A CCOUNTING FOR N ONCURRENT L IABILITIES

KEVIN PHILIP D. GAYAO, CPA, RCA, CAT

A CCOUNTING FOR L ONG -T ERM N OTES P AYABLE

INTEREST-BEARING

Overview

Initial Recognition
Issued for CASH

Initial Recognition
Issued for PROPERTY,
GOODS OR SERVICES
(Asset other than cash /
Expense)

NON-INTEREST-BEARING

@ Market rates /
Realistic (Reasonable) interest rates
A note with a stated interest at
existing market rates for similar
notes (i.e. note is issued at FACE
VALUE)

@ Other than market rates /

Unrealistic (Unreasonable) interest rates
A note with a stated rate other than the
market rate for similar notes (i.e. note is
issued at a PREMIUM or DISCOUNT)

At face value

At the present value of future cash flows (PV of FCF) using the market rate

Entry:
Dr. Cash (@FACE VALUE)
Cr. Notes Payable

Entry: Net method

Dr. Cash (@ amount received)
Cr. Notes Payable (@ PV of FCF)

Entry:
Dr. Asset / Expense (@ FAIR VALUE)
Cr. Notes Payable

Hierarchy of Measurement of the Note:

1. FAIR VALUE of the ASSET or EXPENSE; or
2. FAIR VALUE of the NOTES PAYABLE (i.e. info about the actual market interest rate
of the note is available, or can be imputed)
3. PV of FCF using prevailing market rate on SIMILAR note

A note without a stated rate, or zerointerest-bearing notes

Entry: Net Method

Dr. Asset / Expense
Cr. Notes Payable
* Under the GROSS METHOD (U.S. GAAP), the Notes Payable account is always carried
at the face value of the note and a premium or discount on the note is created.
* The difference between accounting for notes issued with unrealistic interest rates
and non-interest-bearing rates lies in the computation of the present values:
ACC4: Financial Accounting and Reporting 2

Accounting for Noncurrent Liabilities

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Notes on Initial
Recognition
(NET vs. GROSS Method)

PV Principal (PV of 1)
xx PV Principal and Interest (PV of 1) xx
PV Interest payments (PV of an OA) xx Interest is implicitly paid at maturity for
PV FCF
xx non-interest-bearing notes.
Accounting for interest

Interest paid = Interest expense

Interest paid Interest expense

No apparent PAYMENT of interest;

However, accrue interest EXPENSE

Entry:
Dr. Interest expense
Cr. Cash

Entry: Premium Net (Gross) Method

Dr. Interest expense
Dr. Notes Payable (or Premium on N/P)
Cr. Cash (Stated rate x FACE Value)

Entry: Discount Net (Gross) Method

Dr. Interest expense
Cr. Notes Payable (or Discount on N/P)

Entry: Discount Net (Gross) Method

Dr. Interest expense
Cr. Cash (Stated rate x FACE Value)
Cr. Notes Payable (or Discount on N/P)
Settlement

1. Record the last interest payment

2. Record the settlement of the note

1. Record the last interest expense,

payment of the nominal interest and
amortization of the discount or
premium
2. Record the settlement of the note

* There can be NO PREMIUM on noninterest-bearing notes.

1. Record the last interest expense

2. Record the settlement of the note

ACC4: Financial Accounting and Reporting 2

Accounting for Noncurrent Liabilities

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Other Notes:
Periodic Payment of Principal and Interest for Non-interest bearing Notes In completing the amortization table, include a column for principal payments.
Alternatively, you may modify the interest payment column to include principal payment (i.e. interest plus principal payment). D P E A B
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A CCOUNTING FOR B ONDS P AYABLE

NOTES
1. Issuance at a
Discount

2. Issuance at a
Premium

ACCOUNTING TREATMENT

FACE value > ISSUE price (quoted at LESS than 100)

STATED interest rate < EFFECTIVE interest rate
Interest PAID < Interest EXPENSE
FACE value < ISSUE price (quoted at MORE than
100)

STATED interest rate > EFFECTIVE interest rate

Interest PAID > Interest EXPENSE
3. Issuance in Between
Interest Payment
Dates

Entry: (NET method)

Dr. Cash
Cr. Bonds Payable*
*PV FCF using effective interest rate
Entry: (NET method)
Dr. Cash
Cr. Bonds Payable*
*PV FCF using effective interest rate

STATED Interest must be accrued from the last

ISSUANCE:
Entry:
interest payment date.
Dr. Cash
This is paid IN ADVANCE by the bond holder, and is Cr. Bonds Payable
computed to arrive at the CASH PROCEEDS (Issue
Cr. Interest EXPENSE (accrued
Price + Accrued Interest)
NOMINAL interest)
INITIAL INTEREST PAYMENT:
Entry:
Dr. Interest Expense (FULL NOMINAL
interest)
Cr. Cash

Bond issue costs are amortized over the life of the

bonds. This requires the re-computation of the
EFFECTIVE or YIELD interest rate. Bond issue costs
are:

ACC4: Financial Accounting and Reporting 2

Entry:
Dr. Premium (or Discount) on Bonds
Cr. Cash (amount paid for BIC)

ISSUANCE
Entry: (Alternative)
Dr. Cash
Cr. Bonds Payable
Cr. Interest PAYABLE (accrued
NOMINAL interest)
INITIAL INTEREST PAYMENT:
Entry:
Dr. Interest Expense (ACTUAL
NOMINAL interest)
Dr. Interest Payable (accrued
NOMINAL interest)
Cr. Cash
Refer to notes on INTERPOLATION
at the end of this hand-out for
further guidance

Accounting for Noncurrent Liabilities

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4. Bond Issue Costs

(BIC)

Entry: (GROSS Method)

Dr. Cash (Cash received / PV FCF)
Dr. Discount on Bonds
Cr. Bonds Payable (@FACE value)
Entry: (GROSS Method)
Dr. Cash (Cash received / PV FCF)
Cr. Bonds Payable (@FACE value)
Cr. Premium on Bonds

o LUMPED to any DISCOUNT; or

o OFFSET against any PREMIUM
to compute for the EFFECTIVE ISSUE PRICE

The effective interest is imputed using

INTERPOLATION
5. Amortization of
Discount on Bonds

BIC increases the effective interest rate

IFRS requires the use of the EFFECTIVE-INTEREST
METHOD of amortizing discount on bonds
payable.

Amortization of a discount, INCREASE interest

EXPENSE

Entry: (NET method)

Dr. Interest Expense (CV x EIR)
Cr. Cash (FV x SIR)
Cr. Bonds Payable (discount
amortization)

Entry: (GROSS Method)

Dr. Interest Expense (CV x EIR)
Cr. Cash (FV x SIR)
Cr. DISCOUNT on Bonds (discount
amortization)

Entry: (NET method)

Dr. Interest Expense (CV x EIR)
Dr. Bonds Payable (premium
amortization) ----> same amount--->
Cr. Cash (FV x SIR)

Entry: (GROSS Method)

Dr. Interest Expense (CV x EIR)
Dr. PREMIUM on Bonds (premium
amortization)
Cr. Cash (FV x SIR)

The carrying value of the bond INCREASES towards

the FACE value every time the discount is
amortized.

Discount amortization also INCREASES every

period
6. Amortization of
Premium on Bonds

IFRS requires the use of the EFFECTIVE-INTEREST

METHOD of amortizing premium on bonds
payable.

Amortization of a premium, DECREASES interest

EXPENSE

The carrying value of the bond DECREASES

towards the FACE value every time the discount is
amortized.

Premium amortization also DECREASES every

period

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ACC4: Financial Accounting and Reporting 2

Accounting for Noncurrent Liabilities

7. Adjusting Entries at
Yearend (Bond
interest payment
dates do not
coincide with the
Reporting dates)

8. Bond Retirement AT
maturity date

Preparation of an adjusting entry is required to

update the balance of the BONDS PAYABLE
(including any DISCOUNT or PREMIUM) and the
INTEREST EXPENSE and PAYABLE at yearend.

Normal ordinary procedures are followed for the

retirement of bonds at maturity date

Entry to record accrued interest

(NET method)
Premium:
Dr. Interest Expense (pro-rated)
Dr. Bonds Payable (pro-rated)
Cr. Interest Payable (pro-rated)

Entry to record accrued interest

(GROSS method)
Premium:
Dr. Interest Expense (pro-rated)
Dr. PREMIUM on Bonds (pro-rated)
Cr. Interest Payable (pro-rated)

Discount:
Dr. Interest Expense(pro-rated)
Cr. Interest Payable (pro-rated)
Cr. Bonds Payable (pro-rated)

Discount:
Dr. Interest Expense (pro-rated)
Cr. Interest Payable (pro-rated)
Cr. DISCOUNT on Bonds(pro-rated)

1. Update LAST interest expense, and any premium or discount

amortization
2. Record the settlement of the bonds
Entry: - RETIRMENT
Dr. Bonds Payable
Cr. Cash

9. Bond Settlement
BEFORE maturity
date

Important: ACCRUE INTEREST and UPDATE the

CARRYING VALUES of the BONDS first; then
recognize the settlement of the bonds including
any GAIN or LOSS for the settlement of the
BONDS.

SETTLEMENT/RETIREMENT PRICE > BOND

CARRYING VALUE = LOSS

SETTLEMENT/RETIREMENT PRICE < BOND

ACC4: Financial Accounting and Reporting 2

Entry: (NET) UPDATE OF CVs

Dr. Interest Expense
Dr. Premium on Bonds
Cr. Cash
Cr. Discount on Bonds

Entry: (NET) - SETTLEMENT

Dr. Bonds Payable (Carrying Value)
Dr. Loss on Settlement
Cr. Cash
Cr. Gain on Settlement

Entry: (GROSS) - SETTLEMENT

Dr. Bonds Payable (FACE Value)
Dr. Premium on Bonds
Dr. Loss on Settlement
Cr. Cash
Cr. Gain on Settlement
Cr. Discount on Bonds

Accounting for Noncurrent Liabilities

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CARRYING VALUE = GAIN

Entry: (NET) UPDATE OF CVs

Dr. Interest Expense
Dr. Bonds Payable (Premium)
Cr. Cash
Cr. Bonds Payable (Discount)

Settlement / retirement price of the BONDS

Carrying value of the bonds
LOSS (GAIN) on Early Settlement of Bonds

xx
xx
xx

10. Bond Refunding /

Refinancing

Issuance of NEW BONDS PAYABLE, the proceeds of

11. Accounting for

SERIAL Bonds

The principal amount for the bonds is paid in a

which is used to pay an OUTSTANDING BONDS

PAYABLE.

Compound Entry (NET)

Dr. Interest Expense
Dr. Bonds Payable (Carrying Value)
Dr. Loss on Settlement
Cr. Cash (Settlement P + Interest)
Cr. Gain on Settlement

Compound Entry (NET)

Dr. Interest Expense
Dr. Bonds Payable (FACE Value)
Dr. Premium on Bonds
Dr. Loss on Settlement
Cr. Cash (Settlement P + Interest)
Cr. Gain on Settlement
Cr. Discount on Bonds

1. Record accrued interest and update amortization.

2. Retire OUTSTANDING BONDS PAYABLE; recognize any GAIN/LOSS on
settlement (refer to No. 8 or No. 9)
3. Record the NEW BONDS PAYABLE. (refer to No. 1 or No. 2)
In completing the amortization table, include a column for principal
payments. Alternatively, you may modify the interest payment column to
include principal payment (i.e. interest plus principal payment). D P E A B

series of INSTALLMENT, together with the

INTEREST.

The computation of the ISSUE PRICE of the bond

involves the use of multiple computation of the PV
FCF using the PV factor for single sum payments.

Entry: (NET) PERIODIC INTEREST

Dr. Interest Expense
Dr. Bonds Payable (Premium)
Cr. Cash
Cr. Bonds Payable (Discount)

Entry: (NET) PERIODIC INTEREST

Dr. Interest Expense
Dr. Premium on Bonds
Cr. Cash
Cr. Discount on Bonds

Entry: (NET) PRINCIPAL PAYMENT

Dr. Bonds Payable
Cr. Cash

Entry: (NET) PRINCIPAL PAYMENT

Dr. Bonds Payable
Cr. Cash

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ACC4: Financial Accounting and Reporting 2

Accounting for Noncurrent Liabilities

COMPOUND FINANCIAL INSTRUMENTS

Bonds with Share

Warrants / Stock
Rights

This is a special type of bond issuance wherein the

bondholder is given the RIGHT TO PURCHASE
ADDITIONAL SHARES of the company.

The holder acquires a COMPOUND FINANCIAL

INSTRUMENT:
1. Right to receive interest and principal on the
bonds
2. Right to ACQUIRE ORDINARY SHARES of the
issuer at a given price within a certain time period

The RIGHT or WARRANT should be separately

accounted for (BIFURCATION) using the RESIDUAL
approach / method.

Procedures
(1) Identify the TOTAL ISSUE PRICE of the bond issuance or PROCEEDS from
the bond issuance. EXCLUDE any ACCRUED INTEREST
(2) Determine the
a. FAIR MARKET VALUE of similar BONDS WITHOUT the Right or
Warrant; OR if not determinable
b. PV FCF using an INTEREST RATE of SIMILAR DEBT instruments
WITHOUT the rights
(3) The difference between the total issue price and FMV (or PV FCF) shall
be allocated to the rights / warrants (RESIDUAL AMOUNT)
Total Issue Price
FMV of Bonds w/o warrants
Amount allocated to the Warrants

Entry: (NET Method) - ISSUANCE

Dr. Cash
Cr. Bonds Payable (net)
Cr. Share Warrants Outstanding
(Share Premium-Warrants)

Exercise of the
Convertible Bonds

In exercising the right, the bondholder pays for the

ACC4: Financial Accounting and Reporting 2

Entry: (GROSS Method) - ISSUANCE

Dr. Cash
Dr. Discount on Bonds
Cr. Bonds Payable (FACE value)
Cr. Premium on Bonds
Cr. Share Warrants Outstanding
(Share Premium-Warrants)

Entry: EXERCISE
Dr. Cash
Dr. Share Warrants Outstanding
Cr. Ordinary Shares
Cr. Share Premium

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predetermined price which is usually lower than

the prevailing market price for a given number of
shares.

xx
xx
xx ---->Residual amount

Accounting for Noncurrent Liabilities

Convertible Bonds

These are bonds that are CONVERTIBLE TO

Procedures
(1) Identify the TOTAL ISSUE PRICE of the bond issuance or PROCEEDS from
the bond issuance. EXCLUDE any ACCRUED INTEREST
(2) Determine the
a. FAIR MARKET VALUE of similar BONDS WITHOUT the CONVERSION
PRIVILEGE; OR if not determinable
b. PV FCF using an INTEREST RATE of SIMILAR DEBT instruments
WITHOUT the CONVERSION PRIVILEGE
(3) The difference between the total issue price and FMV (or PV FCF) shall
be allocated to the CONVERSION PRIVILEGE (RESIDUAL AMOUNT)

ORDINARY SHARES at a given exchange rate.

The holder acquires: (COMPOUND FINANCIAL

INSTRUMENT)
1. Right to receive interest and principal on the
bonds
2. Right to acquire CONVERT the bonds into
ORDINARY SHARES

The CONVERSION RIGHT or PRIVILEGE must be

separately accounted for (BIFURCATION) using the
RESIDUAL approach

Total Issue Price

xx
FMV of Bonds w/o Conversion privilege
xx
Amount allocated to the Conversion privilege xx ---->Residual amount
Entry: (NET Method) ISSUANCE
Dr. Cash
Cr. Bonds Payable (net)
Cr. Share Premium CONVERSION
PRIVILEGE

Conversion of
Convertible Bonds

The bondholder ops to convert the bonds to

equity holdings.

NO GAIN OR LOSS will be recorded for the

conversion. It is treated as an ordinary issuance of
shares in exchange for the carrying balance of the
bonds.

Entry: (GROSS Method) - ISSUANCE

Dr. Cash
Dr. Discount on Bonds
Cr. Bonds Payable (FACE value)
Cr. Premium on Bonds
Cr. Share Premium CONVERSION
PRIVILEGE

Exercise of Conversion Privilege

(1) Accrue INTEREST EXPENSE and update carrying values of BONDS
PAYABLE, and any DISCOUNT or PREMIUM
(2) Record the de-recognition of the bonds and recognize the CONVERSION
of the bonds
Entry: (NET Method) CONVERSION Entry: (NET Method) CONVERSION
Dr. Bonds Payable (CV)
Dr. Bonds Payable (CV)
Dr. Share Premium Conversion
Dr. Share Premium Conversion
Privilege
Privilege
Cr. Ordinary Share Capital
Cr. Ordinary Share Capital
Cr. Share Premium Ordinary Share Cr. Share Premium Ordinary Share
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ACC4: Financial Accounting and Reporting 2

Accounting for Noncurrent Liabilities

Retirement of
Convertible Bonds
before Maturity

This poses an accounting issue because the

RETIREMENT / SETTLEMENT PRICE would be
ALLOCATED to the LIABILITY component and the
EQUITY component.

The GAIN or LOSS for the settlement of the

LIABILITY component and the EQUITY component
should be SEPARATELY accounted for.

(1) Accrue INTEREST EXPENSE and update carrying values of BONDS

PAYABLE, and any DISCOUNT or PREMIUM
(2) Determine the total SETTLEMENT / RETIREMENT PRICE
(3) ALLOCATE the total settlement price using the RESIDUAL approach:
Total settlement / retirement price
Settlement / retirement price of the BONDS W/O the
CONVERSION privilege (based on FMV w/o the CP)*
Settlement / retirement price of the CONVERSION privilege

xx
xx
xx

*If the FMV of the BONDS W/O the CONVERSION privilege is not available,
make use of the PVFCF using the effective interest rate for similar debt
instrument without the conversion privilege.
(4) Compute for the GAIN or LOSS on the retirement of the BONDS:
Settlement / retirement price of the BONDS W/O the
CONVERSION privilege (based on FMV w/o the CP)
xx
Carrying value of the bonds
xx
LOSS (GAIN) on Early Settlement of Bonds
xx
Settlement / retirement price of the CONVERSION privilege
Carrying value of the equity
LOSS (GAIN) on Cancellation of CONVERSION privilege (EQUITY)

xx
xx
xx

ACC4: Financial Accounting and Reporting 2

Accounting for Noncurrent Liabilities

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(5) Record the settlement of the bonds (refer to No. 9) and the
CONVERSION privilege (equity portion)
Entry:
Dr. Bonds Payable
Dr. Premium on Bonds
Dr. Loss on Retirement of Bonds
Dr. Share Premium Conversion Privilege
Cr. Cash
Cr. Share Premium Unexercised Conversion Privilege
Cr. Discount on Bonds
Cr. Gain on Retirement of Bonds

INTERPOLATION
Pro-forma computations:

FACE value
Less: DISCOUNT
Add: PREMIUM
Less: BIC
EFFECTIVE ISSUE PRICE
1.
2.
3.
4.
5.

Impute an interest rate close to the stated or nominal interest.

Compute the PV FCF using the first imputed interest, and then compare it with the effective issue price.
Once again, impute another interest rate, based on the comparison made with the effective issue price.
Compute the PV FCF using the second imputed interest.
If the effective issue price is within the range of the PV FCF of first and subsequent interest rates, then INTERPOLATE (Ratio and proportion)
(

)
(

( )
)

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ACC4: Financial Accounting and Reporting 2

10

Accounting for Noncurrent Liabilities