1. Gabriela H. Schneider, CMA Northern Alberta Institute of Technology
INTERMEDIATE ACCOUNTING Seventh Canadian Edition KIESO, WEYGANDT, WARFIELD, YOUNG, WIECEK
Prepared by:
Gabriela H. Schneider, CMA Northern Alberta Institute of Technology 2

2. Long-Term Financial Liabilities
C H A P T E R 15
Long-Term Financial Liabilities

3. Learning Objectives
1. Describe the formal procedures associated with issuing long-term debt.
2. Identify various types of long-term debt.
3. Explain the initial measurement of bonds/notes at date of issuance.
4. Apply the methods of bond discount and premium amortization.

4. Learning Objectives
5. Value bonds and consideration in special situations.
6. Describe the accounting procedures for the extinguishment of debt.
7. Explain the issues surrounding off-balance-sheet financing arrangements.
8. Indicate how long-term debt is presented and analysed.

5. Learning Objectives
Account for impairments on notes and loans receivable. (Appendix 15A)
Distinguish between and account for debt restructurings resulting in extinguishment versus debt continuation. (Appendix 15A)

6. Long-Term Financial Liabilities
Measurement and Valuation
Bonds/Notes issued at par
Discounts and premiums
Deep discount/zero interest bonds/notes
Special situations
Issuance costs
Nature of Long-term Debt
Bonds
Notes payable
Types of bonds/notes
Bond ratings
Extinguishment/Derecognition
Repayment prior to maturity date
Exchange of debt instruments
Defeasance
Recognition and Presentation
Off-balance-sheet financing
Presentation Long-term debt
Note disclosures
Appendix 15A-Troubled Debt
Impairment of Loans/Notes receivable
Troubled debt restructuring
Perspectives

7. Issuing Long-Term Debt
Obligations not payable within one year, or one business operating cycle—whichever is longer
Examples include:
Bonds payable
Long-term notes
Mortgages
Pension liabilities
Lease liabilities
Often with restrictive covenants (terms) attached

8. Bonds Most common type of long-term debt
A bond indenture is a promise (by the lender to the borrower) to pay:
a sum of money at the designated date, and
periodic interest at a stipulated rate on the face value
A bond issue may be sold:
either through an investment banker, or
by private placement

9. Notes Payable Similar in nature to bonds
Require repayment of principal at a future date
Require periodic interest payments
Difference is notes do not normally trade on public markets
Accounting for bonds and notes is the same in many respects

10. Types of Long-Term Debt
Bearer bonds: are freely transferable by current owner
Secured and unsecured debt: secured by collateral (real estate, stocks)
Serial bonds: mature in instalments
Callable bonds: give issuer right to call and retire debt prior to maturity
Income and Revenue bonds: interest payments tied to some form of performance
Deep-discount bonds: little or no interest payments; sold at substantial discount
Convertible bonds: can be converted into other corporate securities for a specified time after issue

11. Bond Valuation: Determining Bond Prices
Price of a bond issue is determined by finding the present value (PV) of future cash flows:
the PV of the interest payment annuity (at the stated or coupon rate of interest), plus
the PV of the redemption (face, par) value,
both discounted at the market (yield) rate of interest in effect at issue date
When market rate  stated rate  bond sells at discount
When market rate  stated rate  bond sells at premium

12. Bond Valuation: Bond Price Calculation
Given:
Face value of bond issue: $100,000
Term of issue: 5 years
Stated interest rate: 9% per year, payable end of the year
Market rate of interest: 11%
Determine the issue price of the bonds.

13. Bond Valuation: Bond Price Calculation
Year 1
Year 2
Year 3
Year 4
Year 5
$9,000
Interest
annuity
$100,000
Face Value
Discount the future cash flows
using the market (yield)
rate of interest

14. Bond Valuation: Bond Price Calculation
Year 1
Year 2
Year 3
Year 4
Year 5
$9,000
Discount at market rate, 11%
$9,000 x
$33,263
$100,000
Discount at market rate, 11%
$100,000 x
$ 59,345
plus
=$92,608 is the issue price

15. Entries for the Issuance of Bonds
Sold at Par
Cash 1,000
Bonds Payable 1,000
Sold at a Premium
Cash 1,100
Premium on Bonds 100
Bonds Payable 1000
Sold at a Discount
Cash
Discount on Bonds
Bonds Payable 1000

16. Amortizing the Bond Premium/Discount
A premium effectively decreases the annual interest expense for the corporation
The discount effectively increases the annual interest expense for the issuing corporation

17. Amortizing the Bond Premium/Discount
Two methods available for amortization
Straight line
allocates the same amount of discount (or premium) to each interest period
Effective interest
allocates the discount or premium in increasing amounts over the bond term

18. Amortizing the Bond Premium/Discount
The total discount or premium amortized is the same under both methods
The straight-line method of amortizing is acceptable under GAAP only if the results are not materially different from those produced by using the effective interest method

19. Straight-Line Method—Discount
Given:
Face Value = $800, Discount = $24,000
Coupon Rate = 10% Bond Maturity = 10 years
The annual discount amortization =
$24,00010 years = $2,400
The entry to record the annual discount amortization would be:
Interest Expense 2,400
Discount on Bonds 2,400

20. Straight-Line Method—Premium
Given:
Face Value = $800, Premium = $24,000
Coupon Rate = 10% Bond Maturity = 10 years
The annual premium amortization =
$24,00010 years = $2,400
The entry to record the annual premium amortization would be
Premium on Bonds 2,400
Interest Expense 2,400

21. Effective Interest Method
Considers the change in interest costs as the life of the bonds increases
Uses the market rate at the date of sale to calculate the amortization amount over the life of the bond

22. Effective Interest Method Calculation

23. Effective Interest Method
The journal entry to record the bond issuance is:
Cash ,278
Discount on Bonds Payable 7,722
Bonds Payable 100,000

24. Effective Interest Method
The journal entry for first semi-annual payment is:
Bond Interest Expense 4,614
Discount on Bonds Payable
Cash ,000

25. Effective Interest Method Calculation

26. Effective Interest Method
The journal entry to record the bond issuance is:
Cash ,530
Premium on Bonds Payable ,530
Bonds Payable ,000

27. Effective Interest Method
The journal entry for first semi-annual payment is:
Bond Interest Expense 3,256
Premium on Bonds Payable
Cash ,000

28. Balance Sheet Presentation
Discount on bonds payable is a contra account:
Bonds Payable (face value): $ XXX
Less: Unamortized Discount : ($ XX)
Bonds Payable (carrying value): $ XXX
Premium on bonds payable is an adjunct account:
Bonds Payable (face value) : $ XXX
Add: Unamortized Premium : $ XX
Bonds Payable (carrying value): $ XXX

29. Bonds Issued Between Interest Dates
Interest, for the period between the issue date and the last interest date, is collected with the issue price of the bonds
At the specified interest date, interest is paid for the entire interest period (semi-annual or annual)
Premium or discount is also amortized from the date of sale of bonds to the end of the interest period

30. Deep Discount/Zero-Interest-Bearing Bonds/Notes
If issued for cash PV = cash received by issuer
Interest rate is the rate that causes the PV (of future cash flows) to equal cash received
Difference between face amount and PV is the discount
Amortized over life of the note

31. Deep Discount/Zero-Interest-Bearing Bonds/Notes
Example: Jeremiah Company
10,000 3-year zero-interest-bearing note issued
Cash received at issuance: $
Discount equal to: $10,000 Less: Cash , $ 2,278
Implied interest rate therefore: 9%

32. Note Issued for Cash and Other Rights
Sometimes, an issuer (borrower) of a note payable with below-market interest gives the recipient of the note (lender) additional buying rights
Then, the borrower is also the seller and the lender is also the buyer
The borrower must record both:
a discount on the note, and
unearned revenue
Example

33. Note Issued for Cash and Other Rights
Given:
Issuer gives a 5 year, $100,000 note payable to recipient on January 1st
The note is zero-interest bearing
The market rate is 10%
Recipient company has special rights to buy $500,000 of merchandise from issuer company at below market prices
Journalize in issuer’s books

34. Note Issued for Cash and Other Rights
Books of the Issuer:
Cash ,000
Discount on Note Payable ,908
Note Payable ,000
Unearned Revenue ,908
PV of 100,000 at 10%, (n=5) = 62,902
Discount: (100,000 – 62,902) = 37,908
The discount is amortized over the term of note
The (unearned) revenue is recognized as sales are made

35. Note Issued for Cash and Other Rights
Assume that the recipient purchased $50,000 worth of merchandise from the issuer.
The journal entry to record that revenue:
Cash (or A/R: Recipient) 46,209
Unearned Revenue 3,791
Sales Revenue 50,000
(Revenue recognized = $ 37,908 x ( $50,000/$500,000)
= $3,791

36. Notes Issued for Property, Goods, and Services
Notes issued and payment is asset other than cash
PV of debt at fair value of the property, goods or services if:
No stated interest rate
Stated interest rate is unreasonable
Material difference exists between the stated value of note and market value of the asset being exchanged
Any discount or premium amortized over life of the note

37. Bond Issue Costs Those costs incurred to physically issue the bonds
e.g., costs paid to the broker, legal costs
Not part of any premium or discount
Debited to a deferred charge
Amortized over the life of the bond, using straight line method

38. Extinguishment of Debt
When debt is paid out prior to maturity
Reacquisition, requires gain or loss to be recorded
May be for full amount of debt, or a portion
At the time of reacquisition all outstanding premiums, discounts, and issue costs are amortized to the date of reacquisition
Any gain or loss from the reacquisition is reported with other capital gains/losses (does not qualify as an extraordinary item)

39. Extinguishment of Debt
Generally, when bonds are reacquired they are cancelled
If they are not cancelled, they are considered treasury bonds
May be resold or subsequently cancelled
Treasury bonds are reported as a deduction from Bonds Payable on the balance sheet
Refunding of bonds: when a bond issue is called in and replaced with a new issue (at a lower rate of interest)

40. Extinguishment of Debt: Example
Given:
Existing debt: $800,000
Called and canceled at: $808,000
Unamortized discount: $ 14,400
Unamortized bond issue costs: $ 9,600
Note: Both discount and bond issue costs have been amortized up to the date of cancellation of debt.
Give the journal entry for the extinguishment.

41. Extinguishment of Debt: Example
Bonds Payable 800,000
Loss on Redemption of Bonds ,000
Discount on Bonds ,400
Unamortized Bond Issue Costs ,600
Cash ,000

42. Defeasance
Sufficient funds set aside (i.e. trust) to pay off principal and interest on the debt
“Legal defeasance” occurs when the debt holder no longer has claim on the assets of the original issuer
Trust held responsible for repayment
“In-substance defeasance” occurs when the debt holder is not aware of the trust arrangement
CICA Handbook, Section 3855 (proposed) will deal with whether or not this is deemed an extinguishment of debt

43. Off-Balance-Sheet Financing
Off-balance-sheet financing represents borrowing arrangements that are not recorded
The amount of debt reported in the balance sheet does not include such financing arrangements
The objective is to improve certain financial ratios (such as debt-equity ratio)
In project financing arrangements, companies form a new entity and borrow through that entity
The debt appears on the books of the new entity, and not on those of the parent companies

44. Off-Balance-Sheet Financing
Different forms of off-balance-sheet financing
Non-consolidated subsidiaries
Special Purpose Entities (SPE) or Variable Interest Entities (VIE)
Operating Leases

45. Presentation of Long-Term Debt
Current versus long-term
Debt to be refinanced treated as long-term
Debt versus equity
Dependent on nature of the instrument
Classification of Discount and Premium
Discount – contra account
Premium – adjunct account
Both reported within liability

46. Note Disclosure Include: Nature of the liability Maturity date
Interest rate
Call provision
Conversion privileges
Any restrictions imposed
Assets designated or pledged as security

47. Long-Term Debt Analysis
Debt to Total Assets: Total debt
Total assets
Level or percentage of assets that is financed through debt
Times Interest Earned:
Income before income taxes and interest
Interest Expense
Measures ability to meet interest payments

48. COPYRIGHT
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