Current Liabilities and Bonds

8/11/2019 Current Liabilities and Bonds

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TL 5 Current Liabilities andBonds

9 May 2014

Miriam Koning


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Non-current assets

Property, plant and equipment

Intangible assets

Financial assets

Current assets

Inventories

Trade receivables

Other current assets

Cash and cash equivalents

WHERE ARE WE?

Debit Statement of financial position Credit

Equity

Share capital

Retained earnings

Other components of equity

Provisions (current and non-current)

Non-current liabilities

Long term borrowings

Other non-current liabilities

Current liabilities

Trade and other payables

Short term borrowings

Other current liabilities

Copyright RSM/Accounting& Control/ Miriam Koning


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Agenda

Case 1: Premiums and coupons

Case 2: Environmental provisions

Case 3: Compound financial instruments



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PREMIUMS AND COUPONS

Case 1



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Companies should charge the costs of premiums and

coupons to expense in the period of the sale that benefits

from the plan.

Accounting:

Estimate the number of outstanding premium offers

that customers will present for redemption.

Charge cost of premium offers to Premium Expenseand credits Premium Liability.

Premiums and Coupons



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Case 1: Fluffy Cakemix Company offered its customers a large non-

breakable mixing bowl in exchange for 25 cents and 10 boxtops. The

mixing bowl costs Fluffy Cakemix Company 75 cents, and thecompany estimates that customers will redeem 60 percent of the

boxtops. The premium offer began in June 2011 and resulted in the

transactions journalized below. Fluffy Cakemix Company recordspurchase of 20,000 mixing bowls as follows.

Inventory of Premium Mixing Bowls 15,000

Cash 15,000

20,000 x $0.75 = $15,000




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The entry to record sales of 300,000 boxes of cake mix would be:

Cash 240,000

Sales 240,000

300,000 x$0.80 = $240,000

Fluffy records the actual redemption of 60,000 boxtops, the receipt

of 25 cents per 10 boxtops, and the delivery of the mixing bowls as

follows.

Cash [(60,000 / 10) x $0.25] 1,500

Premium Expense 3,000

Inventory of Premium Mixing Bowls 4,500Computation: (60,000 / 10) x $0.75 = $4,500




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Finally, Fluffy makes an end-of-period adjusting entry for estimated

liability for outstanding premium offers (boxtops) as follows.

Premium Expense 6,000

Premium Liability 6,000




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ENVIRONMENTAL PROVISIONS

Case 2



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A company must recognize an environmental liabilitywhen it has an existing obligation associated with the

retirement of a long-lived asset and when it can

reasonably estimate the amount of the liability.

Environmental provisions



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Obligating Events. Examples of existing obligations, whichrequire recognition of a liability include, but are not limited to:

Decommissioning nuclear facilities,

Dismantling, restoring, and reclamation of oil and gas

properties,

Certain closure, reclamation, and removal costs of

mining facilities,

Closure and post-closure costs of landfills.




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Measurement. A company initially measures an environmentalliability at the best estimate of its future costs.

Recognition and Allocation. To record an environmental

liability a company includes

the cost associated with the environmental liability in the

carrying amount of the related long-lived asset, and

records a liability for the same amount.




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Case 2: On January 1, 2011, Wildcat Oil Company erected an oil

platform in the Gulf of Mexico. Wildcat is legally required to dismantle

and remove the platform at the end of its useful life, estimated to be

five years. Wildcat estimates that dismantling and removal will cost

$1,000,000.




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Case 2: On January 1, 2011, Wildcat Oil Company erected an oil

platform in the Gulf of Mexico. Wildcat is legally required to dismantle

and remove the platform at the end of its useful life, estimated to be

five years. Wildcat estimates that dismantling and removal will cost

$1,000,000. Based on a 10 percent discount rate, the fair value of the

environmental liability is estimated to be $620,920 ($1,000,000 x

.62092). Wildcat records this liability on Jan. 1, 2011 as follows.

Drilling platform 620,920

Environmental liability 620,920




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During the life of the asset, Wildcat allocates the asset retirement

cost to expense. Using the straight-line method, Wildcat makes

the following entries to record this expense.

Depreciation expense ($620,920 / 5) 124,184

Accumulated depreciation 124,184

December 31, 2011, 2012, 2013, 2014, 2015




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In addition, Wildcat must accrue interest expense each period.

Wildcat records interest expense and the related increase in the

environmental liability on December 31, 2011, as follows.

Interest expense ($620,920 x 10%) 62,092

Environmental liability 62,092

December 31, 2011




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On January 10, 2016, Wildcat contracts with Rig Reclaimers, Inc. to

dismantle the platform at a contract price of $995,000. Wildcat makes

the following journal entry to

record settlement of the liability.

Environmental liability 1,000,000

Gain on settlement of liability 5,000

Cash 995,000

January 10, 2016




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Interest 10%

Carryingamount

Provision depreciation

Carryingamount

Asset

620920 620920

62092 683012 124184 496736

68301.2 751313.2 124184 372552

75131.32 826444.5 124184 248368

82644.452 909089 124184 124184

90908.8972 999997.9 124184 0




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Depreciation of major overhaul

Carrying amount

Depreciation major overhaul component in PPE

Residual value

Major overhaul

component



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COMPOUND FINANCIALINSTRUMENTS

Case 3



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(at the holders option)

Benefit of a Bond (guaranteed interest and principal)

Privilege of Exchanging it for Shares

Convertible Debt

Bonds which can be changed into other corporate

securities are called convertible bonds.

+



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Liability vs equity classification

There are just two categories: debt and equity

IFRS: If an entity cannot avoid to pay dividend or toredeem: debt, otherwise equity

Irrespective of legal form

This drives not only balance sheet presentation, butalso profit or loss: If debt: payment of remuneration (whether dividend or

interest) is deducted from profit

If equity: payment of remuneration (whether dividend orinterest) is considered part of profit appropriation



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Liability or Equity?

Ordinary sharesNo contractual obligation to pay

dividendsNo repayment of the share capital

LoanObligation to pay

interestRepay the loan

Compound instruments

? ?Liability part

Split accounting

Equity part



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Convertible debt is accounted for as a compound instrument.

Companies use the with-and-without method to value

compound instruments.

Accounting for Convertible Debt

CONVERTIBLE DEBT



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Implementation of the with-and-without approach:

1. First, determine total fair value of convertible debt with both liability

and equity component.

2. Second, determine liability component by computing net present

value of all contractual future cash flows discounted at the market

rate of interest.

3. Finally, subtract liability component estimated in second step from

fair value of convertible debt (issue proceeds) to arrive at the equity

component.

Accounting for Convertible Debt

CONVERTIBLE DEBT



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Compound financial instrumentsCase 3 Convertible Bond

On 1 January 2009, a company issues 2,000 convertible bonds. The bonds have a four-

year term with a stated interest of 7% , and are issued at par with a face value of 100

per bond (the total proceeds received from issuance of the bonds are 200,000). Interest

is payable annually at 31 December. Each bond is convertible at maturity date into 25

ordinary shares with a par value of 1, option to the holder. The market rate of interest osimilar non-convertible debt is 9%.

Required. How will the company record this bond at the time of issuance

Payment due PV Cash flows

31 Dec 2009 14,000/1.09 12,844

31 Dec 2010 14,000/(1.09)2 11,784

31 Dec 2011 14,000/(1.09)3 10,811

31 Dec 2012 14,000/(1.09)4

+200,000/(1.09)4151,603



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Liability vs equity classification

Example compound financial instrument

On 1 January 2009, a company issues 200K euro of 7% bonds atpar. Interest on these bonds is payable on 31 December each year.The bonds are due for redemption at par on 31 December 2012 butmay be converted into ordinary shares on that date instead (optionto the holder).

Assuming that the market rate of interest is 9% p.a., how should thebonds be accounted for on 1 January 2009?

a. Liability 200,000 euro

b. Equity 200,000 euroc. Liability for 100,000 euro and Equity for 100,000 euro

d. Liability for 187,041 euro and Equity for 12,959 euro



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At Time of Issuance

Cash 200,000

Bonds Payable 187,041

Share PremiumConversion Equity 12,959

JournalEntry

Present value of principal 141,685

Present value of interest payments 45,356

Present value of liability component 187,041

Faur value of convertible debt at date of issuance 200,000

Less: Fair value of liability component at time of issuance 187,041

Fair value of equity componenet at date of issuance 12,059

CONVERTIBLE DEBT



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Settlement of Convertible Bonds

Repurchase at Maturity. If the bonds are not converted at

maturity, the company makes the following entry to pay off the

convertible debtholders.


Cash 200,000

NOTE: The amount originally allocated to equity of 12,959 either remains in

the Share PremiumConversion Equity account or is transferred to the

Share PremiumOrdinary account.

CONVERTIBLE DEBT



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Conversion of Bonds at Maturity. If the bonds are converted at

maturity, the company makes the following entry.



Share CapitalOrdinary 50,000

Share PremiumOrdinary 162,959

NOTE: The amount originally allocated to equity of 12,959 is transferred to

the Share PremiumOrdinary account.

CONVERTIBLE DEBT



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Conversion of Bonds before Maturity.

CONVERTIBLE DEBT

interestpaid

interestexpense

discountamortized

discountaccountbalance

carrying amountof bonds

7% 9%

1/1/2009 12959 187041

31/12/2009 14000 16834 2834 10125 189875

31/12/2010 14000 17089 3089 7037 192963

31/12/2011 14000 17367 3367 3670 196330

31/12/2012 14000 17670 3670 0 200000

56000 68959 12959


CONVERTIBLE DEBT


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Conversion of Bonds before Maturity.

CONVERTIBLE DEBT

interestpaid

interestexpense

discountamortized

discountaccountbalance

carrying amountof bonds

7% 9%

1/1/2009 12959 187041

31/12/2009 14000 16834 2834 10125 189875

31/12/2010 14000 17089 3089 7037 192963

31/12/2011 14000 17367 3367 3670 196330

31/12/2012 14000 17670 3670 0 200000

56000 68959 12959


Please note that this is thecontra-liability used todetermine the correct

carrying amount for thebond. It is NOT the equity

component. The equitycomponent remains

unchanged during the life ofthe compound instrument

CONVERTIBLE DEBT


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Conversion of Bonds before Maturity. Assuming that the

bonds are converted into ordinary shares on December 31, 2010.



Share CapitalOrdinary 50,000

Share PremiumOrdinary 155,922

Bonds Payable Discount 7,037

NOTE: The amount originally allocated to equity of 12,959 is transferred to

the Share PremiumOrdinary account.

CONVERTIBLE DEBT



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See you next week !


Current Liabilities and Bonds

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