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TENTH CANADIAN EDITION

INTERMEDIATE ACCOUNTING

CHAPTER 14Long-TermFinancial

Liabilities

Kieso • Weygandt • Warfield • Young • Wiecek • McConoy

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Issuing Long-Term Debt

• O!ligations not "aya!le #it$in one year% orone !usiness o"erating cycle$ic$e'eris longer 

• E(a"les include) * +onds "aya!le * ,ong-ter notes "aya!le * Mortgages

 * .ension lia!ilities * ,ease lia!ilities

• Often #it$ restricti'e co'enants /ters0attac$ed

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Bonds

• Most coon ty"e of long-ter de!t•  A !ond indenture is a "roise /!y t$e

lender to t$e !orro#er0 to "ay)• a su of oney at t$e designated date% and• "eriodic interest /usually "aid sei-annually0

at a sti"ulated rate on t$e face 'alue1

•  A !ond issue ay !e sold)• eit$er t$roug$ an in'estent !anker% or • !y "ri'ate "laceent1

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Notes Payabe

• 2iilar in nature to !onds * 3e4uire re"ayent of "rinci"al at a future date * 3e4uire "eriodic interest "ayents

• T$e difference is t$at notes do not norallytrade on "u!lic arkets•  Accounting for !onds and notes is t$e sae in

any res"ects

• ,ike a !ond% a note is recorded at t$e .5 offuture interest and "rinci"al% and any"reiu6discount is aorti7ed o'er t$e life oft$e note

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Ty!es o" Bonds#Notes

• +earer /cou"on0 !onds) are freely transfera!le !y currento#ner  

• 2ecured de!t) secured !y collateral /real estate% stocks0• 2erial !onds) ature in instalents

• Incoe and re'enue !onds) interest "ayents tied tosoe for of "erforance

• Dee"-discount !onds) little or no interest "ayents8 soldat a su!stantial discount

• Calla!le !onds) gi'e issuer rig$t to call and retire de!t"rior to aturity

• Con'erti!le !onds) can !e con'erted into ot$ercor"orate securities

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Bond Measurement$  Determining Bond Pri%es

• T$e "rice of a !ond is deterined !y finding t$e"resent 'alue /.50 of future cas$ flo#s)• t$e .5 of t$e interest "ayents /at t$e stated %

cou"on or noinal rate of interest0 "lus• t$e .5 of t$e "rinci"al aount /also called t$e face

'alue% "ar 'alue or aturity 'alue0

• +ot$ aounts are discounted at t$e

arket /yield0 rate of interest in effect atissue date

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Bond Measurement$  Determining Bond Pri%es

• W$en t$e effecti'e yield /arket rate0 9stated rate⇒ !ond sells at "ar 

• W$en t$e effecti'e yield /arket rate0stated rate⇒ !ond sells at a discount

• W$en t$e effecti'e yield /arket rate0stated rate⇒ !ond sells at a "reiu

d

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Bond Measurement$Bond Pri%e Ca%uation

:i'en)

• ;ace 'alue of !ond issue) >%>>>

• Ter of issue) ? years• 2tated interest rate) @ "er year%"aya!le annually at year end

• Market rate of interest) ==Deterine t$e issue "rice of t$e !onds

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B d M

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Bond Measurement$ Bond Pri%e Ca%uation

9

Year = Year B Year Year Year ?

>>  >>  >>  >>  >> 

Interestannuity

>%>>>

;ace 5alue

Discount t$e future cas$ flo#susing t$e effecti'e /arket0 yield

B d M

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Bond Measurement$ Bond Pri%e Ca%uation

10

Discount at effecti'e yield% ==>> 1F@?@>

> 

>> 

>> 

>> 

>> 

>%>>>Discount at effecti'e yield% ==>%>>> >1?@?< ?@%?

"lus

9G is t$e issue "rice 

A i i ' B d

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 Amorti&ing t'e BondPremium#Dis%ount

•  A "reiu effecti'ely decreases t$eannual interest e("ense for t$ecor"oration

• T$e discount effecti'ely increases t$eannual interest e("ense for t$e issuingcor"oration

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A ti i t' B d

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 Amorti&ing t'e BondPremium#Dis%ount

• T#o et$ods a'aila!le for aorti7ation=02traig$t-,ine

•  Allocates t$e sae aount of discount /or

"reiu0 to eac$ interest "eriod•  Acce"ta!le under A2.EB0Effecti'e Interest

•  Allocates t$e discount or "reiu o'er t$e!ond ter /i1e1 aorti7es t$e discount or

"reiu0• 3e4uired under I;32

• T$e total discount or "reiu aorti7edis t$e sae under !ot$ et$ods

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t t L M t

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tra g t-L ne Met o )Dis%ount

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:i'en)

;ace 5alue 9 >%>>> Discount 9 >>

2tated 3ate 9 => +ond Maturity 9 => years

T$e annual discount aorti7ation 9

>> ÷ => years 9 >

T$e entry to record t$e annual discount aorti7ation #ould!e)

Interest E("ense B%>>

+onds .aya!le B%>>

t t L M t

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tra g t-L ne Met o )Premium

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:i'en)

;ace 5alue 9 >%>>> .reiu 9 >>

2tated 3ate 9 => +ond Maturity 9 => years

T$e annual "reiu aorti7ation 9

>> ÷ => years 9 >

T$e entry to record t$e annual "reiu aorti7ation #ould

!e+onds .aya!le B%>>

Interest E("ense B%>>

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E*e%ti+e Interest Met'od

• .roduces a "eriodic interest e("ensee4ual to a constant "ercentage of t$ecarrying 'alue of t$e !ond

 * T$e "ercentage used is t$e effecti'e yield• T$e aorti7ation of t$e discount or

"reiu is deterined !y co"aring t$e

interest e("ense #it$ t$e interest "aid• Total interest e("ense o'er t$e life of t$e!ond is t$e sae as t$at using t$estraig$t-line et$od

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E* ti I t t M t' d

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E*e%ti+e Interest Met'odCa%uation$ Dis%ount

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E*e%ti+e Interest Met'od

• T$e ournal entry to record t$e !ondissuance is)

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Cas$ @B%BG+onds .aya!le @B%BG

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E*e%ti+e Interest Met'od

• T$e ournal entry for first sei-annual"ayent is)

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+ond Interest E("ense %F=+onds .aya!le F=Cas$ %>>>

E* ti I t t M t' d

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E*e%ti+e Interest Met'odCa%uation$ Premium

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E*e%ti+e Interest Met'od

• T$e ournal entry to record t$e !ondissuance is)

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Cas$ =>G%?>+onds .aya!le =>G%?>

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E*e%ti+e Interest Met'od

• T$e ournal entry for first sei-annual"ayent is)

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+ond Interest E("ense %B?F+onds .aya!le

Cas$ %>>>

Bonds Issued Bet,een

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Bonds Issued Bet,eenInterest Dates

• Interest for t$e "eriod !et#een t$e issuedate and t$e last interest date is "aid !yt$e !ond$older in addition to t$e issue

"rice of t$e !onds•  At t$e s"ecified interest date% interest is

"aid for t$e entire interest "eriod /sei-annual or annual0

• .reiu or discount is also aorti7edfro t$e date of sale

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Non Maret Rates o" Interest

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Non-Maret Rates o" Interest.Maretabe (e%urities/

• If !ond issued for cas$% and is arketa!le%its fair 'alue 9 cas$ recei'ed !y issuer 

• I"licit interest rate is t$e rate t$at causes

t$e .5 /of future cas$ flo#s0 to e4ual cas$recei'ed

• Difference !et#een face aount and .5

is t$e discount *  Aorti7ed o'er life of t$e !ond6note

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 .Maretabe (e%urities/ 0E1am!e

• %>>>% -year 7ero-interest-!earingarketa!le !ond issued

• Cas$ recei'ed at issuance) >>,ess) Cas$ 3ecei'ed %BB

< B%BG• I"lied interest rate is t$erefore @  /since t$e .5 of

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 .Non-MaretabeInstruments/

• Non-arketa!le Instruents * Cas$ consideration ig$t not !e e4ual to fair

'alue * t$ere ig$t !e additional 'alue !eing

transferred * Must easure fair 'alue of loan !y

discounting t$e cas$ flo#s using a arket rateof interest

 *  Any difference is !ooked to net incoe unlessit eets t$e definition of an asset or lia!ility

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Note Issued "or Cas'

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Note Issued "or Cas' and Ot'er Rig'ts

• W$ere additional 'alue is !eingtransferred * eit$er for arketa!lesecurities or non-arketa!le securities%

ust !ook se"arately

E(a"le

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 .Non-MaretabeInstruments/ 0 E1am!e

:i'en)• :o'ernent gi'es a ? year% >%>>> note "aya!le to a

co"any on January =st to $el" it finance t$econstruction of a !uilding

• T$e note is 7ero-interest !earing• T$e arket rate is =>• 3eci"ient co"any $as an additional !enefit !eyond t$e

de!t financing * t$e go'ernent is forgi'ing t$e interest

t$at t$e co"any #ould norally !e c$arged1 T$is is ago'ernent grant1

Journali7e in issuers !ooks

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 .Non-MaretabeInstruments/ 0 E1am!e

+ooks of t$e Issuer)

  Cas$ =>>%>>>  Notes .aya!le FB%>@B

 

+uilding * :o'ernent :rant %@>G/.5 of >%>>> at =>% /n9?0 9 @B0

/>%>>> * @B 9 G0

• T$e discount is aorti7ed to interest e("ense o'er t$e

ter of note• T$e go'ernent grant is aorti7ed to net incoe as t$e!uilding is de"reciated

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Notes Issued "or Pro!erty

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Notes Issued "or Pro!erty2Goods2 and (er+i%es

• If t$e issued de!t is a arketa!le security% t$e'alue of t$e transaction #ould !e e4ual to fair'alue of t$e arketa!le security

• If t$e issued de!t is not a arketa!le security) * May try to 'alue de!t !y discounting cas$ flo#s at

arket rate of interest% or 

 * May use t$e fair 'alue of t$e "ro"erty% goods%

ser'ices1•  Any discount or "reiu aorti7ed o'er life of

t$e note

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3air 4aue O!tion

• ,ong-ter de!t is generally easured ataorti7ed cost $o#e'er it can also !eeasured at fair 'alue

 * I;32 allo#s t$e fair 'alue o"tion only if itresults in ore rele'ant inforation

 *  A2.E allo#s t$e fair 'alue o"tion for allfinancial instruents

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E1tinguis'ment o" Debt

• E(tinguis$ent of de!t is recorded #$en) * T$e de!tor "ays t$e creditor% or 

 * T$e de!tor is legally released fro "aying t$e

creditor /due to cancellation% e("iry etc10

Re!ayment e ore Matur ty

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Re!ayment e ore Matur tyDate

• W$en de!t is "aid out "rior to aturity% t$eaount "aid is called t$e reac4uisition"rice

 * May !e for t$e full aount of de!t or a "ortion

 * Includes any call "reiu and e("enses

•  At t$e tie of reac4uisition all outstanding

"reius% discounts% and issue costs areaorti7ed to t$e date of reac4uisition

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Re!ayment e ore Matur ty

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Re!ayment e ore Matur tyDate

• If t$e net carrying aount of t$e de!t isore t$an t$e reac4uisition "rice% t$isresults in a gain fro e(tinguis$ent

• If t$e reac4uisition "rice e(ceeds t$e netcarrying aount of t$e de!t% t$is results ina loss fro e(tinguis$ent

•  Any gain or loss fro t$e reac4uisition isre"orted #it$ ot$er gains and losses

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 Date$ 0 E1am!e:i'en)

• E(isting de!t) >%>>>

• Called and cancelled at) G%>>>

• Lnaorti7ed discount) < =%>>Note) Discount $as !een aorti7ed u" to t$e dateof cancellation of de!t1

:i'e t$e ournal entry for t$e e(tinguis$ent1

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 Date$0 E1am!e+onds .aya!le G?%F>>

,oss on 3ede"tion of +onds BB%>>  Cas$   G>G%>>>

 /!ond carrying aount 9 >%>>> * > 9 >0

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Trou e De t

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Trou e De tRestru%turings

• W$en a creditor grants a fa'oura!leconcession to a de!tor 

• T#o !asic ty"es of transactions

=12ettleent of de!t at less t$an carrying 'alue

B1Continuation of de!t #it$ odification of ters

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(ettement o" Debt

• Old de!t% as #ell as all related discount%"reiu and issuance costs are reo'edfro !ooks /derecogni7ed0

•  A gain is usually recogni7ed since creditorgenerally akes concessions insettleent of trou!led de!t /settled at less

t$an carrying 'alue0

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u stant a Mo %at on o

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u stant a Mo %at on oTerms

• If de!t is continued #it$ su!stantial odificationof ters% t$e transaction is treated like asettleent * Old lia!ility is derecogni7ed

 * Ne# /su!stantially odified0 lia!ility is recogni7ed * T$e difference !et#een t$e old and ne# lia!ility is

recorded as a gain

• Modification of ters is su!stantial if eit$er)

 * Discounted .5 under ne# ters is at least =>different fro discounted .5 of reaining cas$ flo#sunder old de!t% or 

 * Old de!t is legally disc$arged and t$ere is a ne#creditor 

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Non-(ubstantia Modi5%ation

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Non-(ubstantia Modi5%ationo" Terms

• No gain or loss recogni7ed

• Ne# effecti'e interest rate ust !e found * I"uted using t$e rate t$at e4uates t$e

carrying 'alue of old de!t to cas$ flo#s ofne#ly arranged de!t

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De"easan%e

•2ufficient funds set aside /i1e1 in a trust0 to "ayoff "rinci"al and interest of de!t

• ,egal defeasance occurs #$en t$e creditor no

longer $as clai on t$e assets of t$e originalissuer  * i1e1% t$e Trust is $eld res"onsi!le for re"ayent * T$e de!t ay !e derecogni7ed

• In-su!stance defeasance occurs #$en t$ecreditor is not  a#are of t$e trust arrangeent * T$e de!t ay not !e derecogni7ed

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Ba an%e eet

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-Ba an%e- eet3inan%ing

• Off-!alance-s$eet financing re"resents!orro#ing arrangeents t$at are not recorded

• T$e aount of de!t re"orted in t$e stateent of

financial "osition does not include suc$financing arrangeents * T$is is not acce"ta!le and is usually done to i"ro'e

certain financial ratios /suc$ as de!t-e4uity ratio0

• In general% increased note disclosure ist$e accounting "rofessions res"onse tooff-!alance s$eet financing

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id d i i

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Non-%onsoidated entities

• Lnder "resent :AA.% a "arent co"anydoes not $a'e to consolidate anin'estent in a co"any #$ere ?>

o#ned and no control• T$erefore% t$e lia!ilities of t$e co"any

#ould not !e reflected on t$e !alance

s$eet of t$e "arent co"any% alt$oug$ t$e"arent ay !e ultiately lia!le for t$e de!t

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. / b

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 .(PEs/ or 4ariabe InterestEntities .4IEs/

•  A co"any ay create a s"ecial "ur"oseentity or 'aria!le interest entity to "erfora s"ecial "roect or function

• T$is is a concern if 2.Es65IEs are used"riarily to disguise de!t

•  As a general rule% t$e co"anies s$ould

!e consolidated if t$e co"any is t$eain !eneficiary of t$e 2.E65IE

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O i L

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O!erating Leases

•  Anot$er #ay to reduce a co"anys de!tis to lease rat$er t$an o#n

• If a lease is considered an o"erating

lease% t$e co"any #ould need to recordrent e("ense eac$ "eriod #it$ notedisclosure /furt$er co'ered in c$a"ter B>0

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Presentat on o Long-Term

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Presentat on o Long-TermDebt

• Current 'ersus long-ter * De!t to !e refinanced treated as current

unless s"ecific refinancing conditions et

• De!t 'ersus e4uity * De"endent on nature of t$e instruent

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Di

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Dis%osures

• Include) * Nature of t$e lia!ility

 * Maturity date

 * Interest rate

 * Call "ro'ision * Con'ersion "ri'ilege

 *  Any restrictions i"osed

 *  Assets designated or "ledged as security

•  Any assets "ledged as security for t$e de!t s$ould !es$o#n in t$e assets section of t$e stateent of financial"osition

• ;air 'alue of t$e long-ter de!t s$ould also !e disclosed

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A i

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 Anaysis

De!t to Total Assets) Total de!t

  Total assets• ,e'el or "ercentage of assets t$at is

financed t$roug$ de!t

Ties Interest Earned)

Incoe !efore incoe ta(es and interestInterest e("ense

• Measures a!ility to eet interest "ayents