Long-Term Liabilities Slides

Long-term liabilities
Typical coverage of US GAAP
Bonds payable:

Debt modification and extinguishment

Debt impairment Troubled debt restructurings Reporting long-term debt Disclosures
Types of bonds
Valuation of bonds:

Premiums and discounts Effective interest method Accruing interest Balance sheet classification of discounts and premiums
Long-term notes payable Issuance costs Borrowing costs
Long-term liabilities Academic Resource Center
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Executive summary
IFRS requires that premiums or discounts on debt directly reduce the carrying value of the debt upon initial recognition. US GAAP requires that these amounts are recorded separately.
IFRS requires that transaction (issuance) costs directly reduce the carrying value of the debt. US GAAP requires that these costs are deferred.
IFRS requires third-party costs to be recognized as part of the gain or loss in a debt extinguishment. US GAAP permits the capitalization and amortization of these costs over the term of the new debt. For debt modifications, IFRS permits the entity to adjust the carrying amount of the liability and amortize costs over the term of the modified debt. US GAAP requires that these costs be expensed as incurred.
Long-term liabilities Page 3
Academic Resource Center
Executive summary
IFRS allows upward revisions to the carrying value of an investment in a loan after a write-down. US GAAP does not permit upward revisions. In the event of a debt covenant violation, IFRS allows long-term debt to continue to be classified as long term as long as a waiver is received prior to year-end. US GAAP allows a waiver to be received until the time the financial statements are released, to retain the long-term classification.
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Progress on convergence
There are no significant convergence efforts at this time.
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Bonds payable
Types of bonds
US GAAP Bonds should be evaluated based on the underlying debt instrument.
IFRS Similar
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Bonds payable
Valuation of bonds
US GAAP Bonds are recorded at the present value of future interest and principal payments, which generally equal the cash received by the issuer.
IFRS
Similar
Discounts and premiums on bonds are amortized over the life of the bond using the effective-interest method.
Similar
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Valuation of bonds
Discounts and premiums
US GAAP
IFRS
Upon initial recognition, discounts and premiums are recorded separately.
Upon initial recognition, discounts and premiums are included directly in the carrying amount.
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Discounts and premiums example

Example 1 On December 31, 2010, an airplane manufacturer, Airways, issued $1 million in bonds at 5% annual interest, due December 31, 2013, at a discount of $100,000. Show the journal entries to record the issuance of the bonds on December 31, 2010, using US GAAP and IFRS.
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Discounts and premiums example

Solution: US GAAP:
Cash Discount on bonds payable Bonds payable

IFRS: Cash Bonds payable
$900,000 100,000
$1,000,000
$900,000 $900,000
The discount directly reduces the carrying value for IFRS and is recorded separately for US GAAP.
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Long-term notes payable
US GAAP Notes are recorded at the present value of future interest and principal payments. Discounts and premiums are amortized over the term of the note using the effective-interest method. Amounts due beyond one year of the balance sheet date are classified as long term.
IFRS Similar
Similar
Similar
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Long-term notes payable

Discounts and premiums
US GAAP
IFRS
Upon initial recognition, discounts and premiums are recorded separately.
Upon initial recognition, discounts and premiums are included directly in the carrying amount.
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Fair-value option
US GAAP Upon initial recognition of a debt instrument, an accounting policy choice is allowed to measure the debt instrument at fair value with gains/losses recognized in income. This is referred to as the fair-value option.*
IFRS
Similar
*Note that certain criteria must be met before the fair-value option is used and these differ between US GAAP and IFRS. See the Financial assets module for more details.
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Issuance costs
US GAAP Direct and incremental costs related to the issuance of debt, such as legal fees, accounting fees and banker fees, are not expensed. Internal costs are generally excluded from consideration for capitalization. These costs are referred to as issuance costs.
IFRS
Similar
Similar
Referred to as transaction costs.
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Issuance costs
US GAAP
IFRS
Issuance costs should be recorded as a deferred charge, per ASC 835-30-45-3.
Per IAS 39, transaction costs directly reduce the carrying value of the debt.
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Issuance costs example

Example 2 In conjunction with the bonds issued in example 1, assume Airways incurred bank fees of $100,000, legal fees of $50,000 and salaries of $25,000 for its employees in conjunction with issuing the bonds.
How should Airways record the issuance/transaction costs using US GAAP and IFRS?
Show the journal entries to record the issuance/transaction costs on December 31, 2010, using US GAAP and IFRS.
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Issuance costs example

Solution: Using both US GAAP and IFRS, Airways can capitalize the $100,000 of bank fees and $50,000 of legal fees. Salaries must be expensed as they are internal costs and are not direct and incremental. US GAAP: Unamortized bond issuance costs Cash IFRS: Bonds payable Cash $150,000 $150,000 $150,000 $150,000
The transaction costs directly reduce the carrying value for IFRS and are recorded as a deferred charge for US GAAP.
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Borrowing costs
US GAAP Borrowing costs primarily include interest on borrowings and other costs to acquire debt. Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset can be capitalized. The qualifying asset must take a period of time to complete.
IFRS Similar
Similar Similar, although the period of time to complete should be substantial.
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Borrowing costs
US GAAP Interest capitalization commences and continues as long as expenditures and progress are made to get the asset ready for its intended use.
IFRS
Similar
Capitalizable interest is based on the specific borrowing, if available, or the weighted-average costs of the borrowings and cannot exceed actual interest for the period.
Similar
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Borrowing costs
US GAAP
IFRS
This issue is not discussed.
Per IAS 23, entities may choose to capitalize or expense borrowing costs when the related assets are carried at fair value. When funds borrowed to finance the acquisition of a qualified asset are temporarily invested, the interest cost should be reduced by any investment income earned on these funds.
Interest revenue cannot be netted against interest cost.
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Borrowing costs
US GAAP
IFRS
Exchange rate differences on borrowing costs cannot be included in capitalizable interest costs.
Exchange rate differences related to foreign currency borrowings, to the extent they are an adjustment to interest costs, can be capitalized according to IAS 23.
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Borrowing costs example

Example 3 A large UK-based retail company, Harolds Department Stores, Inc. (HDS), wishes to build a US distribution center on the East Coast. HDS has purchased a suitable piece of land, has arranged for a general contractor to construct the facility and has arranged for a construction loan from a US bank. The facility is expected to cost $30 million and take one year to build. The construction loan is $24 million, bears interest at 8% and borrowings commence at the first draw. Ground is broken on April 1, 2008, and construction is expected to continue until March 31, 2009. The Company uses $6 million of its cash in the first two months of construction and begins borrowing under the construction loan based on the schedule on the next slide. The US bank pays the draws on the loan to HDS in dollars. HDS carries its assets in pounds and the debt borrowings will be paid in pounds. HDS incurs exchange rate gains and losses as scheduled on the next slide.
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HDS temporarily invests the loan borrowings and receives quarterly interest as scheduled below. HDS secures permanent financing on April 1, 2009.
Quarterly interest income received on loan borrowings for the previous quarter $50,000 $75,000
Cash draws from construction loan June 1, 2008 September 1, 2008 January 1, 2009 $10,000,000 $ 6,000,000 $ 8,000,000
Exchange rate loss $(50,000) $(40,000) $(20,000)
April 1, 2009
$25,000
What borrowing costs should HDS capitalize in 2008 and in the first quarter of 2009 using US GAAP and IFRS?
Long-term liabilities Academic Resource Center Page 23

Solution: Calculation of interest costs: 2008

First draw: Second draw:
$10,000,000 x 8% x 3/12 = $200,000 $16,000,000 x 8% x 3/12 = 320,000 $520,000
2009
Third draw:
$24,000,000 x 8% x 3/12 = $480,000
US GAAP: HDS should capitalize $520,000 of borrowing costs in 2008 and $480,000 in the first quarter of 2009. IFRS: HDS should capitalize $485,000 ($520,000 + $90,000 exchange rate losses - $125,000 of interest income) of borrowing costs in 2008 and $475,000 ($480,000 + $20,000 exchange rate losses - $25,000 of interest income) of borrowing costs in the first quarter of 2009.

Modification
US GAAP Debt is modified when there is a nonsubstantial modification of terms for the debt.
IFRS Similar
Modifications should be accounted for prospectively.
Similar
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Extinguishment
US GAAP If a modification of debt terms is considered to be substantial or debt is discharged, the debt is considered to be extinguished and the liability should be derecognized. The difference between the reacquisition price or consideration paid, including any non-cash assets transferred, and the carrying amount of the extinguished debt should be recognized in income.
IFRS
Similar
Similar
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Modification
US GAAP
IFRS
Costs incurred for a debt modification are expensed as incurred.
Costs incurred for a debt modification directly reduce the carrying amount of the debt and are amortized over the remaining term of the modified debt using the effective-interest method.
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Extinguishment
US GAAP
IFRS
US GAAP distinguishes treatment for a significant debt modification when the debtor is viable as compared to nonviable. When the company is non-viable, it may be accounted for as a troubled-debt restructuring as discussed below.
IFRS does not specifically address troubled debt restructuring, but according to IAS 39, paragraph 40, the treatment for a substantial modification is the same as an extinguishment whether or not attributable to the financial difficulty of the debtor.
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Extinguishment
US GAAP
IFRS
Costs incurred to extinguish debt in exchange for significantly modified debt or new debt are deferred and amortized over the remaining term of the modified debt or the term of the new debt, respectively, using the effective-interest method. If no new debt is issued, these costs are expensed as incurred.
IFRS permits extinguishment costs to be recognized as part of the gain or loss on the extinguishment.
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Costs to third parties
Modification costs Costs are expensed as incurred. US GAAP Extinguishment costs Costs are deferred and amortized over the remaining term of the modified debt or term of the new debt if new debt is issued; otherwise, costs are expensed as incurred. Costs are recognized as part of the gain or loss.
IFRS
Costs adjust the carrying amount of the modified debt and are amortized over the remaining term of the modified debt.
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Debt extinguishment example

Example 4 The Tempe Company (Tempe) is a viable entity. On January 1, 2009, Tempe intends to extinguish some long-term notes by calling the long-term notes under the provisions of the note agreement. These notes are for $10 million at 10% annual interest due December 31, 2010. Tempe also has $50,000 in unamortized discount on notes payable, but no other deferred costs attributable to the borrowing or accrued interest. Management issues new debt with a new lender for the same amount and maturity date at 9% annual interest. Management has incurred $100,000 in legal costs to negotiate the extinguishment of the long-term notes payable.
Prepare the journal entries to record the extinguishment of the debt using US GAAP and IFRS. Prepare the journal entries to record the interest expense for 2009 using US GAAP and IFRS (round to the nearest thousand).
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Solution: US GAAP: The unamortized discount on the 10% notes is included in the calculation of the gain or loss on extinguishment. The issuance costs on the 9% notes are recorded as a deferred charge. Long-term notes payable 10% Loss on extinguishment of note Unamortized note issuance costs Unamortized discount on notes payable Cash Long-term notes payable 9% $10,000,000 50,000 100,000 $ 50,000 100,000 10,000,000
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Solution (continued): The issuance costs of $100,000 are amortized over the life of the new debt, which is two years using the effective-interest method. Below is an amortization table showing the new effective-interest rate on the note of 9.5729% and related interest expense.
Beginning carrying value of note* Interest expense at 9.5729% Interest paid at 9% Ending carrying value of note
2009 2010
$ 9,900,000 $ 9,948,000
$ 948,000 $ 952,000
$ 900,000 $ 900,000
$ 9,948,000 $ 10,000,000
*The carrying value is the long-term note payable balance net of the balance of unamortized issuance costs.
Interest expense Cash Unamortized note issuance costs
$948,000 $900,000 48,000


Solution (continued): IFRS: The carrying amount of the 10% bonds of $9,950,000 along with the issuance costs on the 9% notes of $100,000 are both included in the calculation of the gain or loss on extinguishment. Long-term notes payable 10% Loss on extinguishment of note Cash Long-term notes payable 9% $9,950,000 150,000 $ 100,000 10,000,000
The effective-interest is the same as the stated interest at 9%, resulting in recording the interest expense as follows: Interest expense Cash $900,000 $900,000
Debt modification example

Example 5 Assume the same debt situation as in the previous example except that management has been able to modify the interest rate to 9% with the same lender to reflect current market rates. The same legal costs of $100,000 are incurred. Prepare the journal entries to record the modification of the debt using US GAAP and IFRS.
Prepare the journal entries to record the interest expense for 2009 using US GAAP and IFRS (round to the nearest dollar).
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Solution: US GAAP: The unamortized discount on the 10% notes continues to be offset against the carrying value of the 9% notes as a deferred charge. The issuance costs on the 9% notes are recorded as an expense as follows: Legal expense Cash $100,000
$100,000
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Solution (continued): The unamortized discount on the notes payable continues to be amortized using the effective-interest method. Below is an amortization table showing the effective-interest rate on the note of 9.28535% and related interest expense.
Beginning carrying value of note* 2009 2010 $ 9,950,000 $ 9,974,000 Interest expense at 9.28535% $ 924,000 $ 926,000
Interest paid at 9%
$ 900,000 $ 900,000
Ending carrying value of note $ 9,974,000 $ 10,000,000
*The carrying value is the long-term note payable balance net of the balance of unamortized discount.
Interest expense Cash Unamortized discount on notes payable
$924,000
$900,000 24,000

Solution (continued): IFRS: The legal costs of $100,000 would be directly charged against the carrying amount of the note and thus would be amortized over the remaining term of the modified debt. Long-term notes payable 10% Cash Long-term notes payable 9% $9,950,000
$ 100,000 9,850,000
On the next slide is an amortization table showing the effective-interest rate on the note of 9.8627% and related interest expense. Note that amounts are rounded to the nearest thousand.
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Solution (continued):
Beginning carrying value of note
2009 2010 $ 9,850,000 $ 9,921,000
Interest expense at 9.8627%

$ 971,000 $ 979,000*
Interest paid at 9% $ 900,000 $ 900,000
Ending carrying value of note

$ 9,921,000 $ 10,000,000
*Rounded up for presentation purposes.
Interest expense $971,000 Cash Long-term notes payable 9%
$900,000 71,000
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Debt impairment
Debtor
US GAAP A debtor may not reduce the carrying amount of its debt due to the inability to pay, unless its contractual obligations have been legally reduced.
IFRS
Similar
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Debt impairment
Creditor
US GAAP A write-down is required for the difference between the investment in the loan (principal and interest) and one of the following:
IFRS
The expected future cash flows discounted at the loans historical effective-interest rate. The market price of the loan. This can be the fair value of the collateral, if secured.
Similar
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Debt impairment
Creditor
US GAAP
IFRS
Upward revisions to investments in loans are not allowed.
Upward revisions to the carrying value of the investment in the loan are allowed after a write-down if an improvement in credit quality occurs; however, the revised carrying value cannot exceed the cost amount prior to the write-down.
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Debt impairment example

Example 6 Part I: On January 1, 2009, the Desert Bank of Arizona (DBA) extended a three-year loan of $16 million to Royal Resorts Incorporated (RRI), a golf resort in southern Arizona, at a 4% interest rate. Interest is due quarterly on March 31, June 30, September 30 and December 31, with the final balance of the loan ($16 million), plus interest, due on December 31, 2011. The note is secured by a golf resort in southern Arizona with a fair value of $18 million as of January 1, 2009. Interest was paid in 2010 and through March 31, 2011. In the second quarter of 2011, RRI informed DBA that it had significant cash flow problems and would not be able to make the remaining contractual interest payments in 2011, and possibly 2012 or the principal due on December 31, 2012. At June 30, 2011, DBA determined that its loan was impaired because the loan balance outstanding of $16 million, plus accrued interest of $160,000 ($16,000,000 x 4% x 3/12), was not collectible at the current time and the balance of the loan exceeded the fair value of the loan, which was deemed to be $14 million based on the underlying value of the secured collateral.
Using US GAAP and IFRS, how should DBA and RRI reflect the asset and liability, respectively, in their accounting records at June 30, 2011?
What are the corresponding journal entries?
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Part II: Use the same facts as part I but assume that on December 31, 2011, RRI was able to obtain a significant cash infusion and able to pay the interest due to DBA, and thus bring the loan current. Also, assume the prospects of its payment of the principal and interest were not in doubt for 2012.
Show the journal entries to record the payment at December 31, 2011, for both DBA and RRI using US GAAP and IFRS.
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Part I solution: DBA DBA should determine what is the best determination of fair value. In the above situation, fair value is deemed to be the collateral value of the golf resort. DBA should write down the asset for both US GAAP and IFRS, but use a valuation allowance for IFRS to allow for any possible future increase in value (so as not to exceed the carrying amount at June 30, 2010). US GAAP: Loss on loan to RRI Interest income Loan receivable from RRI Interest receivable $2,000,000 160,000 $2,000,000 160,000
To write down the loan receivable from RRI to fair value and to reverse the accrued interest through June 30, 2010. IFRS: Loss on loan to RRI Interest income Allowance for loan receivable from RRI Interest receivable $2,000,000 160,000 $2,000,000 160,000
To write down the loan receivable from RRI to fair value and to establish a corresponding allowance and to reverse the accrued interest through June 30, 2010.
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Part I solution (continued): RRI US GAAP and IFRS: At June 30, 2010, RRI would not change the accounting for the loan, but would recognize the quarterly interest payable of $160,000 and maintain the loan balance outstanding of $16 million because RRI has not discharged its legal obligation on the note to DBA. Interest expense Interest payable $160,000 $160,000
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Part II solution: DBA US GAAP: Cash Interest income $480,000 $480,000
To record the interest from RRI from April 1, 2010 through December 31, 2010 ($16,000,000 x 4% x 9/12). IFRS: Cash Allowance for loan receivable from RRI Interest income Loss on loan to RRI $ 480,000 2,000,000 $ 480,000 2,000,000
To record the interest from April 1, 2010 through December 31, 2010, and to reverse the allowance established at June 30, 2010. RRI
US GAAP and IFRS:

RRI would pay off the accrued interest for the three quarters in 2010. Interest payable Cash $480,000 $480,000
Troubled debt restructuring
US GAAP A debtor may be relieved for part or all of its obligations due to financial hardships from the transfer of assets or equity securities to the creditor or through the modification of debt terms (reducing the interest rate or accrued interest, extending the maturity date or reducing the principal obligation).
IFRS
Similar
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US GAAP
IFRS
Relief of obligations due to financial hardship is referred to as a troubled debt restructuring. SFAS No. 15 (ASC 470-60) requires the following treatment for each type of debt restructuring:
As discussed previously, IFRS does not specifically address troubled debt restructuring and, thus, follows the treatment noted for debt extinguishments.
Transfer of assets a gain or loss is recognized to the extent the fair value of assets transferred exceeds the amount payable, including accrued interest.
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US GAAP
IFRS
Debt restructuring treatment (continued):
Transfer of equity securities the difference between the fair value of the equity and the carrying amount of debt is recognized as a gain or loss. Modification of terms (whether substantial or non-substantial) no gain or loss is recorded and a new effective-interest rate is computed. Creditors would follow the guidance using SFAS No. 114 (ASC 31010-35).
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Troubled debt restructuring example

Example 7 Mikes Industrial Company (MIC) has an unused factory in one of the Midwest states that has a book value and fair value of $8.0 million. MIC obtained a mortgage on the factory five years ago from a New York-based bank and the current balance due to the bank totals $10 million. Interest is being paid currently by MIC; however, MIC currently does not have use for the factory or the revenues to support the debt. After a lengthy negotiation process, MIC will be transferring the underlying property to the bank, along with the payment of $1.5 million. This will discharge MIC from the debt. This is considered a troubled debt restructuring for US GAAP purposes.
Using US GAAP and IFRS, what journal entries would MIC and the bank prepare to record this transaction?
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Solution: This transaction would be accounted for in the same manner using US GAAP or IFRS. MIC Under this scenario, MIC would have a gain on the restructuring, calculated as follows: Mortgage note payable Less: carrying value of the building Less: cash to the bank Gain on discharge of debt $ 10,000,000 (8,000,000) (1,500,000) $ 500,000 The journal entry would be as follows:
Mortgage notes payable $10,000,000 Facility $8,000,000 Cash 1,500,000 Gain on discharge of debt 500,000
To record the settlement of the mortgage note payable to the New York bank and the accompanying transfer of the property.
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Solution (continued): Bank The bank would record a loss on the restructuring calculated as follows: Mortgage receivable Less: fair value of the building Less: cash received Loss on restructuring $ 10,000,000 (8,000,000 (1,500,000) $ 500,000 The journal entry to record the restructuring and loss would be as follows: Facility $8,000,000 Cash 1,500,000 Loan loss 500,000 Mortgage loans receivable $10,000,000 To record the payment and settlement of the mortgage loan from MIC and the transfer of the property.
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Reporting long-term debt
US GAAP Long-term debt is classified as a non-current liability.
IFRS Similar
Debt is classified as long term as long as any debt violations are cured by year-end.
Similar
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Reporting long-term debt
US GAAP
IFRS
The debt can be classified as long term if the violation is cleared before the audited financial statements are issued.
The violation must be cured by year-end to classify the debt as long term.
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Disclosures
US GAAP A detailed listing and description of each significant issue is required, including the amounts outstanding, the type of borrowing, the interest rate, payment terms and final maturity date.
IFRS
Similar
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Long-term liabilities

Typical coverage of US GAAP

Debt modification and extinguishment

Long-term notes payable Issuance costs Borrowing costs

Long-term liabilities Academic Resource Center

Academic Resource Center

Long-term liabilities Academic Resource Center

There are no significant convergence efforts at this time.

Long-term liabilities Academic Resource Center

US GAAP Bonds should be evaluated based on the underlying debt instrument.

Long-term liabilities Academic Resource Center

Long-term liabilities Academic Resource Center

Upon initial recognition, discounts and premiums are recorded separately.

Long-term liabilities Academic Resource Center

Discounts and premiums example

Long-term liabilities Academic Resource Center

Discounts and premiums example

Cash Discount on bonds payable Bonds payable

Long-term liabilities Academic Resource Center

Long-term notes payable

Long-term liabilities Academic Resource Center

Long-term notes payable

Upon initial recognition, discounts and premiums are recorded separately.

Long-term liabilities Academic Resource Center

Long-term liabilities Academic Resource Center

Referred to as transaction costs.

Long-term liabilities Academic Resource Center

Issuance costs should be recorded as a deferred charge, per ASC 835-30-45-3.

Long-term liabilities Academic Resource Center

Issuance costs example

Long-term liabilities Academic Resource Center

Issuance costs example

Long-term liabilities Academic Resource Center

Similar Similar, although the period of time to complete should be substantial.

Long-term liabilities Academic Resource Center

Long-term liabilities Academic Resource Center

This issue is not discussed.

Interest revenue cannot be netted against interest cost.

Long-term liabilities Academic Resource Center

Long-term liabilities Academic Resource Center

Borrowing costs example

Long-term liabilities Academic Resource Center

Borrowing costs example

Exchange rate loss $(50,000) $(40,000) $(20,000)

Borrowing costs example

First draw: Second draw:

$10,000,000 x 8% x 3/12 = $200,000 $16,000,000 x 8% x 3/12 = 320,000 $520,000

$24,000,000 x 8% x 3/12 = $480,000

Debt modification and extinguishment

Modifications should be accounted for prospectively.

Long-term liabilities Academic Resource Center

Debt modification and extinguishment

Long-term liabilities Academic Resource Center

Debt modification and extinguishment

Costs incurred for a debt modification are expensed as incurred.

Long-term liabilities Academic Resource Center

Debt modification and extinguishment

Long-term liabilities Academic Resource Center

Debt modification and extinguishment

Long-term liabilities Academic Resource Center

Debt modification and extinguishment

Long-term liabilities Academic Resource Center

Debt extinguishment example