Chapter 10

Reporting and Analyzing Liabilities

Financial Accounting: Tools for

Business Decision-Making
Ninth Canadian Edition

Kimmel; Weygandt; Mitchell; Trenholm; Irvine; Burnley

Prepared by Debbie Musil, FCPA, FCMA
Learning Objectives
LO 2: Account for interest-bearing liabilities with principal due
at maturity or on an instalment basis.
LO 4: Account for bonds payable (Appendix 10A).

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Learning Objective 2
Account for interest bearing liabilities with principal due
at maturity or on an instalment basis.

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Interest-Bearing Liabilities
• Indebtedness to a creditor requiring more than a short
period of time to pay the amount owed
o Original amount borrowed is principal
• In addition to paying off principal, interest is also
payable on the principal amount outstanding
• Interest may be paid on a single due date when the
principal is also due, or interest may be paid on various
dates before the principal is due

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Types of Interest-Bearing Liabilities
• Types of interest-bearing liabilities:
o Operating lines of credit that have no set date for
repayment of principal
o Notes with a single principal payment on maturity
o Loans that require instalment payments of principal and
interest on scheduled dates

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Operating Line of Credit (credit facility)
• Pre-arranged agreement between a company and a lender
to allow the company to borrow up to a pre-authorized
limit whenever required:
o To help manage temporary cash shortfalls
• Company repays whatever portion of the borrowed funds it
chooses whenever it is able to
• Interest is charged using a floating (or variable) interest
rate
o Security (collateral) may be required by bank
• When used, results in bank indebtedness; reported in the
current liabilities section of statement of financial position
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Liabilities with Principal Due at
Maturity
• A promise to pay a specified amount (principal) usually on
a fixed future date
• Often used instead of accounts payable
• Formal written promise, provides stronger legal claim
• Bears interest at a fixed interest rate, which is constant for
the entire term of the note
• Issued for varying periods of time:
o If due within one year of financial statement date, classified
as current liabilities

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Liabilities with Instalment Payments
• Normally non-current liabilities
o Obligations to be paid after one year or more
• Bank loans payable, mortgages payable
• Series of periodic payments, called instalments, consisting
of
o Interest on the unpaid balance of the loan at the beginning
of the period
o A repayment of a portion of the loan principal
• A specified repayment schedule must be followed

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Instalment Payment Schedule – Equal
Payments (1 of 2)
• Loan is repayable in equal periodic payments
• To illustrate, assume that Belanger Ltée borrows
$120,000 for five years at 6%:
o Terms provide for monthly instalment payments of $2,320
• Monthly interest expense is calculated by multiplying
the outstanding principal balance by the interest rate

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Instalment Payment Schedule – Equal
Payments (2 of 2)

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Current and Non-Current Portions
• For a loan requiring instalment payments, the principal
portion of the loan that will be repaid during the next year
is a current liability
o Portion that that will be repaid after the next year is a non-
current liability
• Other non-current liabilities include:
o Bank loans, notes and mortgages payable
o Bonds payable
o Lease liabilities
o Deferred income taxes and pension liabilities

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Advantages and Disadvantages of Debt
Financing
• In most cases, easier to obtain than equity financing
o Issuing shares will dilute percentage of shares owned by
current shareholders
• Borrowing may allow companies to grow faster
• Interest expense is tax deductible
• Principal and interest must be paid back on certain dates
• When incurring debt, companies must earn a rate of return
that exceeds interest rate on that debt
• Often, security must be pledged for debt financing

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Learning Objective 4
Account for Bonds Payable. (Appendix 10A)

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Appendix 10A Bonds Payable
• Promise to repay a specified amount at a fixed future date,
in addition to periodic interest payments
• A form of interest-bearing notes payable
• Large amount is divided into smaller denominations:
o Makes them attractive to investors
• Most have a fixed interest rate (coupon interest rate)
• May be secured or unsecured (debenture)
• Payable at maturity (term bonds) or in instalments (serial
bonds)
• Redeemable bonds can be retired before maturity
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Bond Trading
• Bonds can be publicly traded on exchanges:
o Bond prices are quoted as a percentage of the face value
of the bonds
• Market (or effective) interest rate (yield):
o Rate investors demand for loaning funds
• Coupon interest rate:
o Rate determining amount paid to investors

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Accounting for Bond Issues (1 of 2)
Bonds may be issued at:
• Face value
• Below face value (discount)
o If market interest rate is higher than coupon rate
• Above face value (premium)
o If market interest rate is lower than coupon rate

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Accounting for Bond Issues (2 of 2)

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Issuing Bonds at Face Value
• Assume that Candlestick, Inc. issued five-year $1
million 5% bonds dated January 1 at 100 (100% of face
value)
o Coupon rate equal to market interest rate
o Investors pay face value
o Issue price of $1,000,000

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Issuing Bonds at a Discount (1 of 2)
This occurs when investors pays less than the face value
of the bond:
• The coupon rate is too low – investors can get a better
rate elsewhere
• The bond price must therefore decrease to ensure that
the yield (effective interest rate) is competitive
• Since the coupon rate is fixed, a lower bond price will
result in a higher yield

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Issuing Bonds at a Discount (2 of 2)
• Assume that on January 1, Candlestick, Inc. sells $1
million, five-year, 5% bonds at 98.1417 of face value
o Coupon rate less than market interest rate of 6%
o Investors pay less than face value
o Issue price of $981,417 results in a discount of $18,583

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Issuing Bonds at a Premium (1 of 2)
This occurs when investors pays more than the face value
of the bond:
• The coupon rate is too high − company does not have
to offer such a high interest rate
• The bond price will therefore increase to ensure that
the yield (effective interest rate) is competitive
• Since the coupon rate is fixed, a higher bond price will
result in a lower yield

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Issuing Bonds at a Premium (2 of 2)
Assume that on January 1, Candlestick, Inc. sells $1
million, five-year, 5% bonds at 101.9043 of face value
o Coupon rate greater than market interest rate of 4%
o Investors pay more than face value
o Issue price of $1,019,043 results in a premium of
$19,043

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Accounting for Bond Issues Journal
Entries

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Amortizing the Discount or Premium
• Bond discount (or premium) is allocated to interest
expense over the life of the bonds – called amortizing
the discount (or amortizing the premium)
• Difference between interest expense (at the market
rate or yield) and interest paid (at the coupon rate) is
the discount or premium to be amortized

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Amortization of Bond Premium or
Discount
• Premiums and discounts amortized using effective-
interest method:
1. Calculate bond interest expense
2. Calculate bond interest paid
3. Calculate amortization amount

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Bond Interest Payment Entries

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Carrying Amount
For Discounted Bonds:
• Carrying amount is face value of bond less the unamortized
discount
• Discount balance increases until the bond reaches maturity
value
For Premium Bonds:
• Carrying amount is face value of bond plus the unamortized
premium
• Premium balance decreases until the bond reaches maturity
value

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Accounting for Bond Retirements
• Bonds can be retired at maturity or earlier (by purchasing
on the open market)
• At maturity, the bonds’ carrying amount is equal to their
face value:
o Regardless of the issue price of the bonds
o Any premium or discount will be fully amortized
o No gain or loss occurs

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Determining the Issue Price of Bonds –
Future Value
• Present value is always less than future value
• The difference between present value and future value
is interest
o Interest earned in one period on the interest earned in
previous years is compound interest
• Concept of growing value illustrates the time value of
money

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Future Value of a Single Payment -
$100 at 10%

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Future Value of an Ordinary Annuity

Dec. 31, 2024 Dec. 31, 2025 Dec. 31, 2026 Dec. 31, 2027
Payment 1 $ 100 $ 110 $ 121 $ 133
Payment 2 100 110 121
Payment 3 100 110
Payment 4 100
Future value $100 $210 $331 $464

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Determining Issue Price (Present Value)
of Bonds Terminology
• Face value:
o Amount of principal due at maturity
• Present value:
o Value today of:
1. Bond face value to be received at maturity, and
2. Interest payments (annuity) to be received periodically
o The value today is dependent upon when the amounts are to
be received, and the market rate of interest

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Determining the Issue Price (Present Value)
of a Bond — Using Present Value Tables
• Issue price = the present value of all future cash inflows
(discounted at market rate of interest)
• Face value − use Table 1 (PV of $1) to determine the factor
to use to calculate the face value of bond
o = PV factor × face value of bond
• Interest − use Table 2 (PV of an annuity of $1) to calculate
the present value of bond interest
o = PV annuity factor × periodic interest payment (payment
calculated using coupon rate)
• Sum the two to arrive at the price of the bond
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Calculating the PV of a Bond at Par

Present value of $1,000,000 received in 4 periods

$1,000,000 × 0.90595 (n = 4, i = 2.5%) $ 905,950
Present value of $25,000 received for each of 4 periods
$25,000 × 3.76197 (n = 4, i = 2.5%) 94,050
Present value (issue price) of bonds $1,000,000
Where n = number of interest periods and i = interest rate

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Calculating the PV of a Bond at
Discount
Present value of $1,000,000 received in 4 periods
$1,000,000 × 0.88849 (n = 4, i = 3%) $888,490
Present value of $25,000 received for each of 4 periods
$25,000 × 3.71710 (n = 4, i = 3%) 92,927
Present value (issue price) of bonds $981,417

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Calculating the PV of a Bond at
Premium
Present value of $1,000,000 received in 4 periods
$1,000,000 × 0.92385 (n = 4, i = 2%) $ 923,850
Present value of $25,000 received for each of 4 periods
$25,000 × 3.80773 (n = 4, i = 2%) 95,193
Present value (issue price) of bonds $1,019,043

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Rev Review of IFRS and ASPE
Key standard International Financial
Differences Reporting Standards (IFRS)
Provisions and Under IFRS, a provision is
contingent recorded as a liability whereas
liabilities a contingent liability is not
recorded but disclosed.
Bonds (Appendix 10A) Must use the effective-interest
method to amortize any bond
premium or discount.
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Accounting Standards for Private
Enterprises (ASPE)
ASPE does not use the term provision and
would refer to a recorded liability using a
more specific names.
Normally will use the effective-interest
method to amortize any bond premium or
discount but permitted to use alternative
methods if the results do not differ
materially from the effective-interest
method.
37
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