Current Liabilities and Bonds

TL 5 Current Liabilities and
Bonds
9 May 2014
Miriam Koning
2
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
3
Agenda
Case 1: Premiums and coupons
Case 2: Environmental provisions
Case 3: Compound financial instruments
4
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 Expense
and credits Premium Liability.
Premiums and Coupons
6
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 the
company 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 records
purchase of 20,000 mixing bowls as follows.
Inventory of Premium Mixing Bowls 15,000
Cash 15,000
20,000 x $0.75 = $15,000
7
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 4,500
Computation: (60,000 / 10) x $0.75 = $4,500
8
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
9
ENVIRONMENTAL PROVISIONS
Case 2
10
A company must recognize an environmental liability
when 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
11
Obligating Events. Examples of existing obligations, which
require 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.
12
Measurement. A company initially measures an environmental
liability 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.
13
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.
14
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
15
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
17
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%
Carrying
amount
Provision depreciation
Carrying
amount
Asset
1 Jan 2011
620920 620920
31 Dec 2011
62092 683012 124184 496736
31 Dec 2012
68301.2 751313.2 124184 372552
31 Dec 2013
75131.32 826444.5 124184 248368
31 Dec 2014
82644.452 909089 124184 124184
31 Dec 2015
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
20
COMPOUND FINANCIAL
INSTRUMENTS
Case 3
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Liability vs equity classification
Question compound financial instrument
On 1 January 2009, a company issues 200K euro of 7% bonds at
par. Interest on these bonds is payable on 31 December each year.
The bonds are due for redemption at par on 31 December 2012 but
may be converted into ordinary shares on that date instead (option
to the holder).
Assuming that the market rate of interest is 9% p.a., how should the
bonds be accounted for on 1 January 2009?
a. Liability 200,000 euro
b. Equity 200,000 euro
c. 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 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.
+
23
There are just two categories: debt and equity
IFRS: If an entity cannot avoid to pay dividend or to
redeem: debt, otherwise equity
Irrespective of legal form
This drives not only balance sheet presentation, but
also profit or loss:
If debt: payment of remuneration (whether dividend or
interest) is deducted from profit
If equity: payment of remuneration (whether dividend or
interest) is considered part of profit appropriation
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Liability or Equity?
Ordinary shares
No contractual obligation to pay
dividends
No repayment of the share capital
Loan
Obligation to pay
interest
Repay 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 instruments
Case 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 o
similar 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)
4
151,603
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Example compound financial instrument
On 1 January 2009, a company issues 200K euro of 7% bonds at
par. Interest on these bonds is payable on 31 December each year.
The bonds are due for redemption at par on 31 December 2012 but
may be converted into ordinary shares on that date instead (option
to the holder).
Assuming that the market rate of interest is 9% p.a., how should the
bonds be accounted for on 1 January 2009?
a. Liability 200,000 euro
b. Equity 200,000 euro
c. 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
Journal
Entry
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
32
Conversion of Bonds before Maturity.
CONVERTIBLE DEBT
interest
paid
interest
expense
discount
amortized
discount
account
balance
carrying amount
of 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
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Conversion of Bonds before Maturity.
CONVERTIBLE DEBT
interest
paid
interest
expense
discount
amortized
discount
account
balance
carrying amount
of 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 the
contra-liability used to
determine the correct
carrying amount for the
bond. It is NOT the equity
component. The equity
component remains
unchanged during the life of
the compound instrument
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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
35
See you next week !

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