AKUNTANSI KEUANGAN II

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Non-Current Liabilities
PREVIEW OF CHAPTER 14

Intermediate Accounting
IFRS 3rd Edition
Kieso ● Weygandt ● Warfield
CHAPTER

14 Non-Current Liabilities
LEARNING OBJECTIVES
After studying this chapter, you should be able to:

1. Describe the nature of bonds and indicate the accounting for bond
issuances.
2. Explain the accounting for long-term notes payable.
3. Explain the accounting for the extinguishment of non-current liabilities.
4. Indicate how to present and analyze non-current liabilities.
 LEARNING OBJECTIVE 1
Bonds Payable Describe the nature of bonds
and indicate the accounting for
bond issuances.

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

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

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

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 Types of Bonds
Common types found in practice:

u Secured and Unsecured (debenture) bonds.

u Term, Serial, and Callable bonds.

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

u Registered and Bearer (Coupon) bonds.

u Income and Revenue bonds.

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

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 What Do the Numbers Mean?

Corporate bond listing.

Company Price as a % of par

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

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 Valuation and Accounting for Bonds
Issuance and marketing of bonds to the public:

u Usually takes weeks or months.

u Issuing company must

► Arrange for underwriters.

► Obtain regulatory approval of the bond issue, undergo

audits, and issue a prospectus.

► Have bond certificates printed.

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 Valuation and Accounting for Bonds
Selling price of a bond issue is set by the

u supply and demand of buyers and sellers,

u relative risk,

u market conditions, and

u state of the economy.

Investment community values a bond at the present value of its

expected future cash flows, which consist of

(1) interest and

(2) principal.
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 Valuation and Accounting for Bonds
Interest Rate

u Stated, coupon, or nominal rate = Rate written in the terms of

the bond indenture.

► Bond issuer sets this rate.

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

u Market rate or effective yield = Rate that provides an acceptable

return commensurate with the issuer’s risk.

► Rate of interest actually earned by the bondholders.

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 Valuation and Accounting for Bonds
How do you calculate the amount of interest that is actually paid to
the bondholder each period?

(Stated rate x Face Value of the bond)

How do you calculate the amount of interest that is actually recorded

as interest expense by the issuer of the bonds?

(Market rate x Carrying Value of the bond)

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 Valuation and Accounting for Bonds
Assume Stated Rate of 8%

Market Interest Bonds Sold At

6% Premium

8% Par Value

10% Discount

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 Bonds Issued at Par
Illustration: Santos SA issues R$100,000 in bonds dated January 1, 2019,
due in five years with 9 percent interest payable annually on January 1.
At the time of issue, the market rate for such bonds is 9 percent.

ILLUSTRATION 14.1
Time Diagram for Bonds Issued at Par

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 Bonds Issued at Par ILLUSTRATION 14.1
Time Diagram for Bonds
Issued at Par

ILLUSTRATION 14.2
Present Value
Computation of
Bond Selling at Par

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 Bonds Issued at Par
Journal entry on date of issue, Jan. 1, 2019.
Cash 100,000
Bonds payable 100,000

Journal entry to record accrued interest at Dec. 31, 2019.

Interest expense 9,000
Interest payable 9,000

Journal entry to record first payment on Jan. 1, 2020.

Interest payable 9,000
Cash 9,000

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 Bonds Issued at a Discount
Illustration: Assuming now that Santos issues R$100,000 in bonds,
due in five years with 9 percent interest payable annually at year-end.
At the time of issue, the market rate for such bonds is 11 percent.

ILLUSTRATION 14.3
Time Diagram for Bonds Issued at a Discount

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 Bonds Issued at a Discount ILLUSTRATION 14.3
Time Diagram for Bonds
Issued at a Discount

ILLUSTRATION 14.4
Present Value
Computation of
Bond Selling at
Discount

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 Bonds Issued at a Discount
Journal entry on date of issue, Jan. 1, 2019.
Cash 92,608
Bonds payable 92,608

Journal entry to record accrued interest at Dec. 31, 2019.

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

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 Bonds Issued at a Discount
When bonds sell at less than face value:

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

► Usually occurs because investors can earn a higher rate on

alternative investments of equal risk.

► Cannot change stated rate so investors refuse to pay face value

for the bonds.

► Investors receive interest at the stated rate computed on the

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

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 Effective-Interest Method
Bond issued at a discount - amount paid at maturity is more than the
issue amount.

Bonds issued at a premium - company pays less at maturity relative

to the issue price.

Adjustment to the cost is recorded as bond interest expense over the

life of the bonds through a process called amortization.

Required procedure for amortization is the effective-interest method

(also called present value amortization).

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 Effective-Interest Method
Effective-interest method produces a periodic interest expense equal
to a constant percentage of the carrying value of the bonds.

ILLUSTRATION 14.5
Bond Discount and Premium Amortization Computation

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 Effective-Interest Method
Bonds Issued at a Discount
Illustration: Evermaster AG issued €100,000 of 8% term bonds on
January 1, 2019, due on January 1, 2024, with interest payable each
July 1 and January 1. Investors require an effective-interest rate of
10%. Calculate the bond proceeds.

ILLUSTRATION 14.6
Computation of Discount on Bonds Payable

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 Effective-Interest Method
TABLE 6.2 PRESENT VALUE OF 1 (PRESENT VALUE OF A SINGLE SUM)

$100,000 x .61391 = $61,391

Face Value Factor Present Value
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 Effective-Interest Method
TABLE 6.4 PRESENT VALUE OF AN ORDINARY ANNUITY OF 1

$4,000 x 7.72173 = $30,887

Semiannual Factor Present Value
Payment
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 ILLUSTRATION 14.7
Bond Discount
Amortization Schedule

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 ILLUSTRATION 14.7
Bond Discount
Amortization Schedule

Journal entry on date of issue, Jan. 1, 2019.

Cash 92,278
Bonds Payable 92,278

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 ILLUSTRATION 14.7
Bond Discount
Amortization Schedule

Journal entry to record first payment and amortization of the

discount on July 1, 2019.
Interest expense 4,614
Bonds payable 614
Cash 4,000

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 ILLUSTRATION 14.7
Bond Discount
Amortization Schedule

Journal entry to record accrued interest and amortization of the

discount on Dec. 31, 2019.
Interest expense 4,645
Interest payable 4,000
Bonds payable 645

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 Effective-Interest Method
Bonds Issued at a Premium
Illustration: Evermaster Corporation issued €100,000 of 8% term
bonds on January 1, 2019, due on January 1, 2024, with interest
payable each July 1 and January 1. Investors require an effective-
interest rate of 6%. Calculate the bond proceeds.

ILLUSTRATION 14.8
Computation of Premium on Bonds Payable

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 Effective-Interest Method
TABLE 6.2 PRESENT VALUE OF 1 (PRESENT VALUE OF A SINGLE SUM)

$100,000 x .74409 = $74,409

Face Value Factor Present Value

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 Effective-Interest Method
TABLE 6.4 PRESENT VALUE OF AN ORDINARY ANNUITY OF 1

$4,000 x 8.53020 = $34,121

Semiannual Factor Present Value
Payment
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 ILLUSTRATION 14.9
Bond Premium
Amortization Schedule

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 ILLUSTRATION 14.9
Bond Premium
Amortization Schedule

Journal entry on date of issue, Jan. 1, 2019.

Cash 108,530
Bonds Payable 108,530

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 ILLUSTRATION 14.9
Bond Premium
Amortization Schedule

Journal entry to record first payment and amortization of the

discount on July 1, 2019.

Interest expense 3,256

Bonds payable 744
Cash 4,000

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 Effective-Interest Method
Accrued Interest
What happens if Evermaster prepares financial statements at the
end of February 2019? In this case, the company prorates the
premium by the appropriate number of months to arrive at the
proper interest expense, as follows.

ILLUSTRATION 14.10
Computation of Interest Expense

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 Effective-Interest Method

Accrued Interest ILLUSTRATION 14.10

Computation of Interest Expense

Evermaster records this accrual as follows.

Interest expense 1,085.33

Bonds payable 248.00
Interest payable 1,333.33

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 Effective-Interest Method
Bonds Issued Between Interest Dates
Bond investors will pay the issuer the interest accrued from the last
interest payment date to the date of issue.

On the next semiannual interest payment date, bond investors will

receive the full six months’ interest payment.

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 Effective-Interest Method

Bonds Issued at Par

Illustration: Assume Evermaster issued its five-year bonds, dated
January 1, 2019, on May 1, 2019, at par (€100,000). Evermaster
records the issuance of the bonds between interest dates as
follows. (€100,000 x .08 x 4/12) = €2,667

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

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 Effective-Interest Method
Bonds Issued at Par
On July 1, 2019, two months after the date of purchase,
Evermaster pays the investors six months’ interest, by making the
following entry. ($100,000 x .08 x 1/2) = $4,000

Interest expense 4,000

Cash 4,000

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 Effective-Interest Method

Bonds Issued at Discount or Premium

Illustration: Assume that the Evermaster 8 percent bonds were
issued on May 1, 2019, to yield 6 percent. Thus, the bonds are
issued at a premium price of €108,039. Evermaster records the
issuance of the bonds between interest dates as follows.
Cash 108,039
Bonds payable 108,039
Cash 2,667
Interest expense 2,667
(€100,000 x .08 x 4/12) = €2,667

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 Effective-Interest Method
Bonds Issued at Discount or Premium
Evermaster then determines interest expense from the date of sale
(May 1, 2019), not from the date of the bonds (January 1, 2019).

ILLUSTRATION 14.12
Partial Period Interest Amortization

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 Effective-Interest Method

Bonds Issued at Discount or Premium

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

ILLUSTRATION 14.13
Partial Period Interest Amortization

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 Effective-Interest Method
Bonds Issued at Discount or Premium
Evermaster therefore makes the following entries on July 1, 2019, to
record the interest payment and the premium amortization.
Interest expense 4,000
Cash 4,000
Bonds payable 253
Interest expense 253

The Interest Expense account now contains a debit balance of

€1,080 (€4,000 − €2,667 − €253).

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 LEARNING OBJECTIVE 2
Long-Term Notes Payable Explain the accounting for
long-term notes payable.

Accounting is Similar to Bonds

u A note is valued at the present value of its future interest and
principal cash flows.

u Company amortizes any discount or premium over the life of

the note.

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 Notes Issued at Face Value
Illustration: Scandinavian Imports issues a €10,000, three-year note,
at face value to Bigelow ASA. The stated rate and the effective rate
were both 10 percent. Scandinavian would record the issuance of the
note as follows.
Cash 10,000
Notes Payable 10,000

Scandinavian Imports would recognize the interest incurred each

year as follows.
Interest Expense 1,000
Cash 1,000
(€10,000 x .10 = €1,000)

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 Notes Issued at Face Value
Zero-Interest-Bearing Notes
Issuing company records the difference between the face amount
and the present value (cash received) as

u a discount and
u amortizes that amount to interest expense over the life of
the note.

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 Zero-Interest-Bearing Notes
Illustration: Turtle Cove Company issued the three-year, $10,000,
zero-interest-bearing note to Jeremiah Company. The implicit rate
that equated the total cash to be paid ($10,000 at maturity) to the
present value of the future cash flows ($7,721.80 cash proceeds at
date of issuance) was 9 percent.

ILLUSTRATION 14.14
Time Diagram for Zero-Interest Note

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 Zero-Interest-Bearing Notes
Illustration: Turtle Cove Company issued the three-year, $10,000,
zero-interest-bearing note to Jeremiah Company. The implicit rate
that equated the total cash to be paid ($10,000 at maturity) to the
present value of the future cash flows ($7,721.80 cash proceeds at
date of issuance) was 9 percent.

Turtle Cove records issuance of the note as follows.

Cash 7,721.80
Notes Payable 7,721.80

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 ILLUSTRATION 14.15
Turtle Cove records interest expense at the Schedule of Note
Discount Amortization
end of the first year as follows.
Interest Expense 694.96
Notes Payable 694.96
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 Interest-Bearing Notes
Illustration: Marie Co. issued for cash a €10,000, three-year note
bearing interest at 10 percent to Morgan Corp. The market rate of
interest for a note of similar risk is 12 percent. In this case, because
the effective rate of interest (12%) is greater than the stated rate
(10%), the present value of the note is less than the face value. That
is, the note is exchanged at a discount.
ILLUSTRATION 7-
16
Computation of
Present Value—
Effective Rate
Different from
Stated Rate

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 Interest-Bearing Notes
Illustration: Marie Co. issued for cash a €10,000, three-year note
bearing interest at 10 percent to Morgan Group. The market rate of
interest for a note of similar risk is 12 percent. In this case, because
the effective rate of interest (12%) is greater than the stated rate
(10%), the present value of the note is less than the face value. That
is, the note is exchanged at a discount.

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

Cash 9,520
Notes Payable 9,520

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 ILLUSTRATION 14.16
Schedule of Note
Discount Amortization

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

Interest Expense 1,142
Notes Payable 142
Cash 1,000
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 Special Notes Payable Situations
Notes Issued for Property, Goods, or Services
When exchanging the debt instrument for property, goods, or
services in a bargained transaction, the stated interest rate is
presumed to be fair unless:

1. No interest rate is stated, or

2. The stated interest rate is unreasonable, or

3. The stated face amount is materially different from the

current cash price for the same or similar items or from the
current fair value of the debt instrument.

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 Special Notes Payable Situations
Choice of Interest Rates
If a company cannot determine the fair value of the property,
goods, services, or other rights, and if the note has no ready market,
the present value of the note must be determined by the company
to approximate an applicable interest rate (imputation).

Choice of rate is affected by:

► Prevailing rates for similar instruments.

► Factors such as restrictive covenants, collateral, payment

schedule, and the existing prime interest rate.

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 Special Notes Payable Situations
Illustration: On December 31, 2019, Wunderlich plc issued a
promissory note to Brown Interiors Company for architectural
services. The note has a face value of £550,000, a due date of
December 31, 2024, and bears a stated interest rate of 2 percent,
payable at the end of each year. Wunderlich cannot readily
determine the fair value of the architectural services, nor is the note
readily marketable. On the basis of Wunderlich’s credit rating, the
absence of collateral, the prime interest rate at that date, and the
prevailing interest on Wunderlich’s other outstanding debt, the
company imputes an 8 percent interest rate as appropriate in this
circumstance.

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 Special Notes Payable Situations ILLUSTRATION 14.18
Time Diagram for
Interest-Bearing Note

ILLUSTRATION 14.19
Computation of Imputed Fair Value and Note Discount

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 Special Notes Payable Situations

ILLUSTRATION 14.19
Computation of Imputed Fair Value and Note Discount

On December 31, 2019, Wunderlich records issuance of the note in

payment for the architectural services as follows.

Building (or Construction in Process) 418,239

Notes Payable 418,239

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 ILLUSTRATION 14.20
Schedule of Discount
Amortization Using
Imputed Interest Rate

Payment of first year’s interest and amortization of the discount.

Interest Expense 33,459
Notes Payable 22,459
Cash 11,000
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 Mortgage Notes Payable
A promissory note secured by a document called a mortgage that
pledges title to property as security for the loan.

u Common form of long-term notes payable.

u Payable in full at maturity or in installments.

u Fixed-rate mortgage.

u Variable-rate mortgage.

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 Extinguishment of Non- LEARNING OBJECTIVE 3
Current Liabilities Explain the accounting for
extinguishment of non-
current liabilities.

Three common situations besides payment at maturity:

1. Extinguishment with cash before maturity,

2. Extinguishment by transferring assets or securities, and

3. Extinguishment with modification of terms.

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 Extinguishment of Non-Current Liabilities
Extinguishment with Cash before Maturity
u Net carrying amount > Reacquisition price = Gain

u Reacquisition price > Net carrying amount = Loss

u At time of reacquisition, unamortized premium or

discount must be amortized up to the reacquisition date.

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 Extinguishment with Cash before Maturity
Illustration: Evermaster bonds issued at a discount on January 1, 2019.
These bonds are due in five years. The bonds have a par value of
€100,000, a coupon rate of 8 percent paid semiannually, and were sold
to yield 10 percent. ILLUSTRATION 14.21
Bond Premium Amortization Schedule, Bond Extinguishment

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 Extinguishment with Cash before Maturity
Two years after the issue date on January 1, 2021, Evermaster calls
the entire issue at 101 and cancels it.
ILLUSTRATION 14.22
Computation of Loss on Redemption of Bonds

Evermaster records the reacquisition and cancellation of the bonds

as follows.
Bonds Payable 94,925
Loss on Extinguishment of Debt 6,075
Cash 101,000
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 Extinguishment of Non-Current Liabilities
Extinguishment by Exchanging Assets or Securities
u Creditor should account for the non-cash assets or equity
interest received at their fair value.

u Debtor recognizes a gain equal to the excess of the carrying

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

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 Transfer of Assets
Illustration: Hamburg Bank loaned €20,000,000 to Bonn Mortgage
Company. Bonn, in turn, invested these monies in residential
apartment buildings. However, because of low occupancy rates, it
cannot meet its loan obligations. Hamburg Bank agrees to accept
from Bonn Mortgage real estate with a fair value of €16,000,000 in
full settlement of the €20,000,000 loan obligation. The real estate
has a carrying value of €21,000,000 on the books of Bonn Mortgage.
Bonn (debtor) records this transaction as follows.
Note Payable (to Hamburg Bank) 20,000,000
Loss on Disposal of Real Estate 5,000,000
Real Estate 21,000,000
Gain on Extinguishment of Debt 4,000,000
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 Granting of Equity Interest
Illustration: Now assume that Hamburg Bank agrees to accept from
Bonn Mortgage 320,000 ordinary shares (€10 par) that have a fair
value of €16,000,000, in full settlement of the €20,000,000 loan
obligation. Bonn Mortgage (debtor) records this transaction as
follows.

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

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

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 Extinguishment of Non-Current Liabilities
Extinguishment with Modification of Terms
Creditor may offer one or a combination of the following
modifications:
1. Reduction of the stated interest rate.
2. Extension of the maturity date of the face amount of the
debt.
3. Reduction of the face amount of the debt.

4. Reduction or deferral of any accrued interest.

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 Modification of Terms
Illustration: On December 31, 2019, Morgan National Bank enters into
a debt modification agreement with Resorts Development Group. The
bank restructures a ¥10,500,000 loan receivable issued at par (interest
paid to date) by:
► Reducing the principal obligation from ¥10,500,000 to
¥9,000,000;

► Extending the maturity date from December 31, 2019, to

December 31, 2023; and
► Reducing the interest rate from the historical effective rate of 12
percent to 8 percent. Given Resorts Development’s financial
distress, its market-based borrowing rate is 15 percent.

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 Modification of Terms
IFRS requires the modification to be accounted for as an
extinguishment of the old note and issuance of the new note,
measured at fair value.

ILLUSTRATION 14.23
Fair Value of Restructured Note

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 Modification of Terms
The gain on the modification is ¥3,298,664, which is the difference
between the prior carrying value (¥10,500,000) and the fair value of
the restructured note, as computed in Illustration 14.23
(¥7,201,336). Given this information, Resorts Development makes
the following entry to record the modification.

Note Payable (old) 10,500,000

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

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 ILLUSTRATION 14.24
Schedule of Interest and
Amortization after Debt
Modification
Resorts Development recognizes interest expense
on this note using the effective rate of 15 percent. Thus, on
December 31, 2020 (date of first interest payment after restructure),
Resorts Development makes the following entry.

Interest Expense 1,080,200

Notes Payable 360,200
Cash 720,000

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 ILLUSTRATION 14.24
Schedule of Interest and
Amortization after Debt
Modification
Resorts Development makes a similar entry
(except for different amounts for credits to Notes Payable and debits
to Interest Expense) each year until maturity. At maturity, Resorts
Development makes the following entry.

Notes Payable 9,000,000

Cash 9,000,000

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 LEARNING OBJECTIVE 4
Presentation and Analysis Indicate how to present and
analyze non-current
liabilities.

Fair Value Option

Companies have the option to record fair value in their accounts
for most financial assets and liabilities, including bonds and notes
payable.
The IASB believes that fair value measurement for financial
instruments, including financial liabilities, provides more relevant
and understandable information than amortized cost.

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 Fair Value Option
Fair Value Measurement
Non-current liabilities are recorded at fair value, with unrealized
holding gains or losses reported as part of net income.
Illustrations: Edmonds SE has issued €500,000 of 6 percent bonds
at face value on May 1, 2019. Edmonds chooses the fair value
option for these bonds. At December 31, 2019, the value of the
bonds is now €480,000 because interest rates in the market have
increased to 8 percent.
Bonds Payable (€500,000 - €480,000) 20,000
Unrealized Holding Gain or Loss—Income 20,000

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 Off-Balance-Sheet Financing
Off-balance-sheet financing is an attempt to borrow monies in such
a way to prevent recording the obligations.

Different Forms:
► Non-Consolidated Subsidiary

► Special Purpose Entity (SPE)

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 Off-Balance-Sheet Financing
Rationale
► Removing debt enhances the quality of the balance sheet and
permits credit to be obtained more readily and at less cost.
► Loan covenants often limit the amount of debt a company may
have. These types of commitments might not be considered in
computing the debt limitation.
► Some argue that the asset side of the balance sheet is severely
understated.

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

Fair value of the debt should be disclosed.

Must disclose future payments for sinking fund requirements and

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

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 Presentation and Analysis
Analysis of Non-Current Liabilities
One ratio that provides information about debt-paying ability and
long-run solvency is:

Total Liabilities
Debt to Assets =
Total Assets

The higher the percentage of total liabilities to total assets, the

greater the risk that the company may be unable to meet its
maturing obligations.

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 Presentation and Analysis
Analysis of Non-Current Liabilities
A second ratio that provides information about debt-paying
ability and long-run solvency is:

Income before Income Taxes and

Times Interest Interest Expense
Earned =
Interest Expense

Indicates the company’s ability to meet interest payments as they

come due.

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 Presentation and Analysis
Illustration: Novartis has total liabilities of $54,434 million, total
assets of $131,556 million, interest expense of $655 million, income
taxes of $1,106 million, and net income of $17,794 million. We
compute Novartis’s debt to assets and times interest earned ratios as
shown.

ILLUSTRATION 14.28
Computation of Long-Term Debt Ratios for Novartis

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