IAS 32, 39, IFRS 7, 9 - Long-Term Liabilities

IAS 32 and 39, IFRS 7 and 9 - Long-term liabilities
Executive summary
Under IFRS, the accounting standards in the area have evolved in a cohesive fashion and are
contained in four pronouncements (IAS 1, IAS 23, IAS 32 and IAS 39) with a fifth
pronouncement, IFRS 9 , Financial Instruments to take effect in January 2013. Under US
GAAP, the accounting standards in this area have evolved with many different
pronouncements, but are now codified in the Accounting Standards Codification.
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.
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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 by year-end. US
GAAP allows a waiver to be received until the time the financial statements are
released, to retain the long-term classification.

Progress on convergence
The FASB and the IASB are working on two projects which will
impact long-term liabilities. The first project is fair value
measurement and the second project is the accounting for
financial instruments.
In April 2011, the FASB issued an ASU, Fair Value Measurement,
which amends ASC 820 and the IASB issued IFRS 13, Fair Value
Measurement, a new pronouncement. The releases are essentially
identical, with only minor differences, and have the same definition of
fair value (an exit price). The releases do not create any new
accounting requirements, but bring consistency in defining how fair
value is applied to other accounting pronouncements that call for fair
value measurement. The amendments to ASC 820 are effective for
interim and annual periods beginning after December 15, 2011. The
effective date for IFRS 13 is January 1, 2013 with earlier application
permitted.

The accounting for financial instruments project, which has been ongoing for a number of
years, is nearing completion. Although this is a convergence project, the Boards are taking
slightly different approaches to developing their respective standards, with the objective of
converging the standards in 2011.
The FASB issued a comprehensive proposed ASU, Accounting for Financial Instruments and
Revisions to the Accounting for Derivative Instruments and Hedging Activities, in May 2010. The
comment period ended on September 30, 2010.
On January 31, 2011, the FASB and the IASB proposed a common solution for impairment
accounting, Supplementary Document Accounting for Financial Instruments and Revisions to the
Accounting for Derivative Instruments and Hedging Activities Impairment. The comment period
ended on April 1, 2011 and the Board will deliberate the comments that were received.
On February 9, 2011, the FASB issued a DP, Invitation to Comment Selected Issues about Hedge
Accounting. The comment period ended on April 25, 2011.
The FASB board will consider all of the above comments and responses, deliberate with the IASB
Board and then develop a new pronouncement on financial instruments.

The IASB has taken a more piecemeal approach to the project by dividing it into three phases:
Phase 1 Classification and Measurement of Financial Assets and Liabilities
The IASB issued the asset section in November 2009 and the liability section in October 2010. These now
comprise chapters 1-5 and chapter 7 of IFRS 9, Financial Instruments, which is not effective until January 2013.
Reference should be made to the Financial Assets module for an overview of IFRS 9 as it pertains to financial assets.
In the appendix to this module there is an overview of the liabilities section of IFRS 9, which is basically a carryover of the
accounting for liabilities from IAS 39.
Phase 2 Impairment Methodology
The IASB issued an ED on Impairment in November 2009 and the comment period ended on June 30, 2010.
On January 31, 2011, the IASB issued the supplementary document mentioned above. The IASB Board will be
deliberating on the comments received from this supplementary document.
Phase 3 Hedge Accounting.
In December 2010, the IASB issued an ED, Hedge Accounting, with the comment period ending on March 9,
2011. Additional information was added to this ED in February 2011, and comments received to date. On
March 29, 2011, an Outreach Summary was released and the IASB is continuing to deliberate this phase of the
project. This phase will also be deliberated with the FASB.

Bonds payable
Valuation of bonds
US GAAP IFRS
Bonds are presented on the balance sheet at the

present value of future interest and principal payments, Similar
which generally equal the cash received by the issuer.
Discounts and premiums on bonds are amortized

over the life of the bond using the effective-interest Similar
method.

Long-term notes payable
US GAAP IFRS
Notes are presented on the balance sheet at the

present value of future interest and principal payments. Similar
Discounts and premiums are amortized over the

Similar
term of the note using the effective-interest method.
Amounts due beyond one year of the balance

Similar
sheet date are classified as long term.

Fair-value option
US GAAP IFRS
Upon initial recognition of a debt instrument, an

accounting policy choice is allowed to measure
the debt instrument at fair value with Similar
gains/losses recognized in income. This is
referred to as the fair-value option (FVO).*
*Note that certain criteria must be met before the FVOis used and these differ between US GAAP and
IFRS. As noted in the appendix, the application of the FVO under IFRS 9 is consistent with the
application of the FVO stated here under IAS 39.

Issuance costs
US GAAP IFRS
Direct and incremental costs related to the

issuance of debt, such as legal fees, accounting Similar
fees and banker fees, are not expensed.
Internal costs are generally excluded from

Similar
consideration for capitalization.
These costs are referred to as issuance

Referred to as transaction costs.
costs.

Issuance costs
US GAAP IFRS
Issuance costs should be recorded as a Per IAS 39, transaction costs directly
deferred charge, per ASC 835-30-45-3. reduce the carrying value of the debt.

Issuance costs example
Example 1
On December 31, 2011, an airplane manufacturer, Airways, issued $1 million in bonds at 5% annual interest, due December 31,
2014, at par. 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.
Describe how Airways should record the

issuance/transaction costs using US GAAP and IFRS?
Show the related journal entries.

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. The transaction
costs directly reduce the carrying value for IFRS and are recorded as a deferred charge for US GAAP.
US GAAP:
Cash $825,000
Salary expense 25,000
Unamortized bond issuance costs 150,000
Bonds payable $1,000,000
IFRS:
Cash $825,000
Salary expense 25,000
Bonds payable $850,000

Debt modification and extinguishment
Modification
US GAAP IFRS
Debt is modified when there is a non-

Similar
substantial modification of terms for the debt.
Modifications should be accounted for

prospectively.
Similar

Extinguishment
US GAAP IFRS
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 Similar
be derecognized.
The difference between the reacquisition price or

consideration paid, including any non-cash assets
transferred, and the carrying amount of the
Similar
extinguished debt should be recognized in income.

Modification
US GAAP IFRS
Costs incurred for a debt modification are Costs incurred for a debt modification
expensed as incurred. directly reduce the carrying amount of the
debt and are amortized over the remaining
term of the modified debt using the
effective-interest method.

Extinguishment
US GAAP IFRS
US GAAP distinguishes treatment for a IFRS does not specifically address
significant debt modification when the troubled debt restructuring, but according
debtor is viable as compared to non- to IAS 39, paragraph 40, the treatment for
viable. When the company is non-viable, it a substantial modification is the same as
may be accounted for as a troubled-debt an extinguishment whether or not
restructuring as discussed below.
attributable to the financial difficulty of the
debtor.

Extinguishment
US GAAP IFRS
Costs incurred to extinguish debt in IFRS permits extinguishment costs to be
exchange for significantly modified debt or recognized as part of the gain or loss on
new debt are deferred and amortized over the extinguishment.
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.

Costs to third parties
Modification costs Extinguishment costs

Costs are expensed as Costs are deferred and amortized
incurred. over the remaining term of the
modified debt or term of the new
US GAAP debt if new debt is issued;
otherwise, costs are expensed as
incurred.
Costs adjust the carrying Costs are recognized as part of

amount of the modified debt the gain or loss.
IFRS and are amortized over the
remaining term of the
modified debt.

Debt extinguishment example
Example 3
The Tempe Company (Tempe) is a viable entity. On January 1, 2011, 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, 2012. 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
2011 using US GAAP and IFRS (round to the nearest
thousand).

Example 3 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% $10,000,000

Loss on extinguishment of note 50,000
Unamortized note issuance costs 100,000
Unamortized discount on notes payable $ 50,000
Cash 100,000
Long-term notes payable 9% 10,000,000

Example 3 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 Interest Ending

carrying value expense Interest paid carrying value
of note* at 9.5729% at 9% of note
2011 $ 9,900,000 $ 948,000 $ 900,000 $ 9,948,000
2012 $ 9,948,000 $ 952,000 $ 900,000 $10,000,000
*The carrying value is the long-term note payable balance net of the balance of unamortized issuance costs.
Interest expense $948,000

Cash $900,000
Unamortized note issuance costs 48,000

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.

Loss on extinguishment of note 150,000
Cash $ 100,000
The effective-interest is the same as the stated interest at 9%, resulting in recording the interest expense as
follows:

Cash $900,000

Debt modification example
Example 4
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 2011 using US GAAP and IFRS (round to
the nearest dollar).

Example 4 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 $100,000

Cash $100,000

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.

of note* at 9.28535% at 9% of note
2011 $ 9,950,000 $ 924,000 $ 900,000 $ 9,974,000
2012 $ 9,974,000 $ 926,000 $ 900,000 $10,000,000
*The carrying value is the long-term note payable balance net of the balance of unamortized discount.

Cash $900,000
Unamortized discount on notes payable 24,000

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.

Cash $ 100,000
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.

Solution 4 (continued):

of note at 9.8627% at 9% of note
2011 $ 9,850,000 $ 971,000 $ 900,000 $ 9,921,000
2012 $ 9,921,000 $ 979,000* $ 900,000 $10,000,000
*Rounded up for presentation purposes.

Cash $900,000
Long-term notes payable 9% 71,000

Debt impairment
Debtor
US GAAP IFRS
A debtor may not reduce the carrying amount of

its debt due to the inability to pay, unless its
Similar
contractual obligations have been legally
reduced.

Debt impairment
Creditor
US GAAP IFRS
A write-down is required for the difference

between the investment in the loan (principal
and interest) and one of the following:
The expected future cash flows discounted Similar
at the loans historical effective-interest rate.
The market price of the loan. This can be
the fair value of the collateral, if secured.

Debt impairment
Creditor
US GAAP IFRS
Upward revisions to investments in loans Upward revisions to the carrying value of
are not allowed. 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.

Debt impairment example
Example 5
Part I:
On January 1, 2011, 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, 2013. The note is secured by a golf resort in southern Arizona with a fair value of $18 million as
of January 1, 2011.
Interest was paid in 2010 and through March 31, 2013. In the second quarter of 2013, RRI informed DBA that it had significant cash flow problems and
would not be able to make the remaining contractual interest payments in 2012, and possibly 2013 or the principal due on December 31, 2013.
At June 30, 2012, 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, 2012?
What are the corresponding journal entries?

Example 5 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, 2012).
US GAAP:
Loss on loan to RRI $2,000,000
Interest income 160,000
Loan receivable from RRI $2,000,000
Interest receivable 160,000
To write down the loan receivable from RRI to fair value and to reverse the accrued interest through June 30, 2012.
IFRS:
Loss on loan to RRI $2,000,000
Interest income 160,000
Allowance for loan receivable from RRI $2,000,000
Interest receivable 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, 2012.

Example 5 Part I solution (continued):
RRI
US GAAP and IFRS:
At June 30, 2012, 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 payable $160,000

Example 5 Part II:

Use the same facts as part I but assume that on December 31, 2012,
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 2013.
Show the journal entries to record the payment at

December 31, 2012, for both DBA and RRI using US GAAP
and IFRS.

Example 5 Part II solution:
DBA
US GAAP:
Cash $480,000
Interest income $480,000
To record the interest from RRI from April 1, 2012 through December 31, 2012 ($16,000,000 x 4% x 9/12).
IFRS:
Cash $ 480,000
Allowance for loan receivable from RRI 2,000,000
Interest income $ 480,000
Loss on loan to RRI 2,000,000
To record the interest from April 1, 2012 through December 31, 2012, and to reverse the allowance established at June 30, 2012.
RRI
US GAAP and IFRS:
RRI would pay off the accrued interest for the three quarters in 2012.
Interest payable $480,000

Cash $480,000

Troubled debt restructuring
US GAAP IFRS
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 Similar
(reducing the interest rate or accrued interest,
extending the maturity date or reducing the
principal obligation).

US GAAP IFRS
Relief of obligations due to financial As discussed previously, IFRS does not
hardship is referred to as a troubled debt specifically address troubled debt
restructuring. restructuring and, thus, follows the
SFAS No. 15 (ASC 470-60) requires the treatment noted for debt extinguishments.
following treatment for each type of debt
restructuring:
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.

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 310-
10-35).

Troubled debt restructuring example
Example 6
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 a 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?

Example 6 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 The journal entry would be as follows:
restructuring, calculated as follows:
Mortgage note payable $10,000,000 Mortgage notes payable $10,000,000

Less: carrying value of the building (8,000,000) Facility $8,000,000
Less: cash to the bank (1,500,000) Cash 1,500,000
Gain on discharge of debt $ 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.

Bank
The bank would record a loss on the restructuring The journal entry to record the restructuring and loss would
calculated as follows: be as follows:
Mortgage receivable $10,000,000 Facility $8,000,000

Less: fair value of the building (8,000,000 Cash 1,500,000
Less: cash received (1,500,000) Loan loss 500,000
Loss on restructuring $ 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.

Reporting long-term debt
US GAAP IFRS
Long-term debt is classified as a non-current

Similar
liability.
Debt is classified as long term as long as any debt

violations are cured by year-end.
Similar

Reporting long-term debt
US GAAP IFRS
The debt can be classified as long term if The violation must be cured by year-end
the violation is cleared before the audited to classify the debt as long term.
financial statements are issued.

Disclosures
US GAAP IFRS
A detailed listing and description of each significant

issue is required, including the amounts
outstanding, the type of borrowing, the interest Similar
rate, payment terms and final maturity date.

IFRS 9, Financial Instruments
In November 2009, the IASB issued the first chapters of IFRS 9, Financial
Instruments, which dealt with the classification and measurement of financial
assets. In October 2010, the IASB issued additional chapters that dealt with
classification and measurement of financial liabilities. The objective of IFRS 9
is to establish principles for the financial reporting of financial assets and
liabilities that will be relevant and useful in assessing amounts, timing and
uncertainty of an entitys future cash flows. It will become effective on
January 1, 2013, with earlier application permitted.

Under IFRS 9, financial liabilities are initially recognized at their fair value plus
or minus, in the case of a financial liability not at fair value through profit or
loss, transaction costs that are directly attributable to the issuance of the
financial liability.
Subsequent to initial recognition, financial liabilities are measured at amortized
cost using the effective interest method, except for:
Financial liabilities at fair value through profit or loss, including derivatives that are
liabilities.
Financial liabilities that arise when a transfer of a financial asset does not qualify for
derecognition.
Financial guarantee contracts.
Commitments to provide a loan at below-market interest rates.

FVO: Financial liabilities may also be measured at fair value through profit or
loss, if, at initial recognition, the financial liability is so designated to be
measured at fair value because of either of the following scenarios:
The accounting eliminates or reduces an accounting mismatch.
A group of liabilities is managed on a fair value basis for risk management or investment
strategy purposes.
For FVO liabilities, the change in the fair value of a liability that is attributable
to changes in credit risk must be presented in OCI. The remainder of the
change in fair value is presented in profit or loss. However, if the change in
the credit risk in OCI would create or enlarge an accounting mismatch, the
change is reported in profit or loss.

IAS 32, 39, IFRS 7, 9 - Long-Term Liabilities

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IAS 32 and 39, IFRS 7 and 9 - Long-term liabilities

Long-term liabilities Page 2

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IFRS allows upward revisions to the carrying value of an investment in a loan

Long-term liabilities Page 3

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Bonds are presented on the balance sheet at the

Discounts and premiums on bonds are amortized

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Notes are presented on the balance sheet at the

Discounts and premiums are amortized over the

Amounts due beyond one year of the balance

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Upon initial recognition of a debt instrument, an

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Direct and incremental costs related to the

Internal costs are generally excluded from

These costs are referred to as issuance

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Describe how Airways should record the

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Debt is modified when there is a non-

Modifications should be accounted for

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If a modification of debt terms is considered to be

The difference between the reacquisition price or

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Modification costs Extinguishment costs

Costs adjust the carrying Costs are recognized as part of

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Prepare the journal entries to record the extinguishment of

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Long-term notes payable 10% $10,000,000

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Example 3 solution (continued):

Beginning Interest Ending

2012 $ 9,948,000 $ 952,000 $ 900,000 $10,000,000