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MODULE 13

NOTES PAYABLE & DEBT RESTRUCTURING

LEARNING OBJECTIVES: 1. Explain the accounting for long-term notes payable. 2. Describe the accounting for the extinguishment of non-current liabilities. 3. Describe the accounting for the fair value option. OVERVIEW Notes payable is a formal agreement, or promissory note, between your business and a bank, financial institution, or other lender. Unlike accounts payable, which is considered a short-term liability, notes payable can be classified as either a short-term or long-term liability, depending on the repayment terms indicated in the promissory note. Acquiring new knowledge Asynchronous - links to more information: www.farhatlectures.com; http://www.ifrsbox.com A synchronous discussion for this lesson will be scheduled on AUGUST 18, 2020 (Tuesday 7:30 – 8:30 AM)

Definition of Notes Payable The note payable is a written promissory note in which the maker of the note makes an unconditional promise to pay a certain amount of money after a certain predetermined period of time or on demand. The purpose of issuing a note payable is to obtain loan form a lender (i.e., banks or other financial institution) or buy something on credit. The companies usually issue notes payable when they:  purchase merchandise or raw materials inventory from suppliers.  acquire professional services from an individual or a firm.  purchase plant, machinery, equipment, furniture or some other fixed assets.  obtain loan from banks or other financial institutions.  are required to issue a note as a substitution of a past-due account payable. The notes payable are not issued to general public or traded in the market like bonds, shares or other trading securities. They are bilateral agreements between issuing company and a financial institution or a trading partner. Classification of notes payable The notes payable are usually classified in two ways. These are:  short-term and long-term notes payable and  interest-bearing and zero-interest-bearing notes payable. The short term notes payable are classified as short-term obligations of a company because their principle amount and any interest thereon is mostly repayable within one year period. They are usually issued for purchasing merchandise inventory, raw materials and/or obtaining shortterm loans from banks or other financial institutions. The short-term notes may be negotiable which means that they may be transferred in favor of a third party as a mode of payment or for the settlement of a debt.

The short-term notes are current liabilities and their presence impacts the liquidity position of the business. The long term-notes payable are classified as long term-obligations of a company because the loan obtained against them is normally repayable after one year period. They are usually issued for buying property, plant, costly equipment and/or obtaining long-term loans from banks or other financial institutions. On a company’s balance sheet, the long term-notes appear in long-term liabilities section. Interest-bearing and zero-interest-bearing notes payable: An interest-bearing note is a promissory note with a stated interest rate on its face. This note represents the principal amount of money that a lender lends to the borrower and on which the interest is to be accrued using the stated rate of interest. A zero-interest-bearing note (also known as non-interest bearing note) is a promissory note on which the interest rate is not explicitly stated. When a zero-interest-bearing note is issued, the lender lends to the borrower an amount of money which is less than the face value of the note. At maturity, the borrower is required to repay to the lender the amount equal to the face vale of the note. Thus, the difference between the face value of the note and the amount lent by the lender to the borrower is the interest charged by the lender. In other words, we can say that the borrower receives the amount equal to the present value of the note because the present value of a financial instrument is equal to the face value of the instrument less any interest or discount charged by the lender. Accounting The accounting for long term-notes payable are very similar to bonds payable because their principle amount is due on maturity but the interest thereon is usually paid during the life of the note. Extinguishment of Non-Current Liabilities Extinguishment with Cash before Maturity  Reacquisition price > Net carrying amount = Loss  Net carrying amount > Reacquisition price = Gain  At time of reacquisition, unamortized premium or discount must be amortized up to the reacquisition date. Extinguishment by Exchanging Assets or Securities  Creditor should account for the non-cash assets or equity interest received at their fair value.  Debtor recognizes a gain equal to the excess of the carrying amount of the payable over the carrying value of the assets or fair value of equity transferred. Extinguishment with Modification of Terms Creditor may offer one or a combination of the following modifications: 1. Reduction of the stated interest rate. 2. Extension of the maturity date of the face amount of the debt. 3. Reduction of the face amount of the debt.

4. Reduction or deferral of any accrued interest. PFRS requires the modification to be accounted for as an extinguishment of the old note and issuance of the new note, measured at fair value.

Presentation of Non-Current Liabilities Note disclosures generally indicate the nature of the liabilities, maturity dates, interest rates, call provisions, conversion privileges, restrictions imposed by the creditors, and assets designated or pledged as security. Fair value of the debt should be disclosed. Must disclose future payments for sinking fund requirements and maturity amounts of longterm debt during each of the next five years. Analysis of Non-Current Liabilities Two ratios that provide information about debt-paying ability and long-run solvency are: Debt to total asset = Total debt Total Asset The higher the percentage of debt to total assets, the greater the risk that the company may be unable to meet its maturing obligations. Times interest earned = Income before income taxes and interest expense Interest expense Indicates the company’s ability to meet interest payments as they come due.

MODULE # 14 PRACTICAL ACCOUNTING 1 – REVIEW NOTES PAYABLE & DEBT RESRUCTURING PROF. U.C. VALLADOLID Multiple Choice Identify the choice that best completes the statement or answers the question. All answers shall be submitted on or before AUGUST 21, 2020 (Friday) 1. At year-end, De Vera Company issued a 2,000,000 face amount note payable in exchange for services rendered. The note, made at usual trade terms, is due in nine months and bears interest, payable at maturity, at the annual rate of 3%. The market interest rate is 8%. The compound interest factor of 1 due in nine months at 8% is.944. At what amount should be the note payable be reported at year-end? a. 1,888,000 b. 1,930,400 d. 2,060,000 c. 2,000,000

2. Single Club Company had note payable amounting to 6,450,000 to the bank for them to fund their new project on May 1, 2020. The company signed a 4-year note bearing interest @ 6%. On April 30, 2020, the interest is payable in full at its maturity. The note signed was compounded annually. On December 31, 2021, what will be the amount of the accrued interest liability? d. 387,000 a. 410,220 b. 273,480 c. 660,480

3. Minho Company had a 3,200,000 note payable due on June 30, 2020. On December 31, 2019, the entity signed an agreement to borrow up to 3,200,000 to refinance the note payable on a long-term basis. The financing agreement called for borrowing not to exceed 80% of the value of the collateral the entity was providing. On December 31, 2019, the value of the collateral was 2,700,000. On December 31, 2019, what amount of the note payable should be reported as current liability? a. 3,200,000 b. 500,000 c. 2,700,000 d. 1,040,000

4. On January 1, 2021, Eva Co. sold an equipment to Adan Co. Adan gave Eva a 2,400,000 noninterest bearing note payable in three equal annual installment of 800,000 with the first payment due December 31, 2021. The prevailing rate of interest for a note of this type is 10%. The present value of the note is 1,989,600. 1. What is the discount on note payable on January 1, 2021? a. 410,400 b. 2,201,040 c. 400,000

d. 1,790,640

2. What is the interest expense for 2021? a. 240,000 b. 80,000

d. 0

c. 198,960

3. What is the discount on note payable on December 31, 2021? a. 205,200 b. 198,960 c. 211,440 d. 240,000

4. What is the carrying amount of the note payable on December 31, 2021? a. 1,388,560 b. 1,600,000 c. 2,201,040 d. 1,989,600

5. A note payable to the Bank of the Philippine Islands for 2,400,000 is outstanding on December 31, 2020. The note is dated October 1, 2020, bears interest at 18%, and is payable in three equal annual installment of 800,000. The first interest and principal payment was made on October 1, 2021. 1. What should be reported as the current liability? a. 800,000 b. 908,000 c. 72,000

d. 872,000

2. What should be reported as the accrued interest payable? a. 800,000 b. 908,000 c. 72,000

d. 872,000 e. 108,000

6. On January 1, 2020, CARRIE Company borrowed 1,000,000, 9%, interest-bearing note due in five years. The present value of the note is 835,000. The company has elected fair value option for this liability. At the end of the current year, the fair value of the note is 873,000. 1. What is the carrying amount of the note at the end of the year? a. 835,000 b. 873,000 c. 890,000 d. 1,000,000 2. What amount should be reported as interest expense for 2020? a. 75,150 b. 78,570 c. 90,000

d. 91,570

3. What amount should be reported as net gain from change in fair value in 2020? a. 165,000 b. 127,000 c. 38,000 d. 0

7. ACE Company, after having experienced financial difficulties in 2022, negotiated with a major creditor and arrived at an agreement to restructure a note payable on December 31, 2022. The creditor was owned principal of 4,000,000 and interest of 200,000 but agreed to accept equipment worth 900,000 and note receivable from an ACE Company’s customer with a carrying amount of 3,000,000. The equipment had an original cost of 1,200,000 and accumulated depreciation of 500,000. What amount should be recognized as gain from debt extinguishment on December 31, 2020? a. 800,000 b. 200,000 c. 100,000 d. 500,000

8. On December 31, 2020, Phoebe Company shows the following data with respect to its matured obligation. Notes Payable Accrued Interest Payable

5,520,000 680,000

The company is threatened with a court suit if could not pay its maturing debt. Accordingly, the company enters into an agreement with the creditor for the transfer of a non-cash asset in full settlement of the mortgage. The agreement provides for the transfer of real estate carried in the books of Phoebe at 3,000,000. The real estate has a current fair market value of 4,500,000. What total amount should the Phoebe recognize in profit or loss for the year 2020 as a result of this transaction? a. 500,000 b. 1,000,000 c. 1,500,000 d. 3,200,000

9. PCY Enterprises is experiencing financial distress and is negotiating debt restructuring with its creditor to relieve its financial difficulty. PCY Enterprises has a 5,000,000 note payable to SM Financials. SM Financials accepted an equity interest in the form of 10,000 ordinary shares with a par value of 40 and quoted at 45. The fair value of the note payable on the date of restructuring is 4,400,000. What amount should be recognized as gain from extinguishment as a result of equity swap? a. 500,000 b. 600,000 c. 1,000,000 d. No gain is recorded.

10. Moon corp. have a matured notes payable amounting to 3,000,000 plus accrued interest of 750,000. Moon corp. was sued by Sunrise Co. and they both agreed for the issuance of ordinary share capital for the full settlement of the obligation. The agreement provides the following: Issuance of 35,000 shares, 55 par. Market value of the shares, 75 Fair value of the notes payable on date of restructuring, 2,700,000 Using equity-swap, what is the gain/loss from extinguishment of the debt and the share premium from the issuance of the shares? a. 1,825,000; 700,000 b. 1,125,000; 700,000 c. 825,000; 700,000 d. 75,000; 700,000

11. Shift Company entered into agreement with its creditors to reconstruct the terms of its 5,000,000 notes receivable on December 31, 2020. The agreement term is as follows: Reduced the Principal to 3,000,000 Forgiven accrued interest of 500,000 Change the interest rate from 10% to 8% Extended the maturity from December 31, 2020 to December 31, 2025. What is the gain/loss on the modification of the debt? (Use 5 decimal places on PV/Annuity factors) a. 727,450.40 b. 2,772,549.60 c. 2,277,450.40 d. 2,272,549.60

12. On January 1, 2020, Sonic Corp had an overdue 10% notes payable to BDO at 2,300,000 and accrued interest of 540,000. BDO agreed to the following provisions, as a result of a restructuring agreement on year end 2020: -Reduction in principal obligation to 2,000,000 -Accrued interest is not to be paid anymore -Annual interest of 11% is to be repaid for 5 years every year end Present value of 1 at 10% for 5 periods is 0.62. present value of an ordinary annuity of 1 at 10% for 5 periods is 3.79. What is the gain on extinguishment of debt?

a. 766,200

b. 2,840,000

c. 1,330,000

d. 4,350,000

13. Grow Company had bonds payable with a face value of 5,000,000 and a carrying amount of 4,800,000. In addition, unpaid interest on the bonds was accrued in the amount of 250,000. The creditor had agreed to the settlement of the bonds payable in exchange for 50,000 shares of 50 par value. The shares have no reliable measure of fair value. However, the bonds are quoted at 3,500,000. 1. What is the gain on extinguishment of the bonds payable? a. 1,500,000 b. 1,300,000 c. 1,550,000

d. 0

2. What is the share premium from the issuance of the shares? b. 1,000 000 a. 2,300,000 c. 1,500,000

d. 0

14. SPig Company experienced financial distress on 2,000,000. 10% 2 year note payable to Land bank. October 1, 2019, the bank agreed to settle the note and unpaid interest of 750,000 for 2,000,000 cash payable on January 1, 2020. What amount should be reported as gain from extinguishment of debt? a. 85,000 b. 650,000 c. 750,000

d. 0

15. On February 29, 2020, Toben Company borrowed 500,000 on a 10% note payable due on 5 years. On December 31, 2020, the fair value of note is determined to be 487,500 based on market and interest factors. The company elected the fair value option for reporting financial liability. What is the gain or loss to be recognized in 2020 as a result of the fair value option? a. 0 b. 1,250 loss c. 12,500 loss d. 12,500 gain

16. Benjamin Company borrowed 2,000,000 on a 10% five year note payable on July 1, 2019. On December 31, 2019, the fair value of the note is determined to be 1,975,000 based on market and interest factors. The entity has elected the fair value option for reporting the financial liability.

What is the carrying amount of the note payable on December 31, 2019? a. 2,000,000 b. 1,975,000 c. 500,000 d. 1,900,000 17. On December 31, 2021, Juvia Company purchased a machine from Mira Company in exchange for a noninterest bearing note requiring eight payments of 400,000. The first payment was made on December 31, 2021 and the others are due annually on December 31. At date of issuance, the prevailing note of interest for this type of note was 11%. The PV of an ordinary annuity of 1 at 11% for 8 periods is 5.146, and the PV of an annuity of 1 in advance at 11% for 8 periods is 5.712. On December 31, 2021, what is the carrying amount of the note payable? a. 2,284,800 b. 1,884,800 c. 2,058,400 d. 1,658,400

18. Mabuhay Company had notes payable of 3,000,000 and accrued interest payable of 700,000 on December 31, 2020. Mabuhay is threatened with a court suit if it could not pay a maturing debt. Mabuhay entered into an agreement with the creditor for the issuance of share capital in full settlement on the note payable. The agreement provided for the issuance of 20,000 shares, par value 100. The share is currently quoted at 120. The fair value of the notes on the date of restructuring is 2,600,000. What amount should be recognized as gain from extinguishment of debt? a. 1,300,000 b. 1,700,000 c. 400,000 d. 1,100,000

19. My company is in financial trouble and could not meet maturing installments and interest on its bank loan of 5,000,000. The accrued interest on the loan to date is 1,000,000. The entity and the bank agreed on a “dacion en pago” arrangement. Thus, the mortgaged land and building were given by the entity as full payment for the loan including accrued interest. The cost of land is 1,500,000 and the building, 6,000,000v with accumulated depreciation of 1,800,000. The fair value of the land and building is about 5,900,00. Compute the gain or loss on extinguishment of debt. a. 500,000 b. 400,000 c. 300,000

d. 200,000

20. Barbie Company had a bonds payable with face amount of 4,900,000 and accrued interest of 200,000. The carrying amount of the bonds is 4,500,000. The creditor agreed to the settlement of bonds with an exchange of 60,000 shares with a 55 par value. The bonds are quoted at 3,750,000. 1. What amount should be reported as gain on the extinguishment of the bonds payable? a. 1,250,000 b. 1,300,000 c. 1,350,000 d. 1,400,000 2. What amount should be recorded as share premium from the issuance of shares? a. 400,000 b. 450,000 c. 500,000 d. 550,000...