Notes, Loans, Bonds

Payable and Other

Concepts
PROF. E. ISIP
INTERMEDIATE ACCOUNTING II
Objectives:
A. Notes Payable
 Understand the fair value option of measuring note payable

B. Loans Payable
 Define loans payable and compare it with notes payable.
 Explain the accounting for loans payable and origination fees.

C. Bonds Payable
 Understand the nature and purpose of bond.
 Identify the types of bonds
 State the initial and subsequent measurement of bonds payable
 Understand the concept of bond premium and discount.
 Apply the fair value option of measuring bonds.
 Account for compound financial instrument.
Objectives:
D. Other Concepts
 Understand the different ways of extinguishing financial liabilities
 Account for asset swap
 Account for equity swap
 Account for modification of terms
 Account for condonation or remission of debt
 Understand the concept of offsetting a financial asset and a financial liability
Notes Payable
Accounting for “FAIR VALUE OPTION OF MEASURING NOTES PAYABLE”

PFRS 9, paragraph 5.1.1

Notes payable, not designated at fair value through profit of loss (FVTPL), shall be measured initially at fair value minus
transaction costs that are directly attributable to the issue of the notes payable.
On initial measurement, the only difference is the treatment for transaction cost. If designated at FVTPL, transaction cost
is an outright expense, otherwise is it deducted at the fair value.

If the notes payable is irrevocably designated at FVTPL, PFRS 9, paragraph 5.7.7 provides that GAIN OR LOSS on
financial liability shall be accounted for as follows:
a. The change in FV attributable to credit risk is recognized in Other Comprehensive Income(OCI).
b. The remaining amount of change in FV is recognized in profit or loss (P/L).

There is no amortization of discount and premium on note payable and interest expense is recognized using the
nominal or stated interest rate.
Notes Payable
Accounting for “FAIR VALUE OPTION OF Journal Entries:
MEASURING NOTES PAYABLE”
Jan. 1
Cash 4,000,000
Illustration: Note Payable 4,000,000
On January 1, 2020, an entity borrowed from a
bank P4,000,000 on a 12% 5 year interest
Transaction cost 100,000
bearing note. The entity received P4,000,000 Cash 100,000
which is the fair value of the note on January
1, 2020. Transaction cost of P100,000 was paid Dec 31
by the entity . Interest expense 480,000
Cash 480,000
The fair value of the note payable was Carrying amount 4,000,000
P3,500,000 on December 31, 2020. The entity Fair Value - 12/31/2020 3,500,000
has elected irrevocably the fair value option. Decrese in fair value of liability - gain
500,000
The change in fair value comprised P50,000
attributable to credit risk and P450,000 to Dec 31
interest risk. Notes payable 500,000
Gain from change in FV 450,000
Gain from credit risk-OCI 50,000
Notes Payable
Accounting for “FAIR VALUE OPTION OF MEASURING NOTES PAYABLE”
Practice Problem:
On January 1, 2020, Patrick Company borrowed P500,000 8% note due in four years. The present value of the note on
the date of issuance was P367,500. The entity elected irrevocably the Fair Value option in measuring the note.
On December 31, 2020, the fair value of the note is P408,150.

1. What is carrying amount of the notes payable on December 31, 2020?

2. What amount should be reported as interest expense for 2020?
3. What amount of gain from change in fair value of the note payable should be reported for 2020?
4. At what amount should the discount on note payable be reported on December 31, 2020?
Loans Payable
Same with notes payable, loans payable are obligation incurred by an entity supported by a loan contract to pay a
certain sum of money in the future.
The difference between the notes payable and loans payable are the following:
1. The document supporting the obligation.
Promissory Notes for Notes Payable
Contract of Loan for Loan Payable

2. The involvement of transaction cost.

Transaction with promissory notes mostly, do not include transaction cost.
Loans transactions normally involved transactions cost.

Basically, accounting for loans payable is similar to notes payable except the accounting for transaction costs.
Loans Payable
Financial liabilities are initially recognized at fair value minus transaction cost.

Transaction costs are incremental cost that are attributable to the issuance of financial liability.

Examples of transaction cost:

a. Fees and commission paid to agents, advisers, brokers and dealers or “Origination Fees”
b. Levies by regulatory agencies and securities exchanges
c. Transfer taxes and duties

Examples of expenses not a transaction costs:

a. Debt premiums or discounts
b. Financing cost
c. Internal administrative or holding costs
Loans Payable
The most common type of transaction cost normally present to loan contracts is “Origination Fee”

Origination fee sometimes called as “processing fee or service charge” is the amount charged by the bank or lender to
process your loan application which covers the cost of credit investigation, preparing and processing the document
such as notarial fees and closing transactions.

Origination fees is usually express at a percentage of the principal amount of the loan and is directly deducted from
loan proceeds.

The following rules should be apply in accounting for origination fees:

1. It is deducted when measuring the carrying amount of the loan payable.
2. It is amortized using the effective interest method. The subsequent amortization increases both the interest expense
and carrying amount of the loan.
3. It is included in the calculation of the effective interest rate.
Loans Payable
Illustration: Subsequent measurement:
On January 1, 2021, ABC Co. borrowed P1,000,000 from Amortized cost using the effective interest.
a bank. The bank charged a 3% loan origination fee. The
How to determine the effective interest rate?
principal is due on January 1, 2024 but 10% interest is due
annually starting on January 1, 2022. Use the following cases:
(CA = carrying amount, FA = Face Amount)
Initial measurement: 1. If CA = FA, effective interest rate = nominal or stated
rate.
Principal amount P1,000,000
2. If effective interest rate is not given, use the trial and
Origination fee (30,000)
error and interpolation
Carrying amount – Jan 1 2021 P 970,000
To determine where to begin and limit the trial and
error, apply the following principles:
Cash 970,000 a. IF CA < FA, the difference is a discount and
Discount on loan payable 30,000 EIR > Nominal Rate.
Loans payable 1,000,000 b. IF CA > FA, the difference is a premium and
EIR < Nominal Rate.
Loans Payable
Illustration: We need to determine the correct present value factor
or at least the closest one using the trial rates that will
On January 1, 2021, ABC Co. borrowed P1,000,000 from
provide us the present value of the loan equal to its
a bank. The bank charged a 3% loan origination fee. The
carrying amount on initial recognition.
principal is due on January 1, 2024 but 10% interest is due
annually starting on January 1, 2022. Future cash flows x PV factor of x% = Present Value
1. Determine the future cash flows.
Initial measurement: 2. Determine the appropriate PV model to use based
on the settlement of the loan and interest.
Principal amount P1,000,000
a. If settlement is lump sum payment, use PV of 1.
Origination fee (30,000)
b. If settlement is equal annual installment, use PV of
Carrying amount – Jan 1 2021 P 970,000 ordinary annuity.
c. If settlement is installment in advance, use PV of an
annuity due.
Cash 970,000
d. If settlement is non-uniform installment, use PV of 1 with
Discount on loan payable 30,000 n starts at 1 for first payment and +1 for subsequent
payments.
Loans payable 1,000,000
e. If settlement is non-uniform installment with first
payment in advance, use PV of 1 with n starts at 0 for
first payment and +1 for subsequent payments.
Loans Payable
Illustration: First trial using 11%.
On January 1, 2021, ABC Co. borrowed P1,000,000 from 1. Determine the future cash flows.
a bank. The bank charged a 3% loan origination fee. The
Principal Payment and Interest Payments.
principal is due on January 1, 2024 but 10% interest is due
annually starting on January 1, 2022. 2. Determine the appropriate PV model.
a. Principal is Lump sum payment, use PV of 1.
Initial measurement: b. Interest is equal annual payment, use PV of
ordinary annuity.
Principal amount P1,000,000
3. Compute the PV factors at 11%.
Origination fee (30,000)
PV of 1 at 11% n=3 = 0.731191381
Carrying amount – Jan 1 2021 P 970,000
PV of ordinary annuity at 11% n=3 = 2.443714715
4. PV of Principal (1M x 0.731191381) P731,191
Cash 970,000
PV of Interest (100,000 x 2.443714715) 244,371
Discount on loan payable 30,000
Present value of loan at 11% P975,562
Loans payable 1,000,000
Not equal to the carrying amount of P970,000
Another trial, using 12%
Loans Payable Second trial using 12%.
1. Compute the PV factors at 12%.
PV of 1 at 12% n=3 = 0.711780248
Illustration:
PV of ordinary annuity at 12% n=3 = 2.401831268
On January 1, 2021, ABC Co. borrowed P1,000,000 from
a bank. The bank charged a 3% loan origination fee. The 4. PV of Principal (1M x 0.711780248) P711,780
principal is due on January 1, 2024 but 10% interest is due PV of Interest (100,000 x 2.401831268) 240,183
annually starting on January 1, 2022.
Present value of loan at 11% P951,963
Not equal to the carrying amount of P970,000
Initial measurement:
If using 11%, the present value of loan is P975,562 and if
Principal amount P1,000,000 using 12%, the present value of loan is P951,963. It means
Origination fee (30,000) the correct EIR is higher than 11% but not to exceed 12%.

Carrying amount – Jan 1 2021 P 970,000 To get that, we will use the interpolation formula:
(Initial CA of loan) minus (PV of loan at 11%)

Cash 970,000 (PV of loan at 12%) minus (PV of loan at 11%)

Discount on loan payable 30,000 970,000 – 975,562 (5,562)

= = 0.2357
Loans payable 1,000,000 951,963 – 975,562 (23,599)

The effective interest rate is 11.2357%

Loans Payable
Illustration:
On January 1, 2021, ABC Co. borrowed Amortization Table
P1,000,000 from a bank. The bank charged a
Interest Interest Present
3% loan origination fee. The principal is due on
January 1, 2024 but 10% interest is due annually Date Payments Expense Amortization Value
starting on January 1, 2022. Jan. 1 2021 970,000
Jan. 1 2022 100,000 108,986 8,986 978,986
Jan. 1 2023 100,000 109,996 9,996 988,982
Initial measurement: Jan. 1 2024 100,000 111,018 11,018 1,000,000
Principal amount P1,000,000
Origination fee (30,000)
The entry on December 31, 2021:
Carrying amount – Jan 1 2021 P 970,000
Interest expense 108,986
Cash 970,000
Interest payable 100,000
Discount on loan payable 8,986
Discount on loan payable 30,000
Loans payable 1,000,000
Loans Payable
There will be times where in the effective interest rate is given and it is the future cash flow that is not
indicated in the problem. This happen normally on loan where the payment term is on installment basis.

To get the future cash flows, use the following formula:

Future Cash Flows = Present Value of Loan / PV value factor.

Loans Payable
Different type of loans to bank:
1. Secured loans – loans with supported collateral which can be taken by the bank in case of default.
a. Mortgage loans – loan is secured by a real property such as land or building.
b. Chattel mortgages – loan is secured by a movable personal property such as car, equipment or jewelry.
c. Compensating balance – loan is secured by a minimum amount of deposit in the bank where loan is
granted.

2. Fixed and Variable Interest loans – loan where interest is at a fixed rate or dependent on the movement of interest
in the prevailing market every year (advance accounting).

3. Credit lines – a loan provided to company subject to credit limit whose usage credit limit dependent on the need
of the borrower but should not exceed to the limit granted by the bank. Example: Credit Card, Revolving Credit
Arrangements.
Loans Payable
Practice Problem:
Problem 3 Exercises No. 6 and 7(Page 90)
Bonds Payable and
Other Concepts
PROF. E. ISIP
INTERMEDIATE ACCOUNTING II
Bonds Payable
Concept and Definition
Bonds are long-term debt instruments similar to notes and loans except that bonds are usually offered
to the public and sold to many investors.

In simple language, a bond is a contract of debt whereby one party called the issuer borrows fund
from another party called investor.

A bond is evidenced by a certificate and the contractual agreement between the issuer and investor
is contained in a document called as “Bond Indenture”.

Bonds, are like Shares of Stocks, but instead of an equity, a liability is recognized in the books of the
issuer and is normally issued at a denomination of P1,000.00
Bonds Payable
Bond Indenture
The agreement between the issuer and investor may specify the following:
a. Rights and duties of bondholders and issuer
1. Call provisions (issuer right)
2. Redemption rights (bondholder right)
b. Restriction or requirements on the issuer
1. Sinking fund
2. Financial Ratios
3. Restriction on dividends to shareholders
4. Restriction on the incurrence of obligations
5. Appointment of independent trustee
6. Authorized amount of bonds that can be issued
c. Interest rate, settlement dates, and maturity dates
Bonds Payable
Types of Bonds
a. Term bonds – bonds that mature on single date.
b. Serial bonds – bonds where principal matures in installment.
c. Extendible bonds – bonds that can be extend the maturity date.
d. Retractable bonds – bonds that can be shorten the maturity date.
e. Mortgage bonds – bonds secured by a real property.
f. Collateral trust bonds – bonds secured by stocks or bonds from other company.
g. Debenture bonds – bonds without any collateral or unsecured bonds.
h. Registered bonds – bonds with registered name of holder.
i. Bearer or Coupon Bonds – bonds where the name of the holder is unregistered. Interest payment is
given to the person who bears the certificate or coupon detachable in the certificate.
j. Callable bond – bonds that can be called for redemption before the maturity.
k. Convertible bond – bonds that can be converted into shares of stocks.
Bonds Payable
Accounting for Bonds
Initial Measurement of Bonds Payable
PFRS 9, paragraph 5.1.1
Bonds payable, not designated at fair value through profit of loss (FVTPL), shall be measured initially at
fair value minus transaction costs that are directly attributable to the issue of the bonds payable.
Fair value of the bonds payable is equal to the present value of the future cash payments to settle the
bond liability.
Transaction cost of bonds is called “Bond Issue Cost”. It is deducted to the fair value or issue price of
the bonds payable in measuring the initial cost of bond.
If bonds is designated at fair value through profit of loss (FVTPL), the bond issue costs are treated as
expense immediately.

Actually, the fair value of the bonds payable is the same as the issue price or net proceeds from the
issue of the bonds, excluding accrued interest.
Bonds Payable
Accounting for Bonds
Subsequent Measurement of Bonds Payable
PFRS 9, paragraph 5.3.1, after initial recognition, bonds payable shall be measured either:
a. At amortized cost, using effective interest method
b. At fair value through profit or loss
Bonds Payable
Accounting for Bonds
Issuance of Bonds
Bonds issued Cash Proceeds Effective interest rate Effect of amortization
Vs. vs. on interest expense
Face Amount Nominal Interest Rate
Cash proceeds EIR Interest expense
At a Discount less than < higher greater than >
Face amount NIR Interest paid
Cash proceeds EIR Interest expense
At a Premium greater than > lower less than >
Face amount NIR Interest paid
Bonds Payable
Bonds issued at a discount Amortization Table
Interest Interest Present
Illustration: Bonds issued at a discount Date Payments Expense Amortization Value
On January 1, 2021, ABC Co. issued Jan. 1 2021 951,963
1,000, P1,000, 10%, 3-year bonds for Dec. 31 2022 100,000 114,236 14,236 966,199
P951,963. The principal is due at maturity Dec. 31 2023 100,000 115,944 15,944 982,142
but interest is due annually every year- Dec. 31 2024 100,000 117,858 17,858 1,000,000
end. The effective interest rate is 12%
Journal Entry on Dec 31 of each year (Subsequent Measurement)
Initial Measurement 2022 Interest expense 114,236
Face Amount of Bonds Cash 100,000
(1,000 x P1,000) P1,000,000 Discount on bonds payable 14,236
Issue Price (951,963) 2023 Interest expense 115,944
Discount on bonds payable P 48,037 Cash 100,000
Discount on bonds payable 15,944

Journal Entry on Jan 1, 2021 2024 Interest expense 117,858

Cash 100,000
Cash 951,963
Discount on bonds payable 17,858
Discount on bonds payable 48,037
Bonds Payable P1,000,000
Bonds Payable P1,000,000
Cash P1,000,000
Bonds Payable
Amortization Table
Bonds issued at a premium
Interest Interest Present
Illustration: Bonds issued at a discount Date Payments Expense Amortization Value
On January 1, 2021, ABC Co. issued 1,000, Jan. 1 2021 1,049,737
P1,000, 12%, 3-year bonds for P1,049,737. Dec. 31 2022 120,000 104,974 (15,026) 1,034,711
The principal is due at maturity but interest is Dec. 31 2023 120,000 103,471 (16,529) 1,018,182
due annually every year-end. The effective Dec. 31 2024 120,000 101,818 (18,182) 1,000,000
interest rate is 10%
Journal Entry on Dec 31 of each year (Subsequent Measurement)
Initial Measurement 2022 Interest expense 104,974
Face Amount of Bonds Premium on bonds payable 15,026
(1,000 x P1,000) P1,000,000 Cash 120,000
Issue Price 1,049,737 2023 Interest expense 103,471
Premium on bonds payable P 49,737 Premium on bonds payable 16,529
Cash 120,000

Journal Entry on Jan 1, 2021 2024 Interest expense 101,818

Premium on bonds payable 18,182
Cash 1,049,737
Cash 120,000
Bonds Payable 1,000,000
Premium on bonds payable 49,737 Bonds Payable P1,000,000
Cash P1,000,000
Bonds issued Cash Proceeds Vs. Face Effective interest rate vs. Effect of amortization on interest
Amount Nominal Interest Rate expense
Cash proceeds less than < Interest expense greater than >
At a Discount EIR higher NIR
Face amount Interest paid
Cash proceeds greater than Interest expense less than >
At a Premium EIR lower NIR
> Face amount Interest paid

Amortization Table
Bonds issued at a discount Interest Interest Present
Date Payments Expense Amortization Value
EIR is 12%
Jan. 1 2021 951,963
NIR is 10% Dec. 31 2022 100,000 114,236 14,236 966,199
Dec. 31 2023 100,000 115,944 15,944 982,142
Dec. 31 2024 100,000 117,858 17,858 1,000,000

Amortization Table
Interest Interest Present
Bonds issued at a premium Date Payments Expense Amortization Value
EIR is 10% Jan. 1 2021 1,049,737
Dec. 31 2022 120,000 104,974 (15,026) 1,034,711
NIR is 12% Dec. 31 2023 120,000 103,471 (16,529) 1,018,182
Dec. 31 2024 120,000 101,818 (18,182) 1,000,000
Bonds Payable
Accounting for Bond issue cost
Use the following rulings for bond issue cost:
1. If the bond is issued at its face amount, bond issue cost is accounted for as same a origination fee.
a. It is deducted when measuring the carrying amount of the bond payable.
b. It is amortized using the effective interest method.
c. It is included in the calculation of the effective interest rate using the trial and error and
interpolation formula.
2. If the bond is issued at a discount, bond issue cost is added in the discount on bonds
payable.
3. If the bond is issued at a premium, bond issue cost is deducted in the premium on bonds
payable.
Bonds Payable
Bonds issued at a discount with bond issue cost Amortization Table
Interest Interest Present
Illustration: Bonds issued at a discount
Date Payments Expense Amortization Value
On January 1, 2021, ABC Co. issued 1,000, P1,000, Jan. 1 2021 907,134
10%, 3-year bonds for P951,963. The principal is
Dec. 31 2022 100,000 126,999 26,999 934,133
due at maturity but interest is due annually every
year-end. ABC incurred bond issue cost of Dec. 31 2023 100,000 130,779 30,779 964,911
P44,829. The effective interest rate is 14% after Dec. 31 2024 100,000 135,089 35,089 1,000,000
adjusting the bond issue cost.
Initial Measurement
Journal Entry on Dec 31 of each year (Subsequent Measurement)
Face Amount of Bonds
2022 Interest expense 126,999
(1,000 x P1,000) P1,000,000
Cash 100,000
Issue Price (951,963)
Discount on bonds payable 26,999
Discount on bonds P 48,037
Bond issue cost 44,829
Total discount on bonds P 92,866
Journal Entry on Jan 1, 2021
Cash 907,134
Discount on bonds payable 92,866
Bonds Payable P1,000,000
Bonds Payable
Issuance of bonds in between interest dates
 When bonds are issued in between interest dates, any accrued interest prior to the issuance date is
sold to the investor together with the bonds.
 Any accrued interest charged to an investor should not be included in the carrying amount of the
bond but rather credited to interest payable. It means that the cash proceeds of issuing the bonds
or the bond issue price should include accrued interest.
 Moreover, the net interest expense recognized during the period should represent only the post-
issuance interest expense.
Bonds Payable
Illustration:
On April 1, 2021, ABC Co. issued at 12%, P1,000,000 bonds dated January 1, 2021. Interest are paid semi-annually every January 1 and July 1.

Case no. 1: The bonds were issued at 97 including Case no. 2: The bonds were issued at 97 excluding
accrued interest. accrued interest.
Cash proceeds including Cash proceeds excluding
the accrued interest (1,000,000 x 97%) P970,000 the accrued interest (1,000,000 x 97%) P970,000
Accrued interest Carrying amount of bonds, April 1 P970,000
(1,000,000 x .12 x 3/12) (30,000)
Carrying amount of bonds, April 1 P940,000 Journal Entry:
Cash 1,000,000
Journal Entry Discount on bonds payable 30,000
April 1 Bonds payable 1,000,000
Cash 970,000 Interest payable 30,000
Discount on bonds payable 60,000
Bonds payable 1,000,000 July 1
Interest payable 30,000 Interest expense (1M x .12 x 3/12) 30,000
Interest payable 30,000
July 1 Cash 60,000
Interest expense (1M x .12 x 3/12) 30,000
Interest payable 30,000
Cash 60,000
Bonds Payable
Bond issue price or cash proceed is not always given.
The issue price of the bond can be estimated by discounting the future cash flows of the bonds at a specified
effective interest rate. The difference between the face amount of the bond and the discounted future value
(present value) is the discount or the premium.

When the bond was issued in between the interest dates, the bond issue price should include the accrued
interest.

Illustration on page 117

Case 1: Issued on interest date
Case 2: Issued in between interest dates
Bonds Payable
Retirement of bonds prior to maturity
The carrying amount of the bonds is updated for any discount or premium amortization up to the date of
extinguishment and any difference between the updated carrying amount and the retirement/call price is
recognized in profit or loss as gain or loss from extinguishment.

Carrying Amount (Face amount of Bond (less)/add unamortized (discount)/premium) P XXX

Retirement/Call Price
Face amount of the bond retired XXX
add Call premium/ less Call Discount XXX
add Expenses incurred on retirement XXX
less Accrued interest (if retirement between interest dates) XXX XXX
Gain or Loss on extinguishment P XXX

Bond refunding or Bond refinancing

Bond refunding refers to the issuance of new bonds (normally with lower interest rate), the proceeds
from which is used to retire existing outstanding bonds.

Illustrations: Please refer to your books on page 119 and 120.

Case 1: Retirement on interest date
Case 2: Retirement in between interest dates
Bonds Payable
Serial Bonds
Bonds in which principal matures in installment. Aside from the amortization of discount or premium, the carrying
of the bonds payable is reduced by the installment applicable to principal amount of bonds.
Illustration: Page 122

Zero Coupon Bonds

Bonds in which principal and compounded interest due only in its maturity date. In this case, the future cash flow
is equivalent to the future value of the bonds or the value at maturity date.
Illustration: Page 123
Bonds Payable
Callable bonds
Callable bonds are bonds that the issuer can redeem prior to maturity date.
Instead of using the original maturity date, use the expected holding period to amortize the discount or period.
Subsequent changes in the expected holding period are treated as change in accounting estimate and are
accounted for prospectively.

Redeemable preference shares (with mandatory redemption)

Although in form it is an equity instrument, the substance of the transaction is an obligation where in the
accounting the treatment applies the same for bonds payable.
Redeemable preference shares are presented as liability and measured using the amortized cost.
The dividends paid to the redeemable preference shares are treated as interest expense.
On the date of redemption, the difference between the cash amount paid to redeem the shares over the
carrying amount of the liability is treated as a gain or loss on redemption in the profit or loss.

Illustrations: Page 125

Compound Financial Instrument
A compound financial instrument is a financial instrument that, from the issuer’s perspective, contains both a
liability and an equity element. These elements are classified and accounted for separately.

To account separately the liability and equity component of a compound financial instrument, apply the “Split
Accounting” by using the following procedures:
1. Determined first the fair value of the liability component. This is equivalent to the price of the liability
component if issued “stand-alone” or separately without the equity component or if not given, the present value
of the future cash payment.
2. Deduct the fair value of the liability component from the issue price of the compound instrument to compute
the value of the equity component.

Examples of a compound financial instrument are convertible bonds and bonds with share warrants.
Compound Financial Instrument
Convertible Bonds
These are bonds issued that grants the holders the right to exchange or convert the bonds into share capital of
the issuing entity within the specified period of time.

Accounting problems arise in two situations, namely:

a. When the convertible bonds are originally issued
The issuance of the convertible bonds shall be accounted for as partly liability (bonds) and partly equity
(conversion privilege). The issue price should be allocated to the liability component and the equity
component.

Any transaction cost incurred for the issuance of convertible bonds are allocated also to the liability
component and equity component. Transaction cost for liability component is treated as bond issue cost
while transaction cost for equity component is charged against the value of the equity component.

b. When the convertible bonds are converted into share capital

a. The amortization of the premium or discount and bond issue cost must be recorded up to the date of
conversion.
b. The face amount of the bonds converted shall be cancelled together with the related unamortized
premium or discount and bond issue cost. If the conversion is made partially, the unamortized premium
or discount and bond issue cost shall be cancelled proportionately.
c. Normally the conversion is at an interest date. When it is converted in between interest date, the accrue
interest up to the date of conversion is ordinarily paid. If not paid it is added to the face amount of the
bonds converted to get the carrying amount of the bonds. The accrued interest is treated as interest
expense.

Illustration on page 128 to 135

Compound Financial Instrument
Bonds with Share Warrants
These are bonds issued that grants the holders the right to purchase the shares of the issuing entity at a fixed
price.

Share warrants attached to bonds can be detachable or non-detachable. Regardless when the share warrants
is detachable or not, we need to account the compound financial instrument separately.

Accounting problems arise in two situations, namely:

a. When the bonds with share warrants are originally issued. Use split accounting.
b. When the share warrants are exercise to purchase shares
Normal issuance of shares except that the value of the equity component is transferred to share premium.

Illustration on page 136

Reclassification
PFRS 9 prohibits reclassification of financial liabilities.

An entity who chooses to account a financial liability at amortized cost cannot subsequently reclassify it at fair
value and vice versa.

What about the financial assets?

Derecognition of financial liability
An entity shall remove a financial liability (or a part of a financial liability) from its statement of financial position
when it is extinguished such as when the obligation specified in the contract is discharged or cancelled or
expires.

Mode of extinguishing liabilities:

a. Repayment of cash
b. Transfer of non-cash assets or asset swap (dacion en pago)
c. Issuance of equity instrument or equity swap (stocks)
d. Issuance of new obligation (refinancing or modification of terms)
e. Waiver or cancellation (condonation of debt)
f. Expiration (in case of warranty)
Asset Swap
Asset swap is the transfer by the debtor to the creditor of any non cash assets such as real property, inventory,
receivables, in full payment of obligation.

Accounting procedure:
1. Determine the carrying amount of the non-cash asset.
2. Determine the carrying amount of the liability including any unpaid/accrued interest.
3. Compute for any gain or loss on extinguishment
If CA of Liability is greater than the CA of Non-cash asset, there is a gain on extinguishment.
If CA of Liability is lesser than the CA of Non-cash asset, there is a loss on extinguishment.

Illustration on page 137

Note: This accounting procedures applies also for dacion en pago where in the attached real property served as
a collateral or mortgage to a loan is used to pay the liability.
Total liability to bank includes its carrying amount, any unpaid or accrued interest and bank charges.
Equity Swap
Equity swap is the transaction whereby a debtor and a creditor may renegotiate the terms of the obligation with
the result that the liability will be settled fully or partially by issuing equity instruments.
Accounting issue:
How should the entity initially measured the equity instruments issued to extinguish the liability?
We will apply IFRIC 13.
Accounting procedure:
1. Determine the value of the equity instrument issued based on the following order of priority:
a. Fair value of the equity issued
b. Fair value of the liability extinguished
c. Carrying amount of the liability extinguished
2. Determine the carrying amount of the liability including any unpaid/accrued interest.
3. Compute any gains or loss on extinguishment

Illustration on page 138

Modification of terms
A debtor and creditor may agree to modify the terms of the obligation either by:
a. Increasing or decreasing Interest rate c. Changing the face amount
b. Extending or shortening the maturity date d. Reducing, deferring or cancelling unpaid or accrued interest
e. Combinations of all the modification above.
Accounting procedures:
1. Compute the present value of new or restructured liability using the new terms using the old effective interest rate.
2. Determine the carrying amount of the old liability including any accrued interest.
3. Compute for gain or loss by comparing the no. 1 and no. 2.
a. If PV of new liability is greater than CA of old liability, there is a loss on extinguishment.
b. If PV of new liability is lower than CA of old liability, there is a gain on extinguishment.
4. Determine whether the modification is substantial or not. There is substantial modification if the gain or loss on extinguishment is at
least 10% of the old financial liability.
a. If substantial, gain or loss is at least 10%, treat the modification as extinguishment of old liability and recognized the gain or loss
on extinguishment.
b. If not substantial, gain or loss is less than 10%, no gain or loss should be recognized as no extinguishment occurred.
5. Direct cost of modification are accounted for as follows:
a. If substantial, included in the gain or loss.
b. if not substantial, deducted from carrying amount of the liability and amortized using the effective interest method.
Illustration: Page 140
Cancellation of debt
A creditor, out of goodwill, may forgive a loan of the debtor. In
this case, the entire carrying amount of the liability including
any interest accrued or unpaid is recognized as gain on
extinguishment.

Question:
Will a cancellation of debt result to a loss?
On the part of the debtor – No
On the part of the creditor - Yes
Offsetting
An entity shall offset a financial asset and a financial
liability and the net amount presented in the statement
of financial position only when the entity
1. currently has a legally enforceable right to set off the
recognized amounts; AND
2. intends either to settle on a net basis, or to realize the
asset and settle the liability simultaneously.
Assignment: Problem 3: Exercises