INTERMEDIATE ACCOUNTING II

BSA22A1
EXAMPLES OF LIABILITIES
Accounts payable
Advances from employees and other parties
Accruals
Withholding
Cash dividends
Deposits from customers and officers
Loans and debts payables
Income tax payable
Unearned revenues
LIABILITIES
Present obligations
Legal or contractual
Constructive
Particular entity
Past event-obligating event
Outflow of economic resources
Cash
Non-cash
Value is measurable
MEASUREMENT OF LIABILITIES
INITIAL MEASUREMENT (PFRS 9, PAR. 5.1.1)
Fair value minus transaction costs directly
attributable to the issue of financial liability-in the
case of financial liability not designated at fair value
through profit or loss. Thus, transaction costs is
expensed immediately.
Fair value plus transaction costs directly attributable
to the issue of financial liability- in the case of
financial liability measured at amortized costs
Transaction costs include fees and commissions,
regulatory fees and charges, and transfer taxes and
duties
MEASUREMENT…
Subsequent measurement
At amortized cost using the effective interest
method
At fair value through profit or loss
MEASUREMENT…
Noncurrent liabilities: non-interest bearing
Present value initially
Amortized cost subsequently
Noncurrent liabilities-interest bearing
Face amount because it is equal to present value of
loan payable
Current liabilities
Conceptually at present value initially and amortized
cost subsequently
Face amount-not discounted because the difference
between face amount and present value is not material
MEASUREMENT…
Fair value option of measuring financial liability
PFRS 9, par. 4.2.2
At initial recognition, the entity may irrevocable
designate financial liability at fair value through
profit or loss if it would result in more relevant
information.
The amortization rules for discount or premium no
longer apply
The interest expense is recognized using the
nominal or stated rate.
CLASSIFICATION OF LIABILITIES
Current liabilities-Criteria:
Settled within the normal operating cycle
Held for trading
Settled within 12 months after the end of the
accounting period
No right to extend settlement for at least 12 months
after the end of the accounting period
Noncurrent liabilities-residual definition
CLASSIFICATION…
Long-term debt due within one year-Current
Covenants-undertaking by the borrower
Breach of Covenant-the liability becomes payable
on demand; hence classified as current per PAS
1, par. 74
Even if the lender agreed not to demand payment
The entity does not have an unconditional right to
defer settlement for another 12 months after the
end of the accounting period.
CLASSIFICATION…
Breach of covenant
Liability is classified as noncurrent if the lender
has agreed to provide a grace period on or
before the end of the reporting period ending at
least 12 months after that date.
FINANCIAL AND NON-FINANCIAL
LIABILITIES
Financial liability is any liability that is:
A contractual obligation to deliver cash or
another financial asset to another entity;
A contractual obligation to exchange
financial asset or financial liabilities with
another entity under conditions that are
potentially unfavorable to the entity; or
A contract that will or may be settled in the
entity’s own equity instruments, and is not
classified as the entity’s own equity
instrument.
FINANCIAL AND NON-FINANCIAL
LIABILITIES
Examples are: accounts, notes, loans, bonds and
accrued payables; lease liabilities; held for trading
and derivatives liabilities; redeemable preference
shares issued; security deposits and other
returnable deposits

Non-financial liability- is a liability other than a

financial liability.
Examples are: constructive obligations; unearned
revenues and warranty obligations; and taxes,
SSS, Pag-ibig and Phil health contributions.
PRESENTATION OF CURRENT
LIABILITIES
PAS No. 1, par. 54 provides, as a minimum, the
face of the Statement of Financial Position, shall
include the following line items for current
liabilities:
Trade and other payables
Current provisions
Short-term borrowings
Current portion of long-term debt
Current tax liability
Additional line items may be included where
relevant.
ESTIMATED LIABILITIES
Exists at the end of the accounting period
Amount is not definite
In many cases, the due date is also not definite
In some cases, the payee cannot be identified
The existence of the estimated liabilities is valid and
unquestionable
Either current or non-current
Examples are premium, award points, warranties,
gift certificates and bonus
PAS 37, estimated liability is considered as
“provision” which is both probable and measurable.
PREMIUMS
Articles of values like toys, dishes, silverware
Offers premiums to stimulate sale in return of
product labels, box tops, wrappers and coupons
Accounting liability for future distribution of
premiums
ACCOUNTING FOR PREMIUMS
Acquisition and recognition of premiums,
premium expense and premium liability
Recording sales, premiums purchases and
redemption, year-end adjustment fro estimated
premium liability
Presentation in the financial statements of
premiums, premium liability and premium
expense
CUSTOMER LOYALTY
PROGRAM…
CUSTOMER LOYALTY PROGRAM
Build brand loyalty, retain valued customers, and
increase sales
Reward customers for past purchases and
provide incentives for further purchases
Grants customer award credits described as
“points”
Redeem points for discounted or free goods or
services.
Operates in variety of ways
Administered by the entity itself of a third party
RECOGNITION AND
MEASUREMENT
IFRIC 13 accounts award credits as a separate
component of the initial sale transaction.
Fair value of the consideration received on initial
sale is allocated between award credits and sale
Award credits is measured at its fair value.
Subsequent recognition of award credits depends
on
The entity supplies the award credits
A third party supplies the award credits
ENTITY OPERATES THE CLP
The consideration allocated to award credits is
initially recognized as deferred revenue and
subsequently recognized as revenue when the
award credits are redeemed.
The estimated redemption rate is assessed each
period.
Calculation of the revenue to be recognized is on
a cumulative basis
ILLUSTRATION
CLP IS OPERATED BY THE ENTITY
An entity, a grocery, operates a CLP by granting its customers
loyalty points when they spend a specified amount on
groceries. They can redeem the points for further groceries
without expiry date. In 2018, the entity granted 10,000 points
and the entity expects that 80% or 8,000 points will be
redeemed. The fair value of the loyalty point is estimated at P
100. The sales in 2018 is P 8 million including the loyalty
points. On December 31, 2018, 4,000 points were redeemed in
exchange for groceries. In 2019, the entity expects that 90% or
9,000 points will be redeemed altogether and in that year 4,100
points were redeemed. In 2020, 900 points were redeemed
and management expects that no more points will be
redeemed.
ILLUSTRATION…
 Journal Entries
 Initial Sale
 Cash 8,000,000
 Sales 7,000,000
 Unearned revenue-points 1,000,000
 Total consideration 8,000,000
 Fair value of points(10,000 x 100) (1,000,000)
 Fair value of initial sale 7,000,000
 Redemption of 4,000 points in 2018
 Unearned revenue-points 500,000
 Sales 500,000
 Revenue to be recognized in 2018
 (4,000/8,000 x 1,000,000) 500,000
•
ILLUSTRATION…
Redemption of 4,100 points in 2019
 Unearned revenue-points…………… 400,000
 Sales ……………………………….. 400,000
 Point redeemed in 2018 4,000
 Points redeemed in 2019 4,100
 Total points redeemed in 2019 8,100
 Cumulative revenues in 12/31/19
 ( 8,100/9,000 X 1,000,000) 900,000
 Revenue recognized in 2018 (500,000)
 Revenue to be recognized, 2019 400,000
ILLUSTRATION…
Redemption of 900 points in 2020
Unearned revenue-points……….100,000
 Sales……………………………………………..100,000
Points redeemed in 2018 4,000
Points redeemed in 2019 4,100
Points redeemed in 2020 900
Total points redeemed in 2020 9,000
Cumulative revenue, 12/31/20
 (9,000/9000 x 1,000,000) 1,000,000
Cumulative revenue, 12/31/19 900,000
Revenue to be recognized in 2020 100,000
THIRD PARTY SUPPLIES THE
AWARDS
Entity assesses whether it collects the consideration
allocated to the award credits as
Principal- equal to the gross consideration allocated to the
award credits
Agent- net amount retained on its own account ( amount
allocated to credit awards less amount payable to third party)
The revenue from the award credits is recognized at the
point of initial sale
The entity has already fulfilled its obligation of providing
credit awards to customers
The entity is obliged to supply the awards with a
consideration for doing so.
ILLUSTRATION
THIRD PARTY SUPPLIES THE AWARDS
An entity, a retailer of electrical goods,
participates in a CLP operated by an airline. The
entity grants customers one air travel point for
every P 1,000 spent on electrical goods. They
can redeem the points for travel with the airline
subject to availability. The entity pays the airline P
90 for each point. In the current year the entity
sold goods for P 5 million and granted 5,000
points, with a fair value of P 100 each.
ILLUSTRATION…
JOURNAL ENTRIES
Entity collected the consideration allocated to the
points on its own account
Cash……………………5,000,000
 Sales…………………………………..4,500,000
 Revenue from points………………… 500,000
Total consideration 5,000,000
Fair value of points(5,000 x 100) ( 500,000)
Consideration for the initial sale 4,500,000
ILLUSTRATION…
 Payment to the airline
 Loyalty program expense……..450,000
 Cash…………………………………………….450,000
 ( 5,000 points x P 90)
 If the entity has collected the consideration in behalf of the
airline.
 Cash …………………………..5,000,000
 Sales …………………………………………….4,500,000
 Liability to the airline……………………………. 500,000
 Payment to the airline
 Liability to the airline…………500,000
 Cash……………………………………………..450,000
 Revenue from points…………………………… 50,000
WARRANTY…
WARRANTY
Home appliances and office equipment, furniture
and fixture
Free repair services or replacement during a
specified period
Involve significant costs
A liability is incurred
Two approaches in accounting for warranty
Accrual approach
Expense approach
WARRANTY
 Accrual approach
Soundest theoretical support
Properly matches cost with revenue
At the time of sale, a liability for warranty cost
arises and should be recognized as follows:
Warranty expense……………….xx
Estimated warranty liability…………..xx
When estimated warranty is subsequently incurred
and paid
Estimated warranty liability……..xx
o Cash………………………………..xx
ILLUSTRATION
An entity sells 1,000 TV sets at P 9,000 each for cash. Each set is under
warranty for one year and the entity has estimated from experience that
warranty cost average P 500 per unit and 60% of the units sold were
returned for repair. The entity incurs P 180,00 for repairs during the year.
Journal Entries
To record the sale
Cash ……………………………9,000,000
Sales……………………………..9,000,000
To set up estimated liability on the warranty
Warranty expense…………………300,000
Estimated warranty liability………….300,000
(60%x 1,000=600 x 500)
To record payment of actual cost
Estimated warranty liability………180,000
Cash………………………………………180,000
WARRANTY…
 Change in estimate
 Actual cost > estimate….
Warranty expense…………………xx
Estimated warranty
payable………………………………….xx
 Actual cost<estimate
Estimated warranty payable………xx
Warranty expense…………………………….……
xx
WARRANTY
Expense as incurred approach
Expensing warranty costs when incurred
Popular in practice for income tax purpose
Expedient when warranty cost is minimal and
warranty period is short
The actual warranty cost in the previous illustration
is simply recorded as
 Warranty expense…………………..180,000
 Cash………………………………………..180,000
AMOUNT WITHHELD FROM
SALARIES
Income tax payable by the employee
Employees contribution to the SSS
Employees contribution to the Philhealth
Employees contribution to the Pag-ibig Fund
Other deductions such as Union Dues and Group
Insurance
Employer’s contribution to SSS, Philhealth and
Pag-ibig Fund
Recognized as current liability until remitted.
ILLUSTRATION
The entity reported the following payroll of the
employees for the month of January:
Gross payroll…………………………..500,000
Income tax withheld………………… (20,000)
SSS contribution……………………….( 4,000)
Pag-ibig contribution…………………..(1,000)
Philhealth contribution…………………(2,000)
Net Payroll……………………………..473,000
ILLUSTRATION
Employer’s contribution:
SSS ………………………….6,000
PHILHEALTH………………..3,000
PAGIBIG……………………..2,000
TOTAL CONTRIBUTION……11,000
Journal entries
Gross payroll
Salaries……………………..500,000
 Withholding tax payable………………………20,000
 SSS payable…………………………………….4,000
 Philhealth payable………………………………2,000
 Pagibig payable…………………………………1,000
 Cash…………………………………………473,000
ILLUSTRATION
Journal entries
 Employer’s contribution
 Payroll ……………………..11,000
 SSS Payable…………………………….6,000
 Philhealth payable………………………3,000
 Pab-ibigpayable…………………………2,000
 Remittances to government
 Withholding tax payable…..20,000
 SSS payable………………..10,000
 Philhealth payable………… 5,000
 Pag-ibig payable…………… 3,000
 Cash 38,000
VALUE ADDED TAX(VAT)
 National Internal Revenue Code (NIRC)
 Sales of tangible personal property and certain services
 Subject to VAT at 12%
 Remitted monthly to the BIR
 Illustration
 During the month, an entity sold goods to customers on account for P 5
million including VAT of P 600,000.
 Account Receivable………….5,600,000
 Sales…………………………………………….5,000,000
 Output VAT……………………………………… 600,000
VALUE ADDED TAX
During the same month, the entity bought goods on account
from suppliers for P 2,240,000 including VAT of P 240,000
Purchases…………………….2,000,000
Input VAT………………………...240,000
o Accounts payable………………………….2,240,000
At the end of the month input VAT is offset against the
output VAT to determine the net liability of the entity.
Output VAT…………………..600,000
 Input VAT………………………………………..240,000
 VAT payable……………………………………..360,000

Remittance of VAT payable to the BIR

VAT payable………………....360,000
 Cash……………………………………………..360,000
GIFT CERTIFICATES
Accounting procedures
When the gift certificates are sold
Cash………………………….xx
 Gift certificates payable…………………..xx

When the gift certificates are redeemed.

Gift certificates payable…….xx
 Sales……………………………………xx

When gift certificates expired.

Gift certificates payable……..xx
 Gift certificates forfeited………………xx

Note: The DTI has ruled out that gift certificates no

longer has expiration period.
REFUNDABLE DEPOSITS
 Cash or property received from customers but which are refundable
upon meeting certain conditions. Example: refundable containers like
bottles, drums, tanks and barrels.
 Illustration
 A deposit of P 10,000 is required from customer for returnable
containers which cost P 8,000.
 Cash…………………………10,000
 Containers’ deposit……………………..10,000
 Assume the customers return the containers
 Containers deposit …………10,000
 Cash……………………………………..10,000
 Assume the customers fail to return the containers.
 Containers deposit…………..10,000
 Containers…………………………………8,000
 Gain on sale of containers……………….2,000
BONUS
 BONUS COMPUTATION
Superior income
Motivate employees
Compensation plan results in a liability computed
as follows:
1. Bonus is expressed as a certain percent of income
before bonus and before tax ( Net Income x tax rate)
2. Bonus is expressed as a certain percent of income
after bonus but before tax (B=bonus rate(Net Income-Bonus)
3. Bonus is expressed as a certain percent of income
after bonus and after tax (B=bonus rate(Net Income-Bonus-Tax)
4. Bonus is expressed as a certain percent of income
after tax but before bonus( B=bonus rate(Net Income –Tax)
ILLUSTRATION
 Net Income………………………..4,400,000
 Bonus…………………………………..10%
 Income Tax Rate………………… …30%
 Case I :Before Bonus and Before Tax
 Income before bonus and before tax………4,400,000
 Multiply by……………………………………. 10%
 Bonus……………………………………….. 400,000
ILLUSTRATION
 Case II- After Bonus but Before Tax
 B=.10(4,400,000-B)
 B=440,000-.10B
 B+.10B=440,000
 1.10 B=440,000
 B=440,000/1.10
 B=400,000
 Proof
 Income before bonus and before
tax……………………………………………………………...4,400,000
 Less: Bonus…………………………………………………. 400,000
 Income after bonus but before tax………………………… 4,000,000
 Multiply by………………………………………………….. ….. 10%
 Bonus………………………………………………………… 400,000
ILLUSTRATION
Case IV-After Tax but Before Bonus
B=.10(4,400,000 –T)
T= .30(4,400,000-B)
B=.10[4,400,000-.30(4,400,000-B)]
B=.10(4,400,000-1,320,000+.30B)
B=440,000 -132,000+ .03B
B-.03B=440,000-132,000
.97B=308,000
B=308,000/.97
B=317,526
Proof
Income before bonus and before tax……….4,400,000
Tax ( 4,400,000-317,526x.30)……………….1,224,742
Income after tax but before bonus…………..3,175,258
Multiply by……………………………………… 10%
Bonus………………………………………….. 317,526
ILLUSTRATION
Case III- After Bonus and After Tax
B=.10(4,400,000-B-T)
T=.30(4,400,000-B)
B=.10[4,400,000-B-.30(4,400,000-B)]
B=.10(4,400,000-B-1,320,000+.30B)
B=440,000-.10B-132,000+.03B
B+.10B-.03B=440.000-132,000
1.07B=308,000
B=308,000/1.07
B=287,850
T=.30(4,400,000-287,850)
T=1,233,645
Proof
Income before bonus and before tax……………4,400,000
Bonus………………………………………………( 287,850)
Tax………………………………………………….(1,233,645)
Income after bonus and after tax………………..2,878,505
Multiply by…………………………………………. 10%
Bonus………………………………………………..287,850
DEFERRED/UNEARNED
REVENUE
DEFERRED/UNEARNED
REVENUE
 Income already received but not yet earned
 May be realizable within one year or more than one year from
end of the accounting period
 If realized within one year it is current liability; otherwise it is
noncurrent liability
 Illustration
 An entity received an advanced payment for professional
services in the total amount of P 10 Million
 Cash………………………..10,000,000
 Deferred Service Revenue……………..10,000,000
 Professional Services rendered
 Deferred Service Revenue…10,000,000
 Service Revenue………………………….10,000,000
PROVISION AND CONTINGENT
LIABILITY
PROVISION AND CONTINGENT
LIABILITY
A provision is an existing liability of uncertain timing and
uncertain amount.
It may be an equivalent of estimated liability or a loss
contingency that is accrued because it is probable and
measurable.
It meets the definition of a liability.
PAS 37, par. 11 states that provision is a liability although
there is uncertainty about the timing or amount of the future
expenditure required for settlement.
PAS 37, par. 27 provides that the use of estimates is an
essential part of the preparation of financial statements and
does not undermine their reliability which is especially true in
a provision.
ILLUSTRATION
An oil company is exploring oil off the shores of Philippine Deep.
The entity has employed oil exploration experts from around the
globe. Despite all efforts, a major oil spill occurred and has grabbed
the attention of media. Environmentalists are protesting and the
entity has engaged a lawyer to advise it about legal repercussions.
In the past, other oil firms had to settle with the environmentalists
paying huge amounts in “ out of court” settlements. The lawyer
advised that there is no law that would require the entity to pay for
the oil spill. However, the entity has announced publicly that it
would pay for any damage that it may cause to the public resulting
from its operation.
Analysis: A provision shall be recognized for the best estimate of
the cost to clean up the oil spill. While there is no legal obligation,
there is constructive obligation to do so. There is an obligating
event which is the oil spill.
MEASUREMENT OF A
PROVISION
Best estimate-the entity would rationally pay
Single obligation-individual most likely outcome adjusted for
the effect of other possible outcome
Range of possible outcomes- midpoint of the range
Large population of items- weighting all possible outcomes by
their associated possibilities
Illustration
An entity is a dependant on a patent infringement suit. The
lawyer believe that there is 60% that the court will no dismiss
the case and the entity will incur an outflow of future economic
benefits. There is a 30% chance the entity will pay damages of
P 4 million and 70% that it will be P 2 million if the court decide
in favor of the claimant. A 10% risk adjustment factor to the
probabilities of expected cash flow.
MEASUREMENT OF PROVISION
The provision is measured as follows:
Weighted probabilities:
30%x 4,000,000 x 60%....................720,000
70%x 2,000,000x60%......................840,000
Expected cash outflow……………..1,560,000
Risk adjustment factor(P1.56Mx.01) 156,000
Estimated amount of provision…… 1,716,000
The amount of the provision shall be discounted if
the effect of time value of money is material.
OTHER MEASUREMENT
CONSIDERATIONS
Risks and uncertainties
Present value of obligations
Future events
Expected disposal of assets
Reimbursements
Changes in provision
Use of provision
Future operating losses
Onerous contract
EXAMPLES OF PROVISION
Warranties
Environmental contamination
Decommissioning or abandonment costs
Court case
Guarantee
Restructuring
DECOMMISSIONING LIABILITY
An obligation to dismantle, remove and restore an item
of property, plant and equipment as required by law or
contract.
Illustration
On January 1, 2018, the entity constructed a drilling
platform for P 25 million to be dismantled after 10 years
under the Philippine law. Straight line depreciation is
used in depreciating the platform. The entity has
estimated that said dismantling will cost P 5 million.
Based on 12% discount rate, the present value of 1 for
10 years is 0.322. Thus, the present value of
decommissioning is P 1,610,000( P 5 million x 0.322)
DECOMMISSIONING LIABILITY
 ILLUSTRATION
 Journal Entries
 2018
 Jan 1 Drilling platform……….................26,610,000
• Cash…………………………………………25,000,000
• Decommissioning liability…………………1,610,000
 Dec 31 Depreciation……….................…...2,661,000
• Accumulated depreciation…………………2,661,000
 Dec 31 Interest Expense………………….…193,200
• Decommissioning liability…………………193,200
After 10 years, the entity contracted with another
firm to dismantle and remove the drilling platform
for P 5.5 million
DECOMMISSIONING LIABILITY
ILLUSTRATION
Journal entry to record the decommissioning
 Decommissioning liability………………….5,000,000
 Loss on settlement of decommissioning… 500,000
 Cash……………………………………………………….5,500,000
 The decommissioning liability on Jan 1, 2018 is P 1,610,000.
This amount plus 12% interest compounded annually will build
up to P 5 million after 10 years. Thus the decommissioning
liability is debited at P 5 million.
 The journal entry to derecognize the drilling platform is
 Accumulated depreciation……………..26,610,000
 Drilling Platform…………………………………………..26,610,000
CHANGE IN DECOMMISSIONING
LIABILITY
Under IFRIC 1, changes in decommissioning
liability shall be accounted for as follows:
A decrease in liability is deducted from the cost of
the asset. If the decrease in liability exceeds the
carrying amount of the asset, the excess is
recognized in profit or loss.
An increase in liability is added to the cost of the
asset. However, the entity shall consider whether
this is an indication that the carrying amount of
the asset may not be fully recoverable. Then the
asset should be tested for impairment.
ILLUSTRATION
On January 1, 2018, the plant of Seaoil Company is 10
years old. The cost of the plant is P 12 million with
accumulated depreciation of P 4 million. This plant has
useful life of 30 years and was depreciated using the
straight line method without salvage value. Because of
the unwinding discount of 6% over 10 year, the
decommissioning liability has grown from P 1 million to
P 1.79 million. On January 1, 2018, the discount rate
has not changed. However the entity has estimated
that as a result of technological advances, the net
present value of the decommissioning liability has
decreased by P 800,000.
ILLUSTRATION
Journal Entries for 2018
Jan 1 Decommissioning Liability 800,000
• Plant Asset…………………………………..800,000
Dec 31 Depreciation………….360,000
• Accumulated depreciation………………..360,000
Cost of plant 12,000,000
Decrease in decommissioning
liability ( 800,000)
Net cost 11,200,000
Accumulated depreciation (4,000,000)
Carrying Amount 7,200,000
Depreciation for 2018(7.2 M/20Yrs 360,000
ILLUSTRATION
Dec 31,2018
Interest expense……………….59,400
 Decommissioning liability………………..59,400
Decommissioning liability-1/1/18……………1,790,000
Reduction………………………………………( 800,000)
Adjusted carrying amount-1/1/18…………… 990,000
Interest expense 2018(6%x 990,000)………. 59,400
RESTRUCTURING
PAS 37, par. 10 defines restructuring as a “
program that is planned and controlled by
management and materially changes either the
scope of the business of an entity or the manner
in which the business is conducted.
Examples are:
Sale or termination of a line of business
Closure of a business location or segment
Change in management structure
Fundamental reorganization impacting on the
operation
RESTRUCTURING
Provision for Restructuring
Detailed formal plan for the restructuring
Raised valid expectation in the minds of those
affected
Amount of the Restructuring Provision
Direct expenses associated with restructuring
PAS 37 excludes the following expenses:
 Cost of retraining or relocating continuing staff
 Marketing and advertising program to promote the new
company image
 Investment in new system and distribution network
CONTINGENT LIABILITY
PAS 37 defines it in two ways as follows:
Contingent liability is a possible obligation that arises
from past event and whose existence will be confirmed
only by the occurrence or nonoccurence of one or
more uncertain future events not wholly within the
control of the entity.
Contingent liability is a present obligation that arises
from past event but is not recognized because it is not
probable that an outflow of resources embodying
economic benefits will be required to settle the
obligation or the amount of the obligation cannot be
measured reliably.
CONTINGENT LIABILITY
Treatment of contingent liability
Not recognized but only disclosed in the FSs
Brief description of its nature
An estimate of its financial effect
An indication of the uncertainties that exists
Possibility of any reimbursements
CASE STUDIES
CASE
1. Liability for pending lawsuits, 1. Recognize a provision if
tax assessments,
government-imposed
penalties, etc
2. A defective product causes
injury to customers. No
lawsuits have yet been filed
against the seller.
3. Environmental damages
4. Restructuring by sale of an
operating segment.
5. Restructuring by closure or
reorganization.
ACCOUNTING TREATMENT
there is present obligation
and outflow is both probable
and measurable.
2. Present obligation arises
from injury to customers.
Provision is recognized if
outflow of resources is
probable and estimable
(measurable).
3. Recognize a provision if the
entity’s policy is to clean up
even if there is no legal
requirements to do so.
4. Recognize a provision only if
a binding sale agreement is
obtained on or before the
end of reporting period.
5. Recognize a provision only if
CASE STUDIES
CASE
6. Warranty, Premiums, and
Refunds
7. Guarantee for indebtedness
of others
8. Offshore oil rig must be
installed and sea bed restored.
9. Onerous (loss making)
contract.
10. An entity must train its
employees to increase
productivity. The entity
obtained self-insurance policy.
The entity has a plan to
undertake major overhaul or
ACCOUNTING TREATMENT
6. Recognize a provision at the
point of sale if there is legal or
constructive obligations
7. Recognize a provision only
when the liability for guarantee
becomes probable.
8. Recognize provision only
when oil rig is installed . The
provision is added to the cost of
the asset.
9. Recognize a provision if the
outflow of resources is both
probable and reliably
measurable.
10. No provision to provide
training. No provision until a
loss has incurred on insurance
policy. No provision unless a
commitment was made to third
CONTINGENT ASSET
PAS 37, par. 10 defines it as a “ possible asset that
arises from past event and whose existence will be
confirmed only by the occurrence or nonoccurence of
one or more uncertain future events not wholly within the
control of the entity.
A contingent asset is not recognized because this may
result to recognition of income that may never be
realized.
It is disclosed only when probable.
Its disclosure includes a brief description of the
contingent asset and an estimate of financial effects.
If it is only possible or remote, it should not be disclosed.
EVENTS AFTER REPORTING
PERIOD
PAS 10, par. 3 “ events after the reporting period “
are those events both favorable and unfavorable
that occur between the end of the reporting period
and the date when the financial statements are
authorized for issue.
Two types of events after the reporting period
Adjusting events are those that provide evidence of
conditions that exist at the end of the reporting period
Nonadjusting events are those that are indicative of
conditions that arise after the end of the reporting
period
EVENTS AFTER REPORTING
PERIOD
Examples of Adjusting Events are:
Resolution after the reporting period of a court case because it
confirms that the entity already had a present obligation.
Bankruptcy of a customer which occurs after the reporting period.
Sale of inventory after the reporting period may give evidence
about the net realizable value at reporting date.
The determination after the reporting period of thee cost of
assets purchased or the proceeds from assets sold before the
reporting date.
The determination after the reporting period of the profit sharing
or bonus payment if the entity has the present obligation at the
reporting date to make such payment.
The discovery fraud or errors that show the financial statements
were incorrect.
EVENTS AFTER REPORTING
PERIOD
Examples of Nonadjusting Events
Business combination after the reporting period
Plan to discontinue an operation
Major purchase and disposal of asset or expropriation of major asset
by the government
Destruction of a major production plant by a fire after the reporting
period
Major ordinary share transactions and potential ordinary share
transactions after reporting period
Abnormally large changes after the reporting period in asset prices or
foreign exchange rates
Entering into significant commitments or contingent liabilities,e.g.,
issuing guarantees
Commencing major litigation arising solely from events that occurred
after the reporting period.
FINANCIAL STATEMENTS
AUTHORIZED FOR ISSUE
Board of Directors reviews the FSs and
authorizes them for issue.
Approval of shareholders are sometimes required
but the FSs are authorized for issue on the date of
issue by the BOD.
In other cases, the management of an entity is
required to issue its FSs to a supervisory board
made up solely of nonexecutives for approval. In
such cases, the FSs are authorized for issue
when the management authorizes them for issue
to the supervisory board.
BONDS PAYABLE
BONDS PAYABLE
A bond is a formal unconditional promise, made under seal, to
pay a specified sum of money at a determinable future date,
and to make periodic interest payment at a stated rate until the
principal sum is paid.
It is a contract of indebtedness.
Two parties are the bond issuer and the bond investor/holder.
Bond indenture is the contractual agreement between the bond
issuer and bond investor.
Features of bond issue:
Bond indenture or deed of trust
Bond certificate
A trustee is named
A registrar or disbursing agent is designated.
BONDS PAYABLE
Contents of bond indenture are:
Characteristics of the bond
Maturity date and provision for repayment
Period of grace allowed to issuing party
Establishment of a sinking fund and the periodic deposit therein.
Deposit to cover interest payment
Provisions affecting mortgaged property, such as taxes,
insurance coverage, collection of interest or dividends on
collaterals.
Access to corporate books and records of trustee
Certification of bonds by trustee
Required debt to equity ratio
Minimum working capital to be maintained.
BONDS PAYABLE
Types of bonds
Term and serial bonds
Secured and unsecured bonds
Registered and bearer bonds
Convertible bonds
Callable bonds
Guaranteed bonds
Junk bonds
BONDS PAYABLE
Sale of bonds
Bonds are divided in various denominations or in equal
denomination
The denomination is called the face value of bonds
Each bond is evidenced by a bond certificate.
If P 50 million face value bonds are sold, divided into P 1,000
denomination, there shall be 50,000 bond certificates with
face amount of P 1,000
The sale of bonds may be done
 By the entity itself direct to the public.
 By an underwriter of investment banker who will resell the bonds to the
public
 Sometimes the underwriter or investment banker sell bonds for a
commission.
BONDS PAYABLE
The issuer undertakes to pay the face value of the bond
issue on maturity date and the periodic interest.
Interest is usually payable semi-annually or every six
months as follows:
January 1 and July 1
February 1 and August 1
March 1 and September 1
April 1 and October 1
May 1 and November 1
June 1 and December 1
Of course there are bonds that pay interest annually or
at the end of the bond year.
BONDS PAYABLE
INITIAL MEASUREMENT
Fair value minus transaction costs- bonds payable
not designated at fair value through profit or loss
Fair value is equal to the present value of future
cash payments to settle the bond liability.
Bonds issue costs are deducted from the fair value
or issue price of the bonds payable in measuring
initially the bonds payable
Bonds issue costs are expensed immediately if the
bonds are designated at fair value through profit or
loss.
BONDS PAYABLE
SUBSEQUENT MEASUREMENT (PFRS 9, par. 5.3.1)
At amortized cost using the effective interest method
At fair value through profit or loss
Amortized cost of bonds payable
Amount at which the bonds liability is measured initially
minus principal repayments, plus/minus the cumulative
amortization using the effective interest method of any
difference between the initial amount and the maturity
amount.
The difference between the face amount and present
value of the bonds payable is either the discount or
premium on the issue of the bonds payable.
BONDS PAYABLE
ACCOUNTING FOR THE ISSUANCE OF BONDS
Memorandum entry method- no entry is made upon
the authorization of the bond for issue.
Journal entry method- a journal entry is made to
record the authorized bonds payable.
Illustration
An entity is authorized on January 1, 2018 to issue
P 5 million, 10-year , 12 %, face value bonds,
interest payable January 1 and July 1, consisting
of 5,000 units of P 1,000 face value. The bonds
are sold at face value to an underwriter.
BONDS PAYABLE
Memorandum approach
“ The entity is authorized on January 1, 2018 to
issue P 5,000,000 face value, 10-year, 12% bonds,
dated January 1, 2018, interest payable on January
1 and July 1, consisting of 5,000 units at P 1,000
face value”.
Subsequent sale of the bonds
 Cash……………………………..5,000,000
 Bonds Payable………………………………….5,000,000
The memo approach is the one generally
followed.
BONDS PAYABLE
Journal entry method

Authorization of the bond

Unissued bonds payable………..5,000,000
Authorized bonds payable…………….5,000,000

 Subsequent sale of the bond

Cash……………………………….5,000,000
Unissued bonds payable………………..5,000,000
BONDS PAYABLE
Issuance of bonds at a premium
Sales price > face value of the bonds
For example
An entity sells P 5 million face value bonds at 105.
the quoted price of 105 means 105% of the face
value of the bonds. Thus the sale price is P 5.25
million ( 105% x P 5 million)
Journal entry
 Cash ……………………….5,250,000
o Bonds payable…………………5,000,000
o Premiums on bonds payable… 250,000
BONDS PAYABLE
The bond premium is in effect a gain on the bond issuer
because it receives more than what it is going to pay on
maturity date.
The bond premium is not reported as an outright gain but
amortized over the life of the bonds payable and
credited to interest expense.
Effective rate < nominal rate
Thus in the foregoing example, if the bonds have a 10-
year life and the straight line amortization method is used
the entry to record the amortization of bond premium is
Premium on bonds payable……….25,000
 Interest expense( 250,000/10yrs)…………….25,000
BONDS PAYABLE
Bonds sold at a discount
Sales price < face value
For example:
An entity sells P 5 million face value bonds at 95.
Cash ( P 5 million x 95)……….4,750,000
Discount on bonds payable…. 250,000
 Bonds payable………………………………..5,000,000

A loss to the bond issuer.

Effective rate > nominal rate
Amortized over the life of the bonds payable and debited to
interest expense
Interest expense ( 250,000/10yrs)……25,000
 Discount on bonds payable…………………….25,000
BONDS PAYABLE
Presentation of discount and premium
Bond discount is a deduction from bonds payable
Bond premium is an addition to bonds payable
Recording interest on bonds-two items:
Payment of interest during the year
Accrual of interest at the end of the year
Illustration:
On March 1, 2018, an entity sells P 5 million face value
bonds with 12 % interest payable semiannually on
March 1 and Septembe 1. In as much as the bonds are
sold on March 1, the first payment of interest is on
September 1.
BONDS PAYABLE
Journal entries
2018
Sept 1 Interest expense…………300,000
• Cash ( 5 Mn x 12%x i/2)…………300,000
 Dec 31 Interest expense…………. 200,000 Accrued interest payable (5M x12%x
4/12).200,000
 2019
 Jan 1 Accrued Interest payable….…….200,000
• Interest expense………………………200,000
• Reversing entry
 Mar 1 Interest expense………………….300,000
• Cash……………………………………..300,000
 Sep 1 Interest expense……..............300,000
• Cash………………………………… 300,000
Dec 31 Interest expense…….200,000
• Accrued interest payable…..200,000
ACCOUNTS PAYABLE
Bond issue costs
Transactions costs directly attributable to the issue of bonds
Include engraving, printing, legal, accounting, registration
fee, and commissions
Not treated as outright expense but amortized over the life
of the bonds
Increase interest expense
Debit interest expense and credit bond issue cost
Deducted from bonds payable
Under the effective interest method bond issue costs must
be “ lumped” with the discount on bonds payable and “
netted” against the premiums on bonds payable.
BONDS PAYABLE
ISSUANCE OF BONDS ON INTEREST DATE
Illustration
On June 1, 2018, an entity sells P 5 Million face value
bonds at 97. The bonds mature in 5 years and pay 12%
interest semi-annually on June 1 and December 1. The
straight line method is used for simplicity in amortizing
discount on bonds payable.
Journal entries for 2018
2018
June 1 Cash (5 M x 97)…………..…4,850,000
Discount on bonds payable.…150,000
• Bonds Payable………………….5,000,000
BONDS PAYABLE
Dec 1 Interest expense………300,000
 Cash……………………….300,000
 Semi-annual payment
Dec 31 Interest expense……….50,000
 Accrued interest payable…..50,000
 Interest accrued for one month from
 Dec. 1 to Dec. 31, 2018(5M x12%x1/2)
Dec.31 Interest expense……….17,500
 Discount on bonds payable…17,500
 Amortization of bond discount from June 1
 to Dec. 31, 2018(P 150,000/5yrs=
 P 30,000 x 7/12)
BONDS PAYABLE
ISSUANCE OF BONDS BETWEEN INTEREST DATES
Securities can be sold anytime after they are dated
Adjustments must be made at the time of sale for interest that has accrued
from the last payment date.
Illustration
On April 1, 2018, an entity sells P 5 million face value bonds at P 5,228,000
plus accrued interest. The bonds are dated January 1, 2018, mature in 5
years and pay 12 % interest semiannually on January 1 and July 1.
The sale of the bonds on April 1 is recorded as follows:
 Cash …………………………………………5,378,000
o Bonds Payable………………………………..5,000,000
o Premiums on bonds payable……................ 228,000
o Interest expense………………….. …………. 150,000
 Issue price P 5,228,000
 Add: Accrued interest from Jan. 1 to Apr. 1,2018
 (5,000,000 x 12% x 3/12) 150,000
 Total cash received P 5,378,000
BONDS PAYABLE
July 1, 2018 to record semi-annual interest
Interest expense (5 M x 12%x1/2) 300,000
 Cash…………………………………….300,000
At this point the ledger will show a debit balance in interest expense of P
150,000.
Dec.31 Adjusting entries
Interest expense…………………….300,000
 Accrued interest payable……………………….300,000
 Interest accrued from July 1-Dec. 31, 2018
Premium on bonds payable……….36,000
 Interest expense……………………….36,000
 Original life of bonds (5 years x 12) 60 mos.
 Less: Expired life on date of sale
 Jan1-Apr.1 3 mos.
 Remaining life of bonds 57 mos.
 Monthly amortization (228,000/57) 4,000
 Amortization for 9 months (Apr1-Dec.31)(4,000x9) 36,000
BONDS PAYABLE
Bond Retirement on maturity date
Establishment of sinking fund
Period cash deposits and interest earned equals the
amount of bond issue on maturity date.
The trustee sells the securities and uses the proceeds
of securities to pay the bondholders
Any excess cash is returned by the trustee to the bond
issuer.
Sinking fund is a fund set aside for the liquidation of
long-term debts. It is a non-current investment. If the
related bond payable is due to be settled in one year, it
is classified as current asset.
BONDS PAYABLE
Illustration
An entity sells P 5 million face value bonds on
March 1,2018 with 12 % interest payable March 1
and September 1 and the bonds mature on
March 1, 2023.
Journal entries
To retire the bonds
Bonds payable……………….5,000,000
Interest expense…………….. 300,000
o Sinking fund/Cash……………………300,000
BONDS PAYABLE
Bond retirement prior to maturity date
May be cancelled and permanently retired
Held in the treasury for future reissue when the need for fund arises
Procedures
The bond premium and bond discount and issue cost should be amortized
up to the date of retirement.
The balance of the bond premium or bond discount and issue cost should
be determined.
The accrued interest to date of retirement should be determined.
The total cash payment should be computed which is equal to the
retirement price plus the accrued interest.
The carrying amount of bonds retired is determined.
The gain/loss on the retirement of bonds is computed.
The retirement of the bonds is then recorded by cancelling the bond
liability together with the unamortized premium or discount and issue cost.
BONDS PAYABLE
Illustration
On March 1, 2018 , P 5 million face value bonds are sold for P
4,730,000. The bonds are dated March 1, 2018 and mature in
5 years, and pay 12% interest semi-annually on March 1 and
September 1. The straight line method of amortization is used
for simplicity. All of the bonds are retired on July 1, 2021 at 97.
The procedures for the retirement of the bonds on July 1, 2021
are:
Journal entries
1. Interest expense……………….27,000
 Discount on bond payable…………………27,000
 (270,000/5 years=54,000x1/2=27,000)
Amortization of bond discount up to July 1, 2021
BONDS PAYABLE
2. Balance of the discounts on bonds payable
Discount on bonds payable-3/1/18……P 270,000
Less: Amortization from 3/1/18-7/1/21
 or 40 months(40/60 x 270,000) 180,000
Balance 7/1/21 P 90,000
3. The accrued interest on the date of retirement is
computed as follows: P 5 millionx12%x4/12
=P200,000. The last payment of interest was
3/1/21. Thus, the accrued interest is for 4 months
from March 1 to July 1, 2021.
BONDS PAYABLE
4. The total cash payment is computed as follows:
Retirement price (P 5 million x 97)….P 4,850,000
Add: Accrued interest………………… 200,000
Total cash payment……………………P 5,050,000
5. The carrying amount of the bond is computed as
follows:
Bonds payable………………………….5,000,000
Less: Discount on bonds payable……. 90,000
Carrying Amount, 7/1/21……………….4,910,000
BONDS PAYABLE
6. Gain/loss on retirement of bonds
Carrying amount………………………P 4,910,000
Less: Retirement price……………… 8,850,000
Gain on early retirement……………….. P 60,000
7. Retirement of bonds
Bonds payable…………..5,000,000
Interest expense………. 200,000
Cash……………………………….5,050,000
Discount on bonds payable…….. 90,000
Gain on bond retirement……….. 60,000
BONDS PAYABLE
Treasury Bonds-entity’s own bonds originally
issued and reacquired but not cancelled.
Same accounting procedures as retirement of bonds
Debited at face value and any related unamortized
premium or discount or bond issue cost should be
cancelled.
Any accrued interest paid is charged to interest
expense.
The difference between the acquisition cost and the
carrying amount is treated as gain or loss on
acquisition of treasury bonds.
BONDS PAYABLE
Treasury bonds illustrated
An entity originally issued P 5 million face value bonds at 105
or a premium of P 250,000.Subsequently, the entity reacquired
P1 Million face value bonds to be placed in the treasury for
103. At the time of the reacquisition, the unamortized premium
balance of P 200,000 and accrued interest on the treasury
bonds is P 30,000 which is paid in cash.
Journal entry to record the treasury bonds is
Treasury bonds……………….1,000,000
Premium on bonds payable… 40,000
Interest expense…………….. 30,000
 Cash………………………………………..1,060,000
 Gain on acquisition of treasury bonds……..10,000
BONDS PAYABLE
 Bonds refunding/refinancing
 Floating of new bonds used to pay the original bonds.
 Bond refunding is a premature retirement of the old bonds by issuing
new bonds.
 Refunding may be made on or before the maturity of the old bonds.
 When refunding is made on the maturity date, there is no accounting
problem.
 When refunding is made prior to maturity date of the old bonds,
consideration must be given to the refunding charges pertaining to
the old bonds.
 Bond refunding shall be accounted for extinguishment of a financial
liability.
 The difference between the carrying amount of the financial liability
extinguished and the consideration paid shall be included in profit or
loss.
 Accordingly, the refunding charges are charged to loss on
extinguishment.
BONDS PAYABLE
Treasury bonds Illustrated
Face value of treasury bonds 1,000,000
Applicable premium(1M/5Mx200,000) 40,000
Carrying amount 1,040,000
Less: Reacquisition Price(1Mx103%) 1,030,000
Gain on acquisition of treasury bonds 10,000
Reacquisition price 1,030,000
Accrued interest on the bonds 30,000
Total cash payment 1,060,000
If the treasury bonds are subsequently sold, they are
recorded in the same manner as bonds originally issued.
BONDS PAYABLE
Bond refunding-Illustrated
1. Issuance of new 10-year ,10% bonds, with face value of
P 1.5 million for P 1.6 million.
2. Refunding of old 12% bonds, with remaining life of 4
years, at 102.
Bonds payable-old 1,000,000
Discount on bonds payable 30,000
Retirement price (1,000,000 x 102) 1,020,000
3. Journal Entries
a. To record the issuance of the new bonds payable
Cash 1,600,000
Bonds payable 1,500,000
Premium on bonds payable 100,000
BONDS PAYABLE
Bond refunding-Illustrated
Journal entries
b. To record the retirement of the old bonds payable
Bonds payable ……………. 1,000,000
Loss on extinguishment of
bonds …………………. 50,000
Cash………………………………..1,020,000
Discount on bonds payable……… 30,000
Loss on extinguishment of bonds is represented by refunding
charges of P 50,000 computed as follows:
Unamortized discount……………….……30,000
Redemption premium(1,000,000x2%)…..20,000
Total refunding charges………………….. 50,000
BONDS PAYABLE
AMORTIZATION OF BOND DISCOUNT OR
PREMIUM
Three approaches:
1. Straight-line method
2. Bond outstanding method
3. Effective interest method or simply Interest
Method or Scientific Method
PFRS 9 provides that after initial recognition , an entity
shall measure all financial liabilities either at
amortized cost using the effective interest method
or fair value through profit or loss.
BONDS PAYABLE
Amortization of bond discount or premium
The standard requires the use of the effective
interest method in amortizing discount, premium
and bond issue cost.
Under USA GAAP, APB Opinion No. 21 provides
that the straight line method and bond
outstanding method are acceptable if the periodic
interest expense is not materially different from
the amount obtained by using the effective
interest method.
BONDS PAYABLE
Amortization of bond discount, premium and bond
issue costs
1. Straight line method
Provides for equal amortization of bond discount or
premium
Divide the amount of bond premium or discount by
the life of the bonds to arrive at periodic
amortization.
The life of the bonds is the period commencing on
the date of sale of the bonds up to the maturity
date.
BONDS PAYABLE
2. Bond Outstanding Method
Applicable to serial bonds
Gives recognition to diminishing balance of the bonds
Based on the theory that interest expense shall decrease every
year by reason of decreasing principal bond liability.
Illustration-Accounting year and bond year coincide
Face value of bonds……………………5,000,000
Issue price……………………………….5,300,000
Date of bonds……………………………January 1, 2018
Date of issue………………………………-ditto-
Interest rate………………………………12%
Semi-annual interest dates………………June 30 and December 31
The bonds mature on every December 31 of each year at the rate of P
1,000,000 for 5 years.
 BONDS PAYABLE
Table of Amortization
YEAR BOND FRACTION PREMIUM
OUTSTANDIN AMORTIZATIO
G N
2018 5,000,000 5/15 100,000

2019 4,000,000 4/15 80,000

2020 3,000,000 3/15 60,000

2021 2,000,000 2/15 40,000

2022 1,000,000 1/15 20,000

15,000,000 300,000
BONDS PAYABLE
The bond outstanding is determine every bond
year.
The fractions are developed from the bond
outstanding column.
The annual premium amortization is computed by
multiplying the fractions by the amount of the
premium. Thus, for 2018, 5/15 times P 300,000
equals P 100,000.
Journal entries: Seat work
BONDS PAYABLE
FAIR VALUE OPTION OF MEASUREMENT
 PFRS 9,Par.4.4.2 – at initial recognition, bonds
payable may be irrevocably designated at fair
value through profit or loss.
 Bonds payable shall be measured initially at
fair value and remeasured at every year-end
with any changes in fair value recognized in
P/L.
 There is no more amortization of bond issue
cost, discount and premium.
 Interest expense is recognized using the
nominal or stated rate.
BONDS PAYABLE
FAIR VALUE OPTION MEASUREMENT-ILLUSTRATED
On January 1, 2018, an entity issued bonds with face
amount of P 5 million and 12% stated interest rate for P
5,379,100. The bonds are sold to yield 10%. Interest is
payable annually n December 31. The entity paid bond
issue cost of P 100,000. On December 31, 2018, the fair
value of the bonds is determined to be P 5.3 million.
 JOURNAL ENTRIES
 2018


JAN 1 Cash 5,379,100
• Bonds Payable 5,379,100

Transaction cost 100,000

Cash 100,000
COMPOUND FINANCIAL
INSTRUMENT
PAS 32,PAR. 11 Financial instrument is any
contract that gives rise to a financial asset of
one entity and financial liability of equity
instrument of another entity.
Characteristics of financial instrument are:
Contract
Two parties
Gives rise to financial asset of one entity
and financial liability of equity instrument of
another entity
BONDS PAYABLE
 FAIR VALUE OPTION MEASUREMENT-ILLUSTRATED (CONT’D)
 Dec. 31 Interest expense…………600,000
• Cash ( 12% x P 5 million)………………….600,000

 31 Bonds payable……………………79,100
 Gain from change in fair value…………..79,100

• Bonds payable-January 1,2018…………..5,379,100

• Fair value-December 31, 2013………….. 5,300,000
• Decrease in fair value of bonds payable-gain79,100
COMPOUND FINANCIAL
INSTRUMENT
Examples of financial instrument
Cash in the form of notes and coins
Cash in the form of checks
Cash in bank
Trade accounts
Notes and loans
Debt securities
Equity securities
COMPOUND FINANCIAL
INSTRUMENT
Financial liability- is any liability that is a contractual obligation:
To deliver cash of other financial asset to another entity
To exchange financial instrument with another entity under conditions
that are potentially unfavorable, e.g., option written or issued by the
issuer to sell shares in a specified entity at less than market price.
Examples of financial liability
Trade accounts payable
Notes payable
Loans payable
Bonds payable
Examples of non financial liability
Deferred revenue-delivery of goods or services, not cash
Warranty obligations-delivery of goods or services, not cash
Income tax payable- statutory not contractual
Constructive obligations- not contractual
COMPOUND FINANCIAL
INSTRUMENT
 PAS 32, par. 28, defines compound financial
instrument as “ a financial instrument that contains
both a liability and equity element from the
perspective of the Issuer”.
 Examples:
Bonds payable issued with share warrants
Convertible bonds payable
Accounting for compound instrument
The issuer of the instrument shall evaluate the
terms whether it contains both a liability and equity
component.
COMPOUND FINANCIAL
INSTRUMENT
If it is a compound financial instrument, PAS 32
mandates that such components shall be
accounted for separately by way of ‘split
accounting”
The consideration received is allocated.
Fair value of the liability component is first
determined.
The fair value of the liability is deducted and the
residual amount allocated to equity component.
EQUITY INSTRUMENT
Equity instrument- it represents the basic
accounting equation assets= liabilities + equity
It is any contract that evidences residual interest
in the assets of an entity after deducting all the
liabilities
It includes ordinary shares, preference shares,
warrants and option
BONDS PAYABLE ISSUED WITH
SHARE WARRANTS
Enable the holders to acquire equity shares at specified price at
specified period.
Promote the sale of the bonds
Two securities are sold: the bonds and the share warrants
Share warrants may be detachable or nondetachable
Detachable can be traded separately while nondetachable are not.
Considered as a compound financial instrument.
The issuer of bonds payable shall classify the liability and equity
components separately.
PAS 32 does not differentiate whether the equity is detachable or
nondetachable.
Whether detachable or nondetachable, the warrants have value
and therefore shall be accounted for separately.
ALLOCATION OF ISSUE PRICE
The bonds are assigned an amount equal to the “
market value of the bonds ex-warrants”, regardless of
the market value of the warrants.
The residual amount of the issue price shall then be
allocated to the warrants.
Illustration
An entity sells 5,000, 10-year bonds, face value P
1,000, at 105, Each bond is accompanied by one
warrant that permits the bondholder to purchase 20
equity shares, par 50, at P55 per share, or a total of P
100,000 shares, 5,000 x 20. The market value of the
bond ex-warrant at the time of issuance is 98.
ALLOCATION OF ISSUE PRICE
Illustration
1. To record the issuance of bonds
Cash (5 M x 105)……………..5,250,000
Discount on bonds payable…. 100,000
 Bonds payable……………………………….5,000,000
 Share warrants outstanding……………….. 350,000
 Issue price of bonds with warrants 5,250,000
 Market value of bonds ex-warrants(5 M x 98) 4, 900,000
 Residual amounts allocated to warrants 350,000
ALLOCATION OF ISSUE PRICE
Illustration
2. To record the exercise of 60% warrants.
Cash ( 60,000 shs. X 55)……3,300,000
Share warrants outstanding
(60% x 350,000) 210,000
Share capital( 60,000 x 50) 3,000,000
Share premium 510,000
3. To record the expiration of the remaining warrants.
Share warrants outstanding 140,000
Share premium-unexercised warrants 140,000
MARKET VALUE OF BONDS EX-
WARRANTS UNKNOWN
The amount allocated to the bonds is equal to the present
value of the principal bond liability plus the present value
of the future interest payments using the effective or
market interest rate for similar bonds without the warrants.
Using the preceding illustration, assume the interest is
payable annually at a nominal rate of 10% per annum.
When the bonds are issued, the prevailing market rate of
interest for similar bonds without warrants is 12% per
annum.
The present value of 1 at 12% for 10 periods is 0.322 and
the present value of an ordinary annuity of 1 at 12 % for
10 periods is 5.65.
MARKET VALUE OF BONDS EX-
WARRANTS UNKNOWN
The market value of the bonds is computed as
follows:
 Present value of principal ( 5 M x 0.322) 1,610,000
 Present value of interest (10% x P 5M x 5.65) 2,825,000
 Total present value 4,435,000
 Issue price of bonds with warrant 5,250,000
 Present value of bonds payable ( 4,435,000)
 Residual amount allocated to warrants 815,000
 Journal Entry
 Cash ………………………………5,250,000
 Discount on bonds payable…….. 565,000
 Bonds payable…………………………………………….5,000,000
 Share warrants outstanding……………………………… 815,000
CONVERTIBLE BONDS
Bond issue more attractive
Right to convert bonds to capital
As time goes by, conversion privilege is less
attractive
Amortization of premium or discount is up to the
maturity date rather than conversion date
because it is very difficult to predict whether or
not the conversion will be exercised.
CONVERTIBLE BONDS
Accounting problems arise in the following two
situations:
1. When the convertible bonds are originally issued,
and
2. When the convertible bonds are converted.
 Original Issuance
 Convertible bonds are compound financial
instruments
 Partly liability and partly equity
 Issue price shall be allocated between bonds
payable and conversion privilege
CONVERTIBLE BONDS
Allocation of issue price
Bonds are assigned an amount equal to the
market value of the bonds without the conversion
privilege.
Present value of the principal bonds liability and
the present value of future interest payments if
market value of the bonds is not available
A residual amount of the remainder of the issue
price shall then be allocated to the conversion
privilege or equity component.
CONVERTIBLE BONDS
Illustration
An entity sells 5,000, 5-year face value P 1,000 each
at 105. The bonds contain a conversion privilege that
provides for an exchange of a P 1,000 bond for 20
equity shares with a par value of P 50.It is reliably
determined that the bonds would sell only at 98
without the conversion privilege.
Journal entry
Cash ( 5 M x 105) ……………..5,250,000
Discount on bonds payable….. 100,000
 Bonds payable…………………………………5,000,000
 Share premium-conversion privilege……….. 350,000
CONVERTIBLE BONDS
Illustration:
Total issue price 5,250,000
Issue price of bonds without
 Conversion privilege (5M x 98) (4,900,000)
Residual amount allocated to
 Conversion privilege 350,000
Bonds payable 5,000,000
Allocated issue price 4,900,000
Discount on bonds payable 100,000
CONVERTIBLE BONDS
Using the preceding illustration, assume that the
interest on the bonds is payable semi-annually at
a nominal rate of 8% per annum. When the bonds
are issued , the prevailing market rate of interest
for similar bonds without conversion privilege is
10% per annum. The present value of 1 at 5% for
10 periods is 0.6139 and the present value of an
ordinary annuity of 1 at 5% which is one-half of
10%. The present value of convertible bonds is
computed as follows:
CONVERTIBLE BONDS
 Present value of principal( 5 M x 0.6139) 3,069,500
 Present value of semi-annual interest payments
 ( 5 M x 4% x 7.72) 1,544,000
 Total present value 4,613,500
 Issue price of bonds with conversion privilege 5,350,000
 Present value of bonds payable ( 4,613,500)
 Residual amount allocated to conversion privilege 636,500

Cash…………………….5,250,000
Discount on bonds pay.. 386,500
Bonds payable……………………….5,000,000
Share premium-conversion
privilege…………………. 636,500
CONVERSION OF BONDS
Accounting problem is the determination of a value to be assigned
to the share capital issued
PAS 32 provides that on conversion of a convertible instrument at
maturity, the entity derecognizes the liability component and
recognizes is as equity without any gain or loss on conversion.
The reason is that convertible bond is viewed in substance as an
equity.
The carrying amount of the bonds is the measure of the share
capital issued .
Any cost incurred in conversion shall be deducted from share
premium or expense as the case may be.
The carrying amount of the bonds is equal to the face value plus
accrued interest if not paid, plus unamortized premium or minus
unamortized discount and bond issue cost.
CONVERSION OF BONDS
The amortization of discount and issue cost or
premium up to date of conversion shall be recorded.
The face of the bonds converted shall be cancelled
together with the related unamortized premium,
discount and issue cost.
If only a portion of the bond is converted, the
amortization is also proportionate.
Normally, conversion is at an interest date. If it is not,
then accrued interest up to conversion date is paid.
Otherwise, it is added up to te face value of the
converted bonds and charged to interest expense.
NOTE PAYABLE AND DEBT
RESTRUCTURING
A promissory note is an unconditional promise
in writing made by one person to another, signed
by the maker, engaging to pay on demand or at a
fixed or determinable future time a sum certain in
money to order or bearer.
Initial/subsequent measurement of note payable
–same as in bonds payable
CONVERSION OF BONDS
Illustration
On Dec. 31, 2018, the balance sheet showed the following
balances:
Bonds payable-12% convertible 5,000,000
Premium on bonds payable 200,000
Share capital, P 40 par, 400,000 shs.
authorized and 250,000 shs. issued 10,000,000
Share premium- issuance 3,000,000
Share premium-conversion privilege 500,000
On the same date, the bonds are converted into share
capital. The conversion is 20 shares for each P 1,000 bond
or a total of 100,000 shares
NOTE PAYABLE AND DEBT
RESTRUCTURING
Note issued solely for cash
Illustration
On Nov. 1,2018, an entity discounted its own note of P 1 million at 12% for one
year.
Note Payable 1,000,000
Less: Discount (12% x 1,000,000) 120,000
Net Proceeds 880,000
=======
Journal Entry
November 1, 2018
Cash………………………........880,000
Discount on note pay………….120,000
Note payable………………………1,000,000
December 31,2013
Interest expense………………..20,000
Discount on note payable………….20,000
( 120,000 x 2/12)
DEBT RESTRUCTURING
 Debt Restructuring is a situation where the creditor,
for economic or legal reasons related to the debtor’s
financial difficulties, grants to the debtor concession
that would not be granted in a normal business
relationship.
 By agreement of the parties or imposed by law or
court
 The objective is to make the best of a bad situation or
maximize the recovery of investment.
TYPES OF DEBT
RESTRUCTURING
1. Asset swap- transfer by the debtor to creditor of
any asset, e.g. real estate, inventory.
 Treated as derecognition of liability (PFRS 9, par.3.3.1)
 Difference between carrying amount of the financial
liability and the consideration given shall be recognized
in Profit or Loss (PFRS 9, par. 3.3.3)
 Asset swap is recorded as if two transactions took
place: 1) sale of the asset and 2) extinguishment of
debt (USA GAAP). Gain or loss is thus recognized.
 Dacion en pago- mortgaged property is offered by the
debtor in full settlement of debt. Gain or loss is
recognized.
DEBT RESTRUCTURING
Equity swap-issuance of share capital by the debtor
to the creditor in full or partial payment of an
obligation.
Equity instruments are recognized initially at the fair
value of the equity instruments issued
If fair value of equity instruments is not measurable, the
fair value of the financial liability extinguished is used.
Choose whichever is more reliably determinable.
Order of priority
 Fair value of equity instruments issued
 Fair value of liability extinguished
 Carrying amount of liability extinguished.
EMPLOYEE BENEFITS
RELATED STANDARDS:
PAS 19-Employee Benefits
PAS 26-Accounting and Reporting of Retirement and
Benefit Plans
Employee benefits- all forms of considerations given
by an entity in exchange for service rendered by
employees or for the termination of employment.
(PAS 19.8)
In the form of cash, goods or services
Provided to employees or their dependents
Employees include regular, part-time or casual, rank-
and-file, director or manager
EMPLOYEE BENEFITS
RECOGNITION
Expense-services have been rendered and paid
Cost of another asset- salaries of factory workers
as part of cost of inventories
Liabilities- earned by employees but not yet paid
FOUR CATEGORIES OF EMPLOYEE BENEFITS
UNDER PAS 19
Short-term
Post-employment
Other long-term benefits
Termination benefits
EMPLOYEE BENEFITS
 SHORT-TERM EMPLOYEE BENEFITS
Settled within 12 months after services rendered
Salaries, wages, SSS, Phil health and Pag-ibig
contributions
Paid vacation leaves and sick leaves
Profit –sharing and bonuses
Non-monetary benefits
General accounting requirements
Simple , no actuarial and discounting
Recognized as expense of cost of another asset
A liability is recognized for unpaid services
Prepaid expense for excess payments
EMPLOYEE BENEFITS
ILLUSTRATION-SHORT-TERM EMPLOYEE
BENEFITS
ABC Company pays salaries twice a month and does not
pay salaries in advance. Employees work five days a
week and compensation are computed on these working
days. In December 2018, ABC Co. paid the second semi-
monthly salaries on Dec. 26 which falls on a Friday. The
next non-working holiday is on New Year’s Day. ABC has
100 employees who earn P 1,000 per day. ABC’s cost
accountant identified that 70% of salaries incurred pertain
to the production of goods.
Required: How much is the accrued salaries as of
December 31, 2018?
EMPLOYEE BENEFITS
ILLUSTRATION-SOLUTION
Working days after last salary payment (Dec. 29,30,
and 31) Dec. 27 and 28 fall on weekend 3 days
Multiply by: No. of employees 100
Total number of working days 300
Multiply by average pay per day 1,000
Accrued Salaries –December 31, 2018 300,000
Journal Entry
Direct Labor (300,000 x 70%)…… 210,000
Salaries Expense(300kx 30%)…… 90,000
 Accrued Salaries Payable………… 300,000
EMPLOYEE BENEFITS
Short-term Paid Absences
Vacation
Holiday (Regular And Special)
Maternity
Paternity
Sick
Accumulating And Non-accumulating
Accumulating: Vesting And Non-vesting
Vesting-monetized
Non-vesting-non-monetized
EMPLOYEE BENEFITS
COMPENSATED BALANCES ARE RECOGNIZED AS
Accumulating and Vesting
Accumulating and Non-vesting
Non-accumulating
ILLUSTRATION
ABC Co.’s employees are entitled to 12 days paid vacation leave
per year. Employees are required to take a vacation leave each
year, but not necessarily for the full entitlement. Unused vacation
leaves can be earned over indefinitely.
ABC has 500 employees with an average salary of P 1,000 per
day. The average salary increase is 5% per year. During 2018,
employees took total vacation leaves of 5,400 days. Based on
past experience, 90% of unused vacation leaves in a year are
taken in the immediately following year.
 EMPLOYEE BENEFITS
CASE 1. Unused vacation leaves vest. How
much is the accrued liability on December 31,
2018.
 SOLUTION

Total entitlement in 2018 ( 500 employees x 12

days each) 6,000
Less:Vacation leave in 2018 5,400
Unused vacation leave carried over indefinitely 600
Multiply by: Expected pay rate in 2019 (1,000 x
105%) 1,050
Liability for unused vacation leaves 630,000

JOURNAL ENTRY: December 31, 2018

Salaries Expense…………………630,000
Accrued Salaries Payable…………..630,000
EMPLOYEE BENEFITS
CASE II- Unused vacation leaves do not vest.
How much is the accrued liability on December
31, 2018.
SOLUTION
Total entitlement in 2018(500 employees
x 12 days 6,000
Less: Vacation leave taken in 2018 5,400
Unused vacation leave carried over 600
Multiply by: 90%
Estimated vacation leaves to be taken in
2019 540
Multiply by: Expected pay rate in 2019
(P1,000 x 105%) 1,050
Liability for unused vacation leave 630,000