3. 14-3
1. Describe the formal procedures associated with issuing long-term
debt.
2. Identify various types of bond issues.
3. Describe the accounting valuation for bonds at date of issuance.
4. Apply the methods of bond discount and premium amortization.
5. Describe the accounting for the extinguishment of non-current
liabilities.
6. Explain the accounting for long-term notes payable.
7. Describe the accounting for the fair value option.
8. Explain the reporting of off-balance-sheet financing arrangements.
9. Indicate how to present and analyze long-term debt.
Learning Objectives
Learning Objectives
4. 14-4
Bonds Payable
Long-Term
Notes Payable
Reporting and
Analyzing Long-Term
Debt
Issuing bonds
Types and ratings
Valuation
Effective-interest
method
Costs of issuing
Extinguishment
Notes issued at face
value
Notes not issued at face
value
Special situations
Mortgage notes payable
Fair value option
Off-balance-sheet
financing
Presentation and analysis
Long-Term Liabilities
Long-Term Liabilities
5. 14-5
Bonds Payable
Bonds Payable
Long-term debt consist of probable future sacrifices of
economic benefits arising from present obligations that are
not payable within a year or the operating cycle of the
company, whichever is longer.
LO 1 Describe the formal procedures associated with issuing long-term debt.
Examples:
► Bonds payable
► Long-term notes payable
► Mortgages payable
► Pension liabilities
► Lease liabilities
Long-term debt has various
covenants or restrictions.
6. 14-6
Issuing Bonds
Issuing Bonds
LO 1 Describe the formal procedures associated with issuing long-term debt.
Bond contract known as a bond indenture.
Represents a promise to pay:
(1) sum of money at designated maturity date, plus
(2) periodic interest at a specified rate on the maturity
amount (face value).
Paper certificate, typically a $1,000 face value.
Interest payments usually made semiannually.
Used when the amount of capital needed is too large for one
lender to supply.
7. 14-7
Types and Ratings of Bonds
Types and Ratings of Bonds
LO 2 Identify various types of bond issues.
Common types found in practice:
Secured and Unsecured (debenture) bonds.
Term, Serial, and Callable bonds.
Convertible, Commodity-Backed, Deep-Discount bonds.
Registered and Bearer (Coupon) bonds.
Income and Revenue bonds.
8. 14-8
Types and Ratings of Bonds
Types and Ratings of Bonds
LO 2 Identify various types of bond issues.
Corporate bond listing.
Company
Name
Interest rate paid as
a % of par value
Price as a % of par
Interest rate based on price
9. 14-9
Valuation of Bonds Payable
Valuation of Bonds Payable
LO 3 Describe the accounting valuation for bonds at date of issuance.
Issuance and marketing of bonds to the public:
Usually takes weeks or months.
Issuing company must
► Arrange for underwriters.
► Obtain SEC approval of the bond issue, undergo
audits, and issue a prospectus.
► Have bond certificates printed.
10. 14-10
Valuation of Bonds Payable
Valuation of Bonds Payable
LO 3 Describe the accounting valuation for bonds at date of issuance.
Selling price of a bond issue is set by the
supply and demand of buyers and sellers,
relative risk,
market conditions, and
state of the economy.
Investment community values a bond at the present value of
its expected future cash flows, which consist of (1) interest and
(2) principal.
11. 14-11
Interest Rate
Stated, coupon, or nominal rate = Rate written in the
terms of the bond indenture.
► Bond issuer sets this rate.
► Stated as a percentage of bond face value (par).
Market rate or effective yield = Rate that provides an
acceptable return commensurate with the issuer’s risk.
► Rate of interest actually earned by the bondholders.
Valuation of Bonds Payable
Valuation of Bonds Payable
LO 3 Describe the accounting valuation for bonds at date of issuance.
12. 14-12
How do you calculate the amount of interest that is actually
paid to the bondholder each period?
How do you calculate the amount of interest that is actually
recorded as interest expense by the issuer of the bonds?
Valuation of Bonds Payable
Valuation of Bonds Payable
LO 3 Describe the accounting valuation for bonds at date of issuance.
(Stated rate x Face Value of the bond)
(Market rate x Carrying Value of the bond)
13. 14-13
Bonds Sold At
Market Interest
6%
8%
10%
Premium
Par Value
Discount
Valuation of Bonds Payable
Valuation of Bonds Payable
LO 3
Assume Stated Rate of 8%
14. 14-14
Illustration: ServiceMaster Company issues $100,000 in
bonds, 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 11 percent.
LO 3 Describe the accounting valuation for bonds at date of issuance.
Valuation of Bonds Payable
Valuation of Bonds Payable
Illustration 14-1
15. 14-15
Illustration 14-1
LO 3 Describe the accounting valuation for bonds at date of issuance.
Valuation of Bonds Payable
Valuation of Bonds Payable
Illustration 14-2
16. 14-16
Illustration: Buchanan Company issues at par 10-year term
bonds with a par value of $800,000, dated January 1, 2012,
and bearing interest at an annual rate of 10 percent payable
semiannually on January 1 and July 1, it records the following
entry.
LO 3 Describe the accounting valuation for bonds at date of issuance.
Bonds Issued at Par on Interest Date
Bonds Issued at Par on Interest Date
Journal entry on date of issue, Jan. 1, 2012.
Cash 100,000
Bonds payable 100,000
17. 14-17
Bonds Issued at Par on Interest Date
Bonds Issued at Par on Interest Date
Journal entry to record first semiannual interest payment on
July 1, 2012.
Interest expense 40,000
Cash 40,000
Journal entry to accrue interest expense at Dec. 31, 2012.
Interest expense 40,000
Interest payable 40,000
($800,000 x .10 x ½)
LO 3 Describe the accounting valuation for bonds at date of issuance.
18. 14-18 LO 3 Describe the accounting valuation for bonds at date of issuance.
Bonds Issued at a Discount on Interest Date
Bonds Issued at a Discount on Interest Date
Illustration: Now assume Buchanan Company issues at 97,
10-year term bonds with a par value of $800,000, dated
January 1, 2012, and bearing interest at an annual rate of 10
percent payable semiannually on January 1 and July 1, it
records the issuance as follows.
Cash ($800,000 x .97) 776,000
Discount on bonds payable 24,000
Bonds payable 800,000
19. 14-19
Bonds Issued at a Discount on Interest Date
Bonds Issued at a Discount on Interest Date
Interest expense 41,200
Discount on bonds payable 1,200
Cash 40,000
At Dec. 31, 2012, Buchanan makes the following adjusting entry.
LO 3
Illustration: Buchanan records the first semiannual interest
payment and the bond discount on July 1, 2012 as follows.
Buchanan amortizes the bond discount using the straight-line
method.
Interest expense 41,200
Discount on bonds payable 1,200
Interest payable 40,000
20. 14-20 LO 3 Describe the accounting valuation for bonds at date of issuance.
Bonds Issued at a Premium on Interest Date
Bonds Issued at a Premium on Interest Date
Illustration: Now assume Buchanan Company issues at 103,
10-year term bonds with a par value of $800,000, dated
January 1, 2012, and bearing interest at an annual rate of 10
percent payable semiannually on January 1 and July 1, it
records the issuance as follows.
Cash ($800,000 x .103) 824,000
Premium on bonds payable 24,000
Bonds payable 800,000
21. 14-21
Bonds Issued at a Premium on Interest Date
Bonds Issued at a Premium on Interest Date
Interest expense 38,800
Premium on bonds payable 1,200
Cash 40,000
At Dec. 31, 2012, Buchanan makes the following adjusting entry.
LO 3
Illustration: Buchanan records the first semiannual interest
payment and the bond discount on July 1, 2012 as follows.
Buchanan amortizes the bond premium using the straight-line
method.
Interest expense 38,800
Premium on bonds payable 1,200
Interest payable 40,000
22. 14-22
Bond investors will pay the seller the interest accrued
from the last interest payment date to the date of issue.
On the next semiannual interest payment date, bond
investors will receive the full six months’ interest payment.
Valuation of Bonds
Valuation of Bonds
Bonds Issued between Interest Dates
LO 3 Describe the accounting valuation for bonds at date of issuance.
23. 14-23
Illustration: on March 1, 2012, Taft Corporation issues 10-
year bonds, dated January 1, 2012, with a par value of
$800,000. These bonds have an annual interest rate of 6
percent, payable semiannually on January 1 and July 1. Taft
records the bond issuance at par plus accrued interest as
follows.
LO 4 Apply the methods of bond discount and premium amortization.
Bonds Issued between Interest Dates
Bonds Issued between Interest Dates
Cash 808,000
Bonds payable 800,000
Interest expense ($800,000 x .06 x 2/12) 8,000
24. 14-24
On July 1, 2012, four months after the date of purchase, Taft
pays the purchaser six months’ interest, by making the following
entry.
Bonds Issued between Interest Dates
Bonds Issued between Interest Dates
Interest expense 24,000
Cash 24,000
LO 4 Apply the methods of bond discount and premium amortization.
25. 14-25
If, however, Taft issued the 6 percent bonds at 102, its March 1
entry would be:
Bonds Issued between Interest Dates
Bonds Issued between Interest Dates
Cash 824,000
Bonds Payable 800,000
Premium on Bonds Payable ($800,000 x .02) 16,000
Interest Expense 8,000
* [($800,000 x 1.02) + ($800,000 x .06 x 2/12)]
*
LO 4 Apply the methods of bond discount and premium amortization.
26. 14-26
Effective-interest method produces a periodic interest
expense equal to a constant percentage of the carrying value
of the bonds.
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Effective-Interest Method
Illustration 14-3
27. 14-27 LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Effective-Interest Method
Bonds Issued at a Discount
Illustration 14-4
Illustration: Evermaster Corporation issued $100,000 of 8%
term bonds on January 1, 2012, due on January 1, 2017, with
interest payable each July 1 and January 1. Investors require an
effective-interest rate of 10%. Calculate the bond proceeds.
30. 14-30 LO 4
Effective-Interest Method
Effective-Interest Method
Interest expense 4,614
Discount on bonds payable 614
Cash 4,000
Journal entry to record first payment and amortization of the
discount on July 1, 2012.
Illustration 14-5
31. 14-31 LO 4
Effective-Interest Method
Effective-Interest Method
Journal entry to record accrued interest and amortization of the
discount on Dec. 31, 2012.
Interest expense 4,645
Interest payable 4,000
Discount on bonds payable 645
Illustration 14-5
32. 14-32
Illustration: Evermaster Corporation issued $100,000 of 8%
term bonds on January 1, 2012, due on January 1, 2017, with
interest payable each July 1 and January 1. Investors require an
effective-interest rate of 6%. Calculate the bond proceeds.
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Effective-Interest Method
Bonds Issued at a Premium
Illustration 14-6
35. 14-35 LO 4
Effective-Interest Method
Effective-Interest Method
Interest expense 3,256
Premium on bonds payable 744
Cash 4,000
Journal entry to record first payment and amortization of the
premium on July 1, 2012.
Illustration 14-7
36. 14-36
What happens if Evermaster prepares financial statements at the
end of February 2012? In this case, the company prorates the
premium by the appropriate number of months to arrive at the
proper interest expense, as follows.
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Effective-Interest Method
Accrued Interest
Illustration 14-8
37. 14-37
Evermaster records this accrual as follows.
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Effective-Interest Method
Accrued Interest
Interest expense 1,085.33
Premium on bonds payable 248.00
Interest payable 1,333.33
Illustration 14-8
38. 14-38
Companies report bond discounts and bond premiums as a
direct deduction from or addition to the face amount of the
bond.
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Effective-Interest Method
Classification of Discount and Premium
39. 14-39
Unamortized bond issue costs are treated as a deferred
charge and amortized over the life of the debt.
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Effective-Interest Method
Cost of Issuing Bonds
Illustration: Microchip Corporation sold $20,000,000 of 10-
year debenture bonds for $20,795,000 on January 1, 2012
(also the date of the bonds). Costs of issuing the bonds were
$245,000. Microchip records the issuance of the bonds and
amortization of the bond issue costs as follows.
40. 14-40
Jan. 1,
2012
LO 4 Apply the methods of bond discount and premium amortization.
Effective-Interest Method
Effective-Interest Method
Cash 20,550,000
Unamortized bond issue costs 245,000
Premium on bonds payable 795,000
Bonds payable 20,000,000
Illustration: Microchip Corporation sold $20,000,000 of 10-year
debenture bonds for $20,795,000 on January 1, 2012 (also the
date of the bonds). Costs of issuing the bonds were $245,000.
Dec. 1,
2012
Bond issue expense 24,500
Unamortized bond issue costs 24,500
41. 14-41
Illustration: On January 1, 2005, General Bell Corp. issued at 97
bonds with a par value of $800,000, due in 20 years. It incurred bond
issue costs totaling $16,000. Eight years after the issue date, General
Bell calls the entire issue at 101 and cancels it. General Bell computes
the loss on redemption (extinguishment).
Extinguishment of Debt
Extinguishment of Debt
Illustration 14-10
LO 5 Describe the accounting for the extinguishment of debt.
42. 14-42
Extinguishment of Debt
Extinguishment of Debt
Bonds payable 800,000
Loss on redemption of bonds 32,000
Discount on bonds payable
14,400
Unamortized bond issue costs
9,600
Cash
808,000
General Bell records the reacquisition and cancellation of the bonds
as follows:
LO 5 Describe the accounting for the extinguishment of debt.
43. 14-43
Long-Term Notes Payable
Long-Term Notes Payable
Accounting is Similar to Bonds
A note is valued at the present value of its future interest
and principal cash flows.
Company amortizes any discount or premium over the
life of the note.
LO 6 Explain the accounting for long-term notes payable.
44. 14-44
BE14-12: Coldwell, Inc. issued a $100,000, 4-year, 10% note at
face value to Flint Hills Bank on January 1, 2013, and received
$100,000 cash. The note requires annual interest payments each
December 31. Prepare Coldwell’s journal entries to record (a) the
issuance of the note and (b) the December 31 interest payment.
Notes Issued at Face Value
Notes Issued at Face Value
(a) Cash 100,000
Notes payable 100,000
(b) Interest expense 10,000
Cash 10,000
($100,000 x 10% = $10,000)
LO 6 Explain the accounting for long-term notes payable.
45. 14-45
Notes Not Issued at Face Value
Notes Not Issued at Face Value
Issuing company records the difference between the face
amount and the present value (cash received) as
a discount and
amortizes that amount to interest expense over the life
of the note.
LO 6 Explain the accounting for long-term notes payable.
Zero-Interest-Bearing Notes
46. 14-46
BE14-13: Samson Corporation issued a 4-year, $75,000, zero-
interest-bearing note to Brown Company on January 1, 2013, and
received cash of $47,663. The implicit interest rate is 12%. Prepare
Samson’s journal entries for (a) the Jan. 1 issuance and (b) the
Dec. 31 recognition of interest.
LO 6
0% 12%
Cash Interest Discount Carrying
Date Paid Expense Amortized Amount
1/1/13 47,663
$
12/31/13 0 5,720
$ 5,720
$ 53,383
12/31/14 0 6,406 6,406 59,788
12/31/14 0 7,175 7,175 66,963
12/31/15 0 8,037 8,037 75,000
Zero-Interest-Bearing Notes
Zero-Interest-Bearing Notes
47. 14-47 LO 6 Explain the accounting for long-term notes payable.
Zero-Interest-Bearing Notes
Zero-Interest-Bearing Notes
BE14-13: Samson Corporation issued a 4-year, $75,000, zero-
interest-bearing note to Brown Company on January 1, 2013, and
received cash of $47,663. The implicit interest rate is 12%. Prepare
Samson’s journal entries for (a) the Jan. 1 issuance and (b) the
Dec. 31 recognition of interest.
Cash 47,664
Discount on Notes Payable 27,336
Notes Payable
75,000
(a)
Interest expense 5,720
Discount on Notes Payable
5,720
(b)
48. 14-48
Interest-Bearing Notes
Interest-Bearing Notes
BE14-14: McCormick Corporation issued a 4-year, $40,000, 5%
note to Greenbush Company on Jan. 1, 2013, and received a
computer that normally sells for $31,495. The note requires annual
interest payments each Dec. 31. The market rate of interest is 12%.
Prepare McCormick’s journal entries for (a) the Jan. 1 issuance and
(b) the Dec. 31 interest.
5% 12%
Cash Interest Discount Carrying
Date Paid Expense Amortized Amount
1/1/13 31,495
$
12/31/13 2,000
$ 3,779
$ 1,779
$ 33,274
12/31/14 2,000 3,993 1,993 35,267
12/31/15 2,000 4,232 2,232 37,499
12/31/16 2,000 4,501 2,501 40,000
LO 6
50. 14-50
Notes Issued for Property, Goods, or Services
Special Notes Payable Situations
Special Notes Payable Situations
LO 6 Explain the accounting for long-term notes payable.
(1) No interest rate is stated, or
(2) The stated interest rate is unreasonable, or
(3) The 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.
When exchanging the debt instrument for property, goods, or
services in a bargained transaction, the stated interest rate is
presumed to be fair unless:
51. 14-51
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 company must approximate an applicable interest
rate.
Special Notes Payable Situations
Special Notes Payable Situations
LO 6 Explain the accounting for long-term notes payable.
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.
Choice of Interest Rates
52. 14-52
Special Notes Payable Situations
Special Notes Payable Situations
LO 6 Explain the accounting for long-term notes payable.
Illustration: On December 31, 2012, Wunderlich Company 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, 2017, 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.
53. 14-53
Special Notes Payable Situations
Special Notes Payable Situations
LO 6 Explain the accounting for long-term notes payable.
Illustration 14-15
Illustration 14-16
54. 14-54
Special Notes Payable Situations
Special Notes Payable Situations
LO 6 Explain the accounting for long-term notes payable.
Wunderlich records issuance of the note on Dec. 31, 2012, in
payment for the architectural services as follows.
Building (or Construction in Process) 418,239
Discount on notes payable 131,761
Notes Payable
550,000
55. 14-55
Special Notes Payable Situations
Special Notes Payable Situations
LO 6 Explain the accounting for long-term notes payable.
Illustration 14-20
Payment of first year’s interest and amortization of the discount.
Interest expense 33,459
Discount on notes payable
22,459
Cash
56. 14-56
A promissory note secured by a document called a mortgage
that pledges title to property as security for the loan.
Mortgage Notes Payable
Mortgage Notes Payable
LO 6 Explain the accounting for long-term notes payable.
Most common form of long-term notes payable.
Payable in full at maturity or in installments.
Fixed-rate mortgage.
Variable-rate mortgages.
57. 14-57
Fair Value Option
Fair Value Option
LO 7 Describe the accounting for the 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 FASB believes that fair value measurement for financial
instruments, including financial liabilities, provides more
relevant and understandable information than amortized cost.
58. 14-58
Fair Value Option
Fair Value Option
LO 7 Describe the accounting for the fair value option.
Non-current liabilities are recorded at fair value, with unrealized
holding gains or losses reported as part of net income.
Fair Value Measurement
Illustrations: Edmonds Company has issued $500,000 of 6 percent
bonds at face value on May 1, 2012. Edmonds chooses the fair
value option for these bonds. At December 31, 2012, the value of
the bonds is now $480,000 because interest rates in the market
have increased to 8 percent.
Bonds Payable 20,000
Unrealized Holding Gain or Loss—Income
20,000
59. 14-59
Off-balance-sheet financing is an attempt to borrow
monies in such a way to prevent recording the
obligations.
Off-Balance-Sheet Financing
Off-Balance-Sheet Financing
LO 8 Explain the reporting of off-balance-sheet financing arrangements.
Different Forms:
► Non-Consolidated Subsidiary
► Special Purpose Entity (SPE)
► Operating Leases
60. 14-60
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 discloses.
Must disclose future payments for sinking fund requirements
and maturity amounts of long-term debt during each of the
next five years.
LO 9 Indicate how to present and analyze long-term debt.
Presentation and Analysis
Presentation and Analysis
Presentation of Long-Term Debt
61. 14-61
Analysis of Long-Term Debt
Two ratios that provide information about debt-paying ability
and long-run solvency are:
Total debt
Total assets
Debt to total
assets =
The higher the percentage of debt to total assets, the greater
the risk that the company may be unable to meet its maturing
obligations.
1.
1.
Presentation and Analysis
Presentation and Analysis
LO 9 Indicate how to present and analyze long-term debt.
62. 14-62
Analysis of Long-Term Debt
Two ratios that provide information about debt-paying ability
and long-run solvency are:
Income before income taxes and
interest expense
Interest expense
Times
interest
earned
=
Indicates the company’s ability to meet interest payments as
they come due.
2.
2.
Presentation and Analysis
Presentation and Analysis
LO 9 Indicate how to present and analyze long-term debt.
63. 14-63 LO 9 Indicate how to present and analyze long-term debt.
Illustration: Best Buy has total liabilities of $11,338 million,
total assets of $18,302 million, interest expense of $94 million,
income taxes of $802 million, and net income of $1,317 million.
We compute Best Buy’s debt to total assets and times interest
earned ratios
Illustration 14-21
Presentation and Analysis
Presentation and Analysis
64. 14-64
Usual Progression in Troubled-Debt Situations Illustration 14A-1
A troubled-debt restructuring involves one of two basic types of
transactions:
1. Settlement of debt at less than its carrying amount.
2. Continuation of debt with a modification of terms.
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
65. 14-65
Settlement of Debt
Can involve either a
transfer of noncash assets (real estate, receivables, or
other assets) or
the issuance of the debtor’s stock.
Creditor should account for the noncash assets or
equity interest received at their fair value.
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
66. 14-66
Illustration (Transfer of Assets): American City Bank loaned
$20,000,000 to Union Mortgage Company. Union Mortgage cannot
meet its loan obligations. American City Bank agrees to accept from
Union 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 Union Mortgage.
American City Bank (creditor) records this transaction as follows.
Land 16,000,000
Allowance for Doubtful Accounts 4,000,000
Note Receivable from Union Mortgage
20,000,000
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
67. 14-67
Illustration (Transfer of Assets): The bank records the real estate at
fair value. Further, it makes a charge to the Allowance
for Doubtful Accounts to reflect the bad debt write-off.
Union Mortgage (debtor) records this transaction as follows.
Note Payable to American City Bank 20,000,000
Loss on Disposal of Land 5,000,000
Land
21,000,000
Gain on Restructuring of Debt
4,000,000
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
68. 14-68
Illustration (Granting an Equity Interest): American City Bank agrees
to accept from Union Mortgage 320,000 shares of common stock ($10
par) that has a fair value of $16,000,000, in full settlement of the
$20,000,000 loan obligation. American City Bank (creditor) records this
transaction as follows.
Investment 16,000,000
Allowance for Doubtful Accounts 4,000,000
Note Receivable from Union Mortgage
20,000,000
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
69. 14-69
Illustration (Granting an Equity Interest): It records the stock as an
investment at the fair value at the date of restructure.
Union Mortgage (debtor) records this transaction as follows.
Note Payable to American City Bank 20,000,000
Common Stock
3,200,000
Additional Paid-in Capital
12,800,000
Gain on Restructuring of Debt
4,000,000
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
70. 14-70
Modification of Terms
A debtor’s serious short-run cash flow problems will lead it to
request 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.
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
71. 14-71
Illustration (Example 1—No Gain for Debtor): On December 31,
2011, Morgan National Bank enters into a debt restructuring agreement
with Resorts Development Company, which is experiencing financial
difficulties. The bank restructures a $10,500,000 loan receivable issued
at par (interest paid to date) by:
1. Reducing the principal obligation from $10,500,000 to
$9,000,000;
2. Extending the maturity date from December 31, 2011, to
December 31, 2015; and
3. Reducing the interest rate from 12% to 8%.
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
72. 14-72
Schedule Showing Reduction of Carrying Amount of Note
Illustration 14A-2
Notes Payable 356,056
Interest Expense 363,944
Cash
720,000
Dec. 31,
2012
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
73. 14-73
Schedule Showing Reduction of Carrying Amount of Note
Notes Payable 9,000,000
Cash
9,000,000
Dec. 31,
2015
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
Illustration 14A-2
74. 14-74
Creditor Calculations
Illustration 14A-3
Morgan National Bank (creditor)
Morgan National Bank records bad debt expense as follows
Bad Debt Expense 2,593,428
Allowance for Doubtful Accounts
2,593,428
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
75. 14-75
Creditor Calculations
Illustration 14A-4
In subsequent periods, Morgan National Bank reports interest
revenue based on the historical effective rate.
Cash 720,000
Allowance for Doubtful Accounts 228,789
Interest Revenue
948,789
Dec. 10, 2012
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
76. 14-76
Creditor Calculations
The creditor makes a similar entry (except for different
amounts debited to Allowance for Doubtful Accounts and
credited to Interest Revenue) each year until maturity. At
maturity, the company makes the following entry.
Cash 9,000,000
Allowance for Doubtful Accounts 1,500,000
Notes receivable
10,500,000
Dec. 10, 2015
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
77. 14-77
Illustration (Example 2—Gain for Debtor): Assume the facts in the
previous example except that Morgan National Bank reduces the
principal to $7,000,000 (and extends the maturity date to December 31,
2015, and reduces the interest from 12% to 8%). The total future cash
flow is now $9,240,000 ($7,000,000 of principal plus $2,240,000 of
interest), which is $1,260,000 ($10,500,000 $9,240,000) less than the
pre-restructure carrying amount of $10,500,000. Under these
circumstances, Resorts Development (debtor) reduces the carrying
amount of its payable $1,260,000 and records a gain of $1,260,000. On
the other hand, Morgan National Bank (creditor) debits its Bad Debt
Expense for $4,350,444.
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
78. 14-78
Illustration (Example 2—Gain for Debtor): Morgan National Bank
(creditor) debits its Bad Debt Expense for $4,350,444.
Illustration 14A-5
Illustration 14A-6
LO 10
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
79. 14-79
Illustration (Example 2—Gain for Debtor): Morgan National reports
interest revenue the same as the previous example—
Illustration 14A-7
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
80. 14-80
Illustration (Example 2—Gain for Debtor): Accounting for periodic
interest payments and final principal payment.
Illustration 14A-8
LO 10 Describe the accounting for a debt restructuring.
APPENDIX
APPENDIX 14A TROUBLED-DEBT RESTRUCTURINGS
81. 14-81
RELEVANT FACTS
Under GAAP, companies are permitted to use the straight-line
method of amortization for bond discount or premium, provided that
the amount recorded is not materially different than that resulting
from effective-interest amortization. However, the effective-interest
method is preferred and is generally used. Under IFRS, companies
must use the effective-interest method.
Under IFRS, companies do not use premium or discount accounts
but instead show the bond at its net amount. For example, if a
$100,000 bond was issued at 97, under IFRS a company would
record:
Cash 97,000
Bonds Payable 97,000
82. 14-82
RELEVANT FACTS
Under GAAP, bond issue costs are recorded as an asset. Under
IFRS, bond issue costs are netted against the carrying amount of the
bonds.
GAAP uses the term troubled-debt restructurings and has developed
specific guidelines related to that category of loans. IFRS generally
assumes that all restructurings will be accounted for as
extinguishments of debt.
83. 14-83
Under IFRS, bond issuance costs, including the printing costs and
legal fees associated with the issuance, should be:
a. expensed in the period when the debt is issued.
b. recorded as a reduction in the carrying value of bonds payable.
c. accumulated in a deferred charges account and amortized over
the life of the bonds.
d. reported as an expenses in the period the bonds mature or are
retired.
IFRS SELF-TEST QUESTION
84. 14-84
Which of the following is stated correctly?
a. Current liabilities follow non-current liabilities on the statement of
financial position under GAAP but follow current liabilities under IFRS.
b. IFRS does not treat debt modifications as extinguishments of debt.
c. Bond issuance costs are recorded as a reduction of the carrying value
of the debt under GAAP but are recorded as an asset and amortized to
expense over the term of the debt under IFRS.
d. Under GAAP, bonds payable is recorded at the face amount and any
premium or discount is recorded in a separate account. Under IFRS,
bonds payable is recorded at the carrying value so no separate
premium or discount accounts are used.
IFRS SELF-TEST QUESTION
![14-25
If, however, Taft issued the 6 percent bonds at 102, its March 1
entry would be:
Bonds Issued between Interest Dates
Bonds Issued between Interest Dates
Cash 824,000
Bonds Payable 800,000
Premium on Bonds Payable ($800,000 x .02) 16,000
Interest Expense 8,000
* [($800,000 x 1.02) + ($800,000 x .06 x 2/12)]
*
LO 4 Apply the methods of bond discount and premium amortization.](https://image.slidesharecdn.com/ch14-14thedition-250418170938-e866e5ce/85/Ch14-14th-edition-ppt-has-the-same-issue-25-320.jpg)
