current Liabilities

Extinguishment of Non-Current Liabilities

(repurchase or retirement of its outstanding bonds)
1. Extinguishment with cash before maturity,

2. Extinguishment by transferring assets or securities, and

3. Extinguishment with modification of terms.

Retirement of bonds at maturity. There is no recognition
of any gain or loss on retirement, as the carrying value is
equal to the maturity value, which is also equal to the
market value of the bonds at that point.
14-66
 Extinguishment of Non-Current Liabilities

Extinguishment with Cash before Maturity

When debt is retired prior to maturity, a gain or loss must
be recognized for the difference between the carrying
value of the debt and the amount paid to satisfy the
obligation.
 Net carrying amount > Reacquisition price = Gain
 Reacquisition price > Net carrying amount = Loss
 At time of reacquisition, unamortized premium or discount
must be amortized up to the reacquisition date.
If the redemption occurs between interest payment dates, adjusting
entries must be made to recognize the accrued interest and to amortize
the bond discount or premium.
14-67
 Extinguishment with Cash before Maturity

Illustration: Evermaster bonds issued at a discount on January 1,

2015. These bonds are due in five years. The bonds have a par value
of €100,000, a coupon rate of 8% paid semiannually, and were sold to
yield 10%.

14-68
 Extinguishment with Cash before Maturity

Two years after the issue date on January 1, 2017, Evermaster

calls the entire issue at 101 and cancels it.

Evermaster records the reacquisition and cancellation of the

bonds as follows.
Bonds Payable 94,925
Loss on Extinguishment of Bonds 6,075
Cash 101,000
14-69
 Extinguishment of Non-Current Liabilities

Extinguishment by Exchanging Assets or

Securities
 Creditor should account for the non-cash assets or equity
interest received at their fair value.

 Debtor recognizes a gain equal to the excess of the

carrying amount of the payable over the fair value of the
assets or equity transferred (gain).

14-70
 Exchanging Assets

Illustration: Hamburg Bank loaned €20,000,000 to Bonn Mortgage

Company. Bonn, in turn, invested these monies in residential apartment
buildings. However, because of low occupancy rates, it cannot meet its
loan obligations. Hamburg Bank agrees to accept from Bonn Mortgage
real estate with a fair value of €16,000,000 in full settlement of the
€20,000,000 loan obligation. The real estate has a carrying value of
€21,000,000 on the books of Bonn Mortgage. Bonn (debtor) records this
transaction as follows.

Note Payable (to Hamburg Bank) 20,000,000

Loss on Disposal of Real Estate 5,000,000
Real Estate 21,000,000
14-71 Gain on Extinguishment of Debt 4,000,000
 Exchanging Securities

Illustration: Now assume that Hamburg Bank agrees to

accept from Bonn Mortgage 320,000 ordinary shares
(€10 par) that have a fair value of €16,000,000, in full
settlement of the €20,000,000 loan obligation. Bonn
Mortgage (debtor) records this transaction as follows.

Notes Payable (to Hamburg Bank) 20,000,000

Share Capital—Ordinary 3,200,000
Share Premium—Ordinary 12,800,000
Gain on Extinguishment of Debt 4,000,000

14-72
 Extinguishment with Modification of Terms

Creditor may offer one or 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 face amount of the debt.
4. Reduction or deferral of any accrued interest.

14-73
 Modification of Terms
Illustration: On December 31, 2015, Morgan National Bank enters
into a debt modification agreement with Resorts Development
Company. The bank restructures a ¥10,500,000 loan receivable
issued at par (interest paid to date) by:
► Reducing the principal obligation from ¥10,500,000 to
¥9,000,000;
► Extending the maturity date from December 31, 2015, to
December 31, 2019; and
► Reducing the interest rate from the historical effective rate of
12 percent to 8 percent. Given Resorts Development’s
financial distress, its market-based borrowing rate is 15
14-74 percent.
 Modification of Terms

IFRS requires the modification to be accounted for as an

extinguishment of the old note and issuance of the new
note, measured at fair value.

14-75
 Modification of Terms

The gain on the modification is ¥3,298,664, which is the

difference between the prior carrying value (¥10,500,000) and
the fair value of the restructured note, as computed in
Illustration 14-23 (¥7,201,336). Given this information, Resorts
Development makes the following entry to record the
modification.

Note Payable (old) 10,500,000

Gain on Extinguishment of Debt 3,298,664
Note Payable (new) 7,201,336

14-76
 Modification of Terms

Amortization schedule for the new note.

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 VII. Presentation and Analysis

Presentation of Non-Current Liabilities

Note disclosures generally indicate the nature of the liabilities,
maturity dates, interest rates, call provisions, conversion
privileges, restrictions imposed by the creditors, and assets
designated or pledged as security.

Fair value of the debt should be disclosed.

Must disclose future payments for sinking fund requirements

and maturity amounts of long-term debt during each of the
next five years.

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