978-1118334324 Chapter 10 Lecture Note Part 3

2. Bond interest expense is computed by adding (subtracting) the bond

discount (premium) amortization per period to (from) the interest to be paid.

3. The bond discount or premium amortization each period is computed by

dividing the total bond discount (premium) by the number of interest periods.

4. Over the term of the bonds, the balance in Discount (Premium) on Bonds

Payable will decrease annually by the same amount until it has a zero

balance at the bonds’ maturity date.

IFRS

A Look at IFRS

IFRS and GAAP have similar definitions of liabilities. IFRSs related to reporting

and recognition of liabilities are found in IAS 1 (revised) (“Presentation of Financial

Statements”) and IAS 37 (“Provisions, Contingent Liabilities, and Contingent

Assets”). The general recording procedures for payroll are similar although

differences occur depending on the types of benefits that are provided in different

countries. For example, companies in other countries often have different forms

of pensions, unemployment benefits, welfare payments, and so on. The account–

ing for various form of compensation plans under IFRS is found in IAS 19

“Employee Benefits” and IFRS 2 (“Share-based Payments”), IAS 19 addresses

the accounting for a wide range of compensation elements, including wages,

bonuses, post-employment benefits, and compensated absences. Both of these

standards were recently amended, resulting in significant convergence between

IFRS and GAAP.

KEY POINTS

 The basic definition of a liability under GAAP and IFRS is very similar. In a

more technical way, liabilities are defined by the IASB as a present

obligation of the entity arising from past events, the settlement of which is

expected to result in an outflow from the entity of resources embodying

economic benefits. Liabilities may be legally enforceable via a contract or

law but need not be; that is, they can arise due to normal business

practices or customs.

 IFRS requires that companies classify liabilities as current or non-current

on the face of the statement of financial position (balance sheet), except in

industries where a presentation based on liquidity would be considered to

provide more useful information (such as financial institutions). When

current liabilities (also called short-term liabilities) are presented, they are

generally presented in order of liquidity.

 Under IFRS, liabilities are classified as current if they are expected to be

paid within 12 months.

 Similar to GAAP, items are normally reported in order of liquidity.

Companies sometimes show liabilities before assets. Also, they will

sometimes show long-term liabilities before current liabilities.

 Under IFRS, companies sometimes will net current liabilities against

current assets to show working capital on the face of the statement of

financial position. (This is evident in the Zetar financial statements in

Appendix F.)

 The basic calculation for bond valuation is the same under GAAP and

IFRS. In addition, the accounting for bond liability transactions is essentially

the same between GAAP and IFRS.

 IFRS requires use of the effective-interest method for amortization of bond

discounts and premiums. GAAP also requires the effective-interest method,

except that it allows use of the straight-line method where the difference is

not material. Under IFRS, companies do not use a premium or discount

account but instead show the bond at its net amount.

 The accounting for convertible bonds differs between IFRS and GAAP.

Unlike GAAP, IFRS splits the proceeds from the convertible bond between

an equity component and a debt component. The equity conversion rights

are reported in equity.

 Assume that Harris Corp. issues convertible 7% bonds with a face value of

$1,000,000 and receives $1,000,000. Comparable bonds without a

conversion feature would have required a 9% rate of interest. To determine

how much of the proceeds would be allocated to debt and how much to

equity, the promised payments of the bond obligation would be discounted

at the market rate of 9%.

LOOKING TO THE FUTURE

The FASB and IASB are currently involved in two projects, each of which has

implications for the accounting for liabilities. One project is investigating

approaches to differentiate between debt and equity instruments. The other

project, the elements phase of the conceptual framework project, will evaluate

the definitions of the fundamental building blocks of accounting. The results of

these projects could change the classification of many debt and equity securities.

20 MINUTE QUIZ

Circle the correct answer.

True/False

True False

2. With an interest-bearing note, the amount of cash received upon issuance of the note will

True False

3. An unearned revenue arises when payment is accepted in advance of the goods being

delivered.

True False

4. If the market rate of interest is higher than the contractual rate, the bonds will sell at a

premium.

True False

5. The amount that must be invested today at current interest rates in order to receive a

True False

6. When bonds are issued at face value, the debit to Cash is equal to the credit to Bonds

Payable.

True False

7. Bonds with a higher contractual interest rate than the market rate for similar bonds will

probably sell at a discount.

True False

8. The sale of bonds above face value causes the total cost of borrowing to be more than

the bond interest paid.

True False

*10. Under the effective-interest method, the amortization of a bond discount will result in an

increasing interest expense each year over the life of the bond.

True False

Multiple Choice

1. The account Unearned Subscription Revenue

a. is considered a miscellaneous revenue account.

b. has a normal debit balance.

d. is a current liability.

2. The total cost of borrowing on a 10-year, 9%, $1,000 bond that sold for $960 is

a. $960.

b. $940.

c. $860.

d. $870.

3. If bonds payable are issued at a discount, the contractual interest rate is

d. changed to reflect the market rate of interest.

4. A $2,000,000 bond issue with a carrying value of $2,080,000 is called at 103 and retired.

Which of the following is true?

a. A gain of $80,000 is recorded.

b. A loss of $20,000 is recorded.

c. A gain of $20,000 is recorded.

d. No gain or loss is recorded.

calculated by multiplying the

a. face value of the bonds at the beginning of the period by the contractual interest

rate.

c. face value of the bonds at the beginning of the period by the effective-interest rate.

d. carrying value of the bonds at the beginning of the period by the effective-interest

rate.

ANSWERS TO QUIZ

True/False

Multiple Choice