COLLEGE OF SCIENCE AND TECHNOLOGY

Cagamutan Norte, Leganes, Iloilo - 5003

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Email Address : [email protected]

COO – FORM 12
SUBJECT TITLE: INTERMEDIATE ACCOUNTING 2
INSTRUCTOR: REYMAR N. SOMODIO, CPA
SUBJECT CODE: FA4

MIDTERM MODULE

Topic 1: BONDS PAYABLE

Objectives:

At the end of this topic, students are expected to:

1. Understand the nature and purpose of a bond.

2. Identify the types of bonds.
3. Know the measurement of bonds payable.
4. Understand the concept of bond premium and bond discount.
5. Describe the methods of amortizing bond premium and bond discount.

NOTES:

1. Definition

A bond is a formal unconditional promise, made under seal, to pay a specified sum of money at a
determinable future date, and to make periodic interest payment at a stated rate until the principal
sum is paid.

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

2. Term and Serial Bonds

Term bonds are bonds with a single date of maturity.

Serial bonds are bonds with a series of maturity dates instead of a single one.

3. Initial Measurement

PFRS 9, paragraph 5.1.1, provides that bonds payable not designated at fair value through profit or
loss shall be measured initially at fair value minus transaction costs that are directly attributable to
the issue of the bonds payable.

General: FV minus Transaction Cost

Exemption: if designated at FVPL, Transaction cost shall be expensed outright.

The fair value of the bonds payable is equal to the present value of the future cash payments to
settle the bond liability.

4. Subsequent Measurement of Bonds Payable

PFRS 9, paragraph 5.3.1, provides that after initial recognition, bonds payable shall be measured
either:

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 a. At amortized cost using the effective interest method
b. At fair value through profit or loss

5. Accounting for Issuance of Bonds

There are two approaches in accounting for the authorization and iissuance of bonds, namely:

a. Memorandum Approach
b. Journal Entry Approach

6. Memorandum Approach

Authorization of shares:
NO JOURNAL ENTRY – Memo
entry

Sale of bonds at face amount:

Cash xx
Bonds Payable xx

7. Journal Entry Approach

Authorization of the bonds:

Unissued Bonds Payable xx
Authorized Bonds Payable
xx

Sale of bonds at face amount:

Cash xx
Unissued Bonds Payable xx

8. Issuance of Bonds at Premium

If the sale price is more than the face amount of the bonds, the bonds are said to be sold at premium.

The bond premium is amortized over the life of the bonds and credited to interest expense.

9. Issuance of Bonds at Premium

If the sales price of the bonds is less than the face amount, the bonds are said to be sold at a
discount.

The bond discount is amortized as loss over the life of the bonds and charged to interest expense.

10. Presentation of Discount and Premium

The discount on bond payable is a deduction from the bond payable and the premium on bond
payable is an addition to the bond payable.

11. Effective Interest Method

PFRS 9 requires that discount on bonds payable, premium on bonds payable shall be amortized
using the effective interest method.

Nominal Rate is the coupon or stated rate. Effective rate is the yield or market rate.
Under the effective interest method, the effective interest expense is determined by multiplying the
effective rate by the carrying amount of the bonds.

The effective interest is then compared wit the nominal interest. The difference is the premium or
discount amortization.

END OF TOPIC 1

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Topic 2: COMPOUND FINANCIAL INSTRUMENT

Objectives:

At the end of this topic, students are expected to:

1. Define a financial instrument.

2. Describe a financial liability and an equity instrument.
3. Understand the nature of a compound financial instrument.
4. Identify common forms of compound financial instrument.
5. Know the accounting for a compound financial instrument.

NOTES:

1. Financial Instrument

PAS 32, paragraph 11, defines a financial instrument as any contract that gives rise to both a
financial asset of one entity and a financial liability or equity instrument of another entity.

2. Characteristics

a. There must be a contract.

b. There are at least two parties to the contract.
c. The contract shall give rise to a financial liability or equity instrument of another party.

3. Financial Liability

A financial liability is any liability that is a contractual obligation:

a. To deliver cash or other financial asset to another entity.

b. To exchange financial instruments with another entity under conditions which are potentially
unfavorable.

Examples are trade accounts liability, notes payable, loans payable and bonds payable.

4. Equity Instrument

An equity instrument is any contract that evidences a residual interest in the assets of an entity after
deducting all of the liabilities. It includes ordinary share capital, preference share capital and
warrants or options.

5. Compound Financial Instrument

PAS 32, paragraph 28, defines a compound financial instrument as a financial instrument that
contains both a liability and an equity element from the perspective of the issuer.

Common examples are bonds payable issued with share warrants and convertible bonds payable.

6. Accounting for Compound Instrument

If the financial instrument contains both a liability and an equity component, PAS 32 mandates that
such components shall be accounted for separately.

The approach in accounting for a compound financial instrument is to apply “split accounting” which
means that the consideration received from the issuance of the compound financial instrument shall
be allocated between the liability and equity components.

The fair value of the liability component is first determined and the residual amount is allocated to
the equity component.

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7. Bonds Payable Issued with Share Warrants

When the bonds are sold with share warrants, the bondholders are given the right to acquire shares
of the issuing entity at a specified price at some future time.

Whether detachable or nondetachable, the warrants have a value and therefore shall be accounted
for separately.

8. Allocation of Issue Price

The bonds are assigned an amount equal to the “market value of the bonds ex-warrants” regardless
of the market value of the warrants.

The residual amount or remainder of the issue price shall then be allocated to the warrants.

9. Convertible Bonds

Convertible bonds are those which give the holders the right to convert their bond holdings into
share capital or other securities of the issuing entity within a specified period of time.

END OF TOPIC 2

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Topic 3: NOTES PAYABLE

Objectives:

At the end of this topic, students are expected to:

1. Define a promissory note.

2. Know the initial measurement of note payable.
3. Understand the subsequent measurement of note payable.
4. Know the accounting for note payable solely for cash, interest-bearing note payable and noninterest-
bearing note payable.

NOTES:

1. Definition

A promissory note is an unconditional promise in writing made by one person to another, signed by the
maker, engaging to pay on demand or at a fixed or determinable future time a sum certain in money to
order or to bearer.

2. Initial Measurement

PFRS 9, paragraph 5.1.1, provides that a note payable not designated at fair value through profit or loss
shall be measured initially at fair value minus transaction cost that are directly attributable to the issue of
the note.

The “fair value” of the note payable is equal to the present value of the future cash payment to settle the
note payable using market rate of interest.

If the note is related to FVPL, transaction costs are expense outright.

3. Subsequent Measurement

PFRS 9, paragraph 5.3.1, provides that after initial recognition, a note payable shall be measured:

a. At amortized cost using the effective interest method.

b. At fair value through profit or loss if the note payable is designated irrevocably as measured at fair
value through profit or loss

4. Amortized cost of Note Payable

The amortized cost of note payable is the amount at which the note payable is measured initially:

a. Minus principal repayment

b. Plus or minus the cumulative amortization using the effective interest method of any difference
between the face amount and present value of the note payable.

5. Note Issued Solely for Cash

When a note is issued solely for cash, the present value is equal to the cash proceeds.

6. Interest-Bearing Note Issued

When a property or noncash asset is acquired by issuing a promissory note which is interest bearing,
the property or asset is recorded at the purchase price.

The purchase price is reasonably assumed to be the present value of the note and therefore, the fair
value of the property because the note issued is interest bearing.

7. Noninterest-Bearing Note Payable Issued

When a noninterest bearing note is issued for property, the property is recorded at the cash price of the
property.

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The difference between the cash price and the face of the note issued represents the imputed interest.

The imputed interest is based on the sound philosophy that no lender would part away with his money
or property interest-free.

END OF TOPIC 3

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Topic 4: DEBT RESTRUCTURING

1. Definition.

The creditor grants the debtor concession that would not otherwise be granted in a normal business
relationship.

Concession - stems from an agreement between creditor and debtor or imposed by law or a court

2. Forms of Debt Restructuring

a. Asset Swap
b. Equity Swap
c. Modification of Terms

3. Asset Swap

• The transfer by the debtor to the creditor of any asset, in full payment of an obligation.
• Treated as a derecognition of financial liability or extinguishment of obligation through transfer of
any asset such as real estate, inventory or investment by the debtor

Basic Entry: Note Payable xxx

Accrued Interest Payable (if any) xxx
Asset given (carrying value) xxx
Gain on extinguishment of debt xxx

Note: The difference between the carrying amount of the financial liability and the consideration given
shall be recognized in profit or loss

4. Equity Swap

• Issuance of share capital by the debtor to the creditor in full or partial payment of an obligation
• Measurement of equity instrument under IFRIC 19 in order of priority

a. Fair value of equity instrument

b. Fair value of liability extinguished
c. Carrying amount of liability extinguished

Note: The difference between the carrying amount of the financial liability extinguished and the “initial
measurement” of the equity instrument issued shall be recognized in profit or loss and shall be disclosed
as a separate line item in the income statement

5. Modification of Terms

May involve either the interest or maturity value or both

• Interest concession-may involve a reduction of the interest rate, forgiveness of unpaid interest
or a moratorium on interest payment
• Maturity value concession-may involve an extension of the maturity date reduction of the amount
to be paid on maturity
• Accounted as an extinguishment of old financial liability and the recognition of new liability

Note:

• Present value of new liability minus carrying amount of old liability is equal to gain or loss on
extinguishment
• Present value is computed using the original effective interest rate
• Any cost or fees incurred shall be recognized as part of gain or loss on extinguishment

Don’t forget that in computing for the present value, always use the OLD effective rate.

End of Topic 4.

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Topic 5: ACCOUNTING FOR INCOME TAX

Objectives:

At the end of this topic, students are expected to:

6. Know the distinction between accounting income and taxable income.

7. Distinguish permanent differences and temporary differences between accounting income and taxable
income.
8. Know the recognition and measurement of deferred tax asset and deferred tax liability.
9. Know the recognition and measurement of current tax asset and current tax liability.
10. Know the computation of accounting income subject to tax, taxable income, total income tax expense
and current tax expense.

NOTES:

1. Accounting income (vs) taxable income

Accounting income or financial income is the net income for the period before deducting income tax
expense.

Taxable income is the income for the period determined in accordance with the rules established by the
taxation authorities upon which income taxes are payable or recoverable.

2. Differences between accounting and taxable income

Differences between accounting income and taxable income may be classified into two, namely:

a. Permanent difference

Permanent difference are items of revenues and expense which are included in either accounting
income or taxable income but will never be included on the other. Permanent differences pertain to
nontaxable revenue and nondeductible expenses.

Examples include the following:

1. Interest income on deposits

2. Dividends received
3. Life insurance premium
4. Tax penalties, surcharges and fines are nondeductible

b. Temporary difference

Temporary difference are difference between the carrying amount of an asset or liability and the tax
base.

Temporary difference give rise to either deferred tax asset or deferred tax liability.

3. Kinds of temporary difference

a. Taxable temporary difference is the temporary difference that will result in future taxable amount in
determining taxable income of future periods when the carrying amount of the asset or liability is
recovered or settled.
b. Deductible temporary difference is the temporary difference that will result in future deductible
amount in determining taxable income of future periods when the carrying amount of the asset or
liability is recovered or settled.

4. Deferred tax liability

Deferred tax liability is the amount of income tax payable in future periods with respect to a taxable
temporary difference.

A deferred tax liability arises from the following

a. Accounting income > taxable income

b. Carrying amount of asset > tax base
c. Carrying amount of liability < tax base

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5. Deferred tax asset

A deferred tax asset is the amount of income tax recoverable in future periods with respect to deductible
temporary difference and operating loss carryforward.

A deferred tax asset arises from the following:

a. Accounting income < taxable income

b. Carrying amount of asset < tax base
c. Carrying amount of liability > tax base

6. Accounting procedures

Accounting income Xx
Permanent difference (+) Xx
Permanent difference (-) Xx
Accounting income subject to
tax Xx Multiply by tax rate Total income tax expense
Taxable temporary difference
(-) Xx Multiply by tax rate Deferred tax liability
Deductible temporary
difference (+) Xx Multiply by tax rate Deferred tax asset
Taxable income xx Multiply by tax rate Current tax expense

Journal entries:

Current tax expense:

Income tax expense Xx
Income tax payable Xx

Deferred tax liability:

Income tax expense Xx
Deferred tax liability Xx

Decrease of deferred tax

liability:
Deferred tax liability Xx
Income tax expense Xx

Deferred tax asset:

Deferred tax asset Xx
Income tax benefit Xx

Decrease of deferred tax asset:

Income tax benefit Xx
Deferred tax asset Xx

END OF TOPIC 5

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Topic 6: POSTEMPLOYMENT BENEFITS

Objectives:

At the end of this topic, students are expected to:

6. Understand postemployment benefits.

7. Distinguish defined contribution plan and defined benefit plan.
8. Identify the components of defined benefit cost.
9. Understand the relationship between fair value of plan assets and projected benefit obligation.
10. Know the computation of employee benefit expense.
11. Understand the T-account of FVPA and PBO.

NOTES:

1. Employee benefits

Employee benefits are all forms of considerations given by an entity in exchange for services rendered
by employees or for the termination of employment.

The employee benefits include:

a. Postemployment benefits
b. Short term employee benefits
c. Other long term employee benefits
d. Termination benefits

2. Postemployment benefits

Postemployment benefits are employee benefits, other than termination benefits and short term
employee benefits, which are payable after completion of employment.

Postemployment benefits are classified as either defined contribution plans or defined benefit plans.

Postemployment benefit plans under the law

a. This postemployment benefit plan is defined contributions to the plan as a percentage of salary.
b. R.A. 7641 – this postemployment benefit plan is a defined benefit plan because the entity’s obligation
is to provide specific level of benefit for every year of service.

3. Defined contribution plan

A defined contribution plan is a postemployment benefit plan under which an entity pays fixed
contributions into a separate entity knows as the fund.

The entity makes a specific or definite amount of contribution to a separate fund without specifying the
retirement benefit to be received by the employee.

The contribution is definite but the benefit is infinite.

4. Defined benefit plan is simply defined as a postemployment plan other than a defined contributory plan.

An entity’s obligation is to provide the agreed benefits to employees.

An employee is guaranteed a specific or definite amount of benefit which is usually related to his salary
and years.

The benefit is definite but the contribution is indefinite.

5. Accounting for defined benefit plan

Accounting for a defined benefit plan is complex because actuarial assumptions are required to measure
the obligation and the expense and there is a possibility of actuarial gains and losses.

Moreover, the obligation is measured on a discounted basis.

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 Defined contributions plan may be unfunded, fully unfunded or partly funded by the contributions of the
entity.

Under a defined benefit plan, the expense recognized is not necessarily the amount of contributions for
the period.

6. Components of defined benefit cost

1. Service cost which comprises

a. Current service cost
b. Past service cost
c. Any gain or loss on settlement
2. Net interest which comprises
a. Interest expense on defined benefit obligation
b. Interest income on plan assets
c. Interest expense on effect of asset ceiling

3. Remeasurement which comprises

a. Remeasurement of plan assets
b. Remeasurement of projected benefit obligation
c. Remeasurement of the effect of asset ceiling

The service cost and net interest are included in profit or loss as component of employee benefit
expense.

All of the remeasurements are fully recognized through other comprehensive income.

7. Defined benefit plan accounting procedures

The benefit plan shall be viewed as a subentity separate and distinct from the primary entity, which is
the employer entity.

The subentity maintains information that does not appear in the financial statements of the primary
entity.

The information contained in the memorandum records of the subentity contains the following:

a. Fair value of plan assets (FVPA)

b. Projected benefit obligation (PBO)

FVPA PBO
BEGINNING BEGINNING
CONTRIBUTION CURRENT SERVICE COST
ACTUAL RETURN PAYMENT PAST SERVICE COST
ENDING PAYMENT INTEREST EXPENSE
ACTUARIAL GAIN ACTUARIAL LOSS
ENDING

If the FVPA is more than PBO the plan is overfunded and therefore there is a prepaid benefit cost, a
noncurrent asset.

If the FVPA is less than PBO the plan is underfunded and therefore there is an accrued benefit cost,
a noncurrent liability.

Underfunding journal entry:

Employee benefit expense Xx

Cash Xx
Prepaid/accrued benefit cost Xx

Overfunding journal entry:

Employee benefit expense Xx

Prepaid/accrued benefit cost Xx
Cash Xx
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 The “prepaid/ accrue benefit cost” account is the balancing figure.

As the years go by, this account will build up and it may have debit or credit balance at the end of
current reporting period.

If the account is has a debit balance, it is classified as noncurrent asset presented as prepaid benefit
cost.

Otherwise, if the account has a credit balance, it is classified as noncurrent liability presented as
accrued benefit cost.

END OF TOPIC 6

Reference:

Conrado T. Valix, Jose F. Peralta and Christian Aris M. Valix

Intermediate accounting Volume 2 (2023 edition)

END OF MIDTERM MODULE

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