Intermediate financial accounting II, Non-Current liability

Chapter Two
Non-current liability
Companies may rely on different forms of long-term borrowing, depending on market conditions and the
features of various non-current liabilities. In this chapter, we explain the accounting issues related to non-current
liabilities. The content and organization of the chapter are as follows.
BONDS PAYABLE
Non-current liabilities (sometimes referred to as long-term debt) consist of an expected outflow of resources
arising from present obligations that are not payable within a year or the operating cycle of the company,
whichever is longer. Bonds payable, long-term notes payable, mortgages payable, pension liabilities, and lease
liabilities are examples of non-current liabilities.
A corporation, per its bylaws, usually requires approval by the board of directors and the shareholders before
bonds or notes can be issued. The same holds true for other types of long-term debt arrangements. Generally,
long-term debt has various covenants or restrictions that protect both lenders and borrowers. The indenture or
agreement often includes the amounts authorized to be issued, interest rate, due date(s), call provisions, property
pledged as security, sinking fund requirements, working capital and dividend restrictions, and limitations
concerning the assumption of additional debt. Companies should describe these features in the body of the
financial statements or the notes if important for a complete understanding of the financial position and the
results of operations.

Although it would seem that these covenants provide adequate protection to the long-term debt holder, many
bondholders suffer considerable losses when companies add more debt to the capital structure. Consider what
can happen to bondholders in leveraged buyouts (LBOs), which are usually led by management. In an LBO of
RJR Nabisco (USA), for example, solidly rated 93/8 percent bonds due in 2016 plunged 20 percent in value
when management announced the leveraged buyout. Such a loss in value occurs because the additional debt
added to the capital structure increases the likelihood of default. Although covenants protect bondholders, they
can still suffer losses when debt levels get too high.

Issuing Bonds
A bond arises from a contract known as a bond indenture. A bond represents a promise to pay (1) a sum of
money at a designated maturity date, plus (2) periodic interest at a specified rate on the maturity amount (face
value). Individual bonds are evidenced by a paper certificate and typically have a €1,000 face value. Companies
usually make bond interest payments semi-annually although the interest rate is generally expressed as an
annual rate. As discussed in the opening story, the main purpose of bonds is to borrow for the long term when
the amount of capital needed is too large for one lender to supply. By issuing bonds in €100, €1,000, or €10,000
denominations, a company can divide a large amount of long-term indebtedness into many small investing units,
thus enabling more than one lender to participate in the loan.

A company may sell an entire bond issue to an investment bank, which acts as a selling agent in the process of
marketing the bonds. In such arrangements, investment banks may either underwrite the entire issue by

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Intermediate financial accounting II, Non-Current liability

guaranteeing a certain sum to the company, thus taking the risk of selling the bonds for whatever price they can
get (firm underwriting). Or, they may sell the bond issue for a commission on the proceeds of the sale (best-
efforts underwriting). Alternatively, the issuing company may sell the bonds directly to a large institution,
financial or otherwise, without the aid of an underwriter (private placement).

Types and Ratings of Bonds

a) SECURED AND UNSECURED BONDS. Secured bonds are backed by a pledge of some sort of
collateral. Mortgage bonds are secured by a claim on real estate. Collateral trust bonds are secured by
shares and bonds of other corporations. Bonds not backed by collateral are unsecured. A debenture
bond is unsecured. A “junk bond” is unsecured and also very risky, and therefore pays a high interest
rate. Companies often use these bonds to finance leveraged buyouts.
b) TERM, SERIAL BONDS, AND CALLABLE BONDS. Bond issues that mature on a single date are
called term bonds; issues that mature in instalments are called serial bonds. Serially maturing bonds
are frequently used by school or sanitary districts, municipalities, or other local taxing bodies that
receive money through a special levy. Callable bonds give the issuer the right to call and retire the
bonds prior to maturity.
c) CONVERTIBLE, COMMODITY-BACKED, AND DEEP-DISCOUNT BONDS. If bonds are
convertible into other securities of the corporation for a specified time after issuance, they are
convertible bonds. Two types of bonds have been developed in an attempt to attract capital in a tight
money market—commodity-backed bonds and deep-discount bonds. Commodity-backed bonds (also
called asset-linked bonds) are redeemable in measures of a commodity, such as barrels of oil, tons of
coal, or ounces of rare metal. To illustrate, Sunshine Mining (USA), a silver-mining company, sold
two issues of bonds redeemable with either $1,000 in cash or 50 ounces of silver, whichever is greater
at maturity, and that have a stated interest rate of 8½ percent. The accounting problem is one of
projecting the maturity value, especially since silver has fluctuated between $4 and $40 an ounce since
issuance. Deep-discount bonds, also referred to as zero-interest debenture bonds, are sold at a
discount that provides the buyer’s total interest payoff at maturity.
d) REGISTERED AND BEARER (COUPON) BONDS. Bonds issued in the name of the owner are
registered bonds and require surrender of the certificate and issuance of a new certificate to complete
a sale. A bearer or coupon bond, however, is not recorded in the name of the owner and may be
transferred from one owner to another by mere delivery.
e) INCOME AND REVENUE BONDS. Income bonds pay no interest unless the issuing company is
profitable. Revenue bonds, so called because the interest on them is paid from specified revenue
sources, are most frequently issued by airports, school districts, counties, toll-road authorities, and
governmental bodies.
Valuation of Bonds Payable
The issuance and marketing of bonds to the public does not happen overnight. It usually takes weeks or even
months. First, the issuing company must arrange for underwriters that will help market and sell the bonds. Then,
it must obtain regulatory approval of the bond issue, undergo audits, and issue a prospectus (a document that
describes the features of the bond and related financial information). Finally, the company must generally have

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the bond certificates printed. Frequently, the issuing company establishes the terms of a bond indenture well in
advance of the sale of the bonds. Between the times the company sets these terms and the time it issues the
bonds, the market conditions and the financial position of the issuing corporation may change significantly.
Such changes affect the marketability of the bonds and thus their selling price. The selling price of a bond issue
is set by the supply and demand of buyers and sellers, relative risk, market conditions, and the state of the
economy. The investment community values a bond at the present value of its expected future cash flows,
which consist of (1) interest and (2) principal. The rate used to compute the present value of these cash flows is
the interest rate that provides an acceptable return on an investment commensurate with the issuer’s risk
characteristics. The interest rate written in the terms of the bond indenture (and often printed on the bond
certificate) is known as the stated, coupon, or nominal rate. The issuer of the bonds sets this rate. The stated
rate is expressed as a percentage of the face value of the bonds (also called the par value, principal amount, or
maturity value).
Bv=P/ (1+r)n + I(1- 1/(1+r)n )
r
or Pv of the principal + Pv of an interest payment
P(PVFn,r) + R(PV-OAn,r)
where,
p= the principal amount of the bond
I=simple interest rate
r= effective rate
R=periodic interest payment
n= number of periods
Bonds Issued at Par
If the rate employed by the investment community (buyers) is the same as the stated rate, the bond sells at par.
That is, the par value equals the present value of the bonds computed by the buyers (and the current purchase
price). To illustrate the computation of the present value of a bond issue, assume that Santos Company issues
R$100,000 in bonds dated January 1, 2015, due in five years with 9 percent interest payable annually on January
1. At the time of issue, the market rate for such bonds is 9 percent.
The actual principal and interest cash flows are discounted at a 9 percent rate for five
Periods, as shown below,
Present value of the principal:
R$100,000 x .64993 $ 64,993
Present value of the interest payments:
R$9,000 x 3.88965 35,007
Present value (selling price) of the bonds $100,000
By paying R$100,000 (the par value) at the date of issue, investors realize an effective rate or yield of 9 percent
over the five-year term of the bonds. Santos makes the following entry when it issues the bonds.
January 1, 2015
Cash………….. 100,000
Bonds Payable…………. 100,000

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Intermediate financial accounting II, Non-Current liability

Santos records accrued interest expense of R$9,000 (R$100,000 3 .09) at December 31,
2015 (year-end), as follows.
December 31, 2015
Interest Expense……………..9,000
Interest Payable………………….. 9,000
It records the first interest payment as follows.
January 1, 2016
Interest Payable…………….. 9,000
Cash…………………………9,000
Bonds Issued at Discount or Premium
If the rate employed by the investment community (buyers) differs from the stated rate, the present value of the
bonds computed by the buyers (and the current purchase price) will differ from the face value of the bonds. The
difference between the face value and the present value of the bonds determines the actual price that buyers pay
for the bonds. This difference is either a discount or premium.
• If the bonds sell for less than face value, they sell at a discount.
• If the bonds sell for more than face value, they sell at a premium.
The rate of interest actually earned by the bondholders is called the effective yield
or market rate. If bonds sell at a discount, the effective yield exceeds the stated rate.

Conversely, if bonds sell at a premium, the effective yield is lower than the stated rate. Several variables affect
the bond’s price while it is outstanding, most notably the market rate of interest. There is an inverse relationship
between the market interest rate and the price of the bond.
To illustrate, assume now that Santos issues R$100,000 in bonds, due in five years with 9 percent interest
payable annually at year-end. At the time of issue, the market rate for such bonds is 11 percent.
Present value of the principal:
$100,000 x .59345 $59,345.00
Present value of the interest payments:
R$9,000 x 3.69590 33,263.10
Present value (selling price) of the bonds $92,608.10
By paying R$92,608.10 at the date of issue, investors realize an effective rate or yield of 11 percent over the
five-year term of the bonds. These bonds would sell at a discount of $7,391.90 (R$100,000 2 R$92,608.10).
The price at which the bonds sell is typically stated as a percentage of the face or par value of the bonds. For
example, the Santos bonds sold for 92.6 (92.6% of par). If Santos had received R$102,000, then the bonds sold
for 102 (102% of par).

When bonds sell at less than face value, it means that investors demand a rate of interest higher than the stated
rate. Usually, this occurs because the investors can earn a higher rate on alternative investments of equal risk.
They cannot change the stated rate, so they refuse to pay face value for the bonds. Thus, by changing the amount
invested, they alter the effective rate of return. The investors receive interest at the stated rate computed on the

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face value, but they actually earn at an effective rate that exceeds the stated rate because they paid less than
face value for the bonds.
Effective-Interest Method
As discussed earlier, by paying more or less at issuance, investors earn a rate different than the coupon rate on
the bond. Recall that the issuing company pays the contractual interest rate over the term of the bonds but also
must pay the face value at maturity. If the bond is issued at a discount, the amount paid at maturity is more than
the issue amount. If issued at a premium, the company pays less at maturity relative to the issue price. The
company records this adjustment to the cost as bond interest expense over the life of the bonds through a
process called amortization. Amortization of a discount increases bond interest expense. Amortization of a
premium decreases bond interest expense. The required procedure for amortization of a discount or premium
is the effective interest method (also called present value amortization). Under the effective-interest method,
companies:
1. Compute bond interest expense first by multiplying the carrying value (book value) of the bonds at the
beginning of the period by the effective-interest rate.
2. Determine the bond discount or premium amortization next by comparing the bond Interest expense with the
interest (cash) to be paid.
(Bond Interest Expense) - ( Bond Interest Paid) = Amortization Amount
Carrying Value of Bonds X Effective Interest Rate - Face Amount x Stated Interest rate
Beginning of Period of Bonds

The effective-interest method produces a periodic interest expense equal to a constant percentage of the carrying
value of the bonds.
Bonds Issued at a Discount
To illustrate amortization of a discount under the effective-interest method, Evermaster Corporation issued
€100,000 of 8 percent term bonds on January 1, 2015, due on January 1, 2020, with interest payable each July 1
and January 1. Because the investors required an effective-interest rate of 10 percent, they paid €92,278 for the
€100,000 of bonds, creating a €7,722 discount. Evermaster computes the €7,722 discount as follows
Maturity value of bonds payable €100,000
Present value of €100,000 due in 5 years at 10%, interest payable
Semi-annually P(PVF10,5%); (€100,000 x .61391)………………..€61,391
Present value of €4,000 interest payable semi-annually for 5 years at
10% annually R(PVF-OA10,5%); (€4,000 x 7.72173) …………….. 30,887
Proceeds from sale of bonds (92,278)
Discount on bonds payable € 7,722

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Intermediate financial accounting II, Non-Current liability

 The five-year amortization schedule appears below

Schedule of bond discount amortization
effective-interest method—semi-annual interest payments
5-year, 8% bonds sold to yield 10%

Date Cash Paid Interest Expense Discount Amortized Carrying

Amount of Bonds

1/1/15 92,278

7/1/15 € 4,000a € 4,614b € 614c 92,892d

1/1/16 4,000 4,645 645 93,537

7/1/16 4,000 4,677 677 94,214

1/1/17 4,000 4,711 711 94,925

7/1/17 4,000 4,746 746 95,671

1/1/18 4,000 4,783 783 96,454

7/1/18 4,000 4,823 823 97,277

1/1/19 4,000 4,864 864 98,141

7/1/19 4,000 4,907 907 99,048

1/1/20 4,000 4,952 952 100,000

€40,000 €47,722 €7,722

A) €4,000 = €100,000 x .08 x 6/12 c) €614= €4,614 - €4,000

B) €4,614 = €92,278 x .10 x 6/12 d) €92,892 = €92,278 + €614

Evermaster, records the issuance of its bonds at a discount on January 1, 2015, as

follows.
Cash………………. 92,278
Bonds Payable 92,278
It records the first interest payment on July 1, 2015, and amortization of the discount
as follows.
Interest Expense…………………….. 4,614
Bonds Payable ……………………..614
Cash…………………………………4,000
Because companies pay interest semi-annually, the interest rate used is 5% (10% x 6/12). The number of periods
is 10 (5 years x 2).

Evermaster records the interest expense accrued at December 31, 2015 (year-end),
and amortization of the discount as follows.
Interest Expense……………… 4,645
Interest Payable………… 4,000
Bonds Payable…………… 645
Bonds Issued at a Premium
Now assume that for the bond issue described above, investors are willing to accept an
Effective-interest rate of 6 percent. In that case, they would pay €108,530 or a premium
of €8,530, computed as follows.

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Maturity value of bonds payable ……………………………………………….€100,000

Present value of €100,000 due in 5 years at 6%, interest payable
Semi-annually P(PVF10,3%); (€100,000 x .74409)………...€74,409
Present value of €4,000 interest payable semi-annually for 5 years
at 6% annually R (PVF-OA10,3%); (€4,000 x 8.53020)………34,121
Proceeds from sale of bonds…………………………………………………….. (108,530)
Premium on bonds payable ………………………………………………………€ 8,530

The five-year amortization schedule appears below

Schedule of bond premium amortization
effective-interest method—semi-annual interest payments
5-year, 8% bonds sold to yield 6%

Date Cash Paid Interest Expense Premium Amortized Carrying

Amount of Bonds

1/1/15 €108,530

7/1/15 € 4,000a € 3,256b € 744c 107,786d

1/1/16 4,000 3,234 766 107,020

7/1/16 4,000 3,211 789 106,231

1/1/17 4,000 3,187 813 105,418

7/1/17 4,000 3,162 838 104,580

1/1/18 4,000 3,137 863 103,717

7/1/18 4,000 3,112 888 102,829

1/1/19 4,000 3,085 915 101,914

7/1/19 4,000 3,057 943 100,971

1/1/20 4,000 3,029 971 100,000

€40,000 €31,470 €8,530

a€4,000 = €100,000 x .08 x 6/12 c€744 = €4,000- €3,256

b€3,256 = €108,530 x .06 x 6/12 d€107,786 = €108,530 - €744

Evermaster records the issuance of its bonds at a premium on January 1, 2015, as

follows.
Cash……………… 108,530
Bonds Payable………………. 108,530
Evermaster records the first interest payment on July 1, 2015, and amortization of
the premium as follows.
Interest Expense………………. 3,256
Bonds Payable…………………744
Cash……………………………….4,000

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Intermediate financial accounting II, Non-Current liability

Evermaster should amortize the discount or premium as an adjustment to interest expense over the life of the
bond in such a way as to result in a constant rate of interest when applied to the carrying amount of debt
outstanding at the beginning of any given period.

LONG-TERM NOTES PAYABLE

The difference between current notes payable and long-term notes payable is the maturity date. Short-term
notes payable are those that companies expect to pay within a year or the operating cycle—whichever is longer.
Long-term notes are similar in substance to bonds in that both have fixed maturity dates and carry either a stated
or implicit interest rate. However, notes do not trade as readily as bonds in the organized public securities
markets. Non-corporate and small corporate enterprises issue notes as their long-term instruments. Larger
corporations issue both long-term notes and bonds. Accounting for notes and bonds is quite similar. Like a
bond, a note is valued at the present value of its future interest and principal cash flows. The company
amortizes any discount or premium over the life of the note, just as it would the discount or premium on a
bond.

Mortgage Notes Payable

A common form of long-term notes payable is a mortgage note payable. A mortgage note payable is a
promissory note secured by a document called a mortgage that pledges title to property as security for the loan.
Individuals, proprietorships, and partnerships use mortgage notes payable more frequently than do corporations.
(Corporations usually find that bond issues offer advantages in obtaining large loans.)

The borrower usually receives cash for the face amount of the mortgage note. In that case, the face amount of
the note is the true liability, and no discount or premium is involved. When the lender assesses “points,”
however, the total amount received by the borrower is less than the face amount of the note.9 Points raise the
effective-interest rate above the rate specified in the note. A point is 1 percent of the face of the note.

For example, assume that Harrick Co. borrows $1,000,000, signing a 20-year mortgage note with a stated
interest rate of 10.75 percent as part of the financing for a new plant. If Associated Savings demands 4 points to
close the financing, Harrick will receive 4 percent less than $1,000,000—or $960,000—but it will be obligated
to repay the entire $1,000,000 at the rate of $10,150 per month. Because Harrick received only $960,000 and
must repay $1,000,000, its effective-interest rate is increased to approximately 11.3 percent on the money
actually borrowed.

On the statement of financial position, Harrick should report the mortgage note payable as a liability using a title
such as “Mortgage Notes Payable” or “Notes Payable— Secured,” with a brief disclosure of the property

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pledged in notes to the financial statements. Mortgages may be payable in full at maturity or in instalments over
the life of the loan. If payable at maturity, Harrick classifies its mortgage payable as a non-current liability.
Points, in mortgage financing, are analogous to the original issue discount of bonds.
on the statement of financial position until such time as the approaching maturity date warrants showing it as a
current liability. If it is payable in instalments, Harrick shows the current instalments due as current liabilities,
with the remainder as a non-current liability. Lenders have partially replaced the traditional fixed-rate
mortgage with alternative mortgage arrangements. Most lenders offer variable-rate mortgages (also called
floating rate or adjustable-rate mortgages) featuring interest rates tied to changes in the fluctuating market rate.
Generally, the variable-rate lenders adjust the interest rate at either one- or three-year intervals, pegging the
adjustments to changes in the prime rate or the London Interbank Offering (LIBOR) rate.
Extinguishment of Non-Current Liabilities
How do companies record the payment of non-current liabilities—often referred to as extinguishment of debt?
If a company holds the bonds (or any other form of debt security) to maturity, the answer is straightforward: The
company does not compute any gains or losses. It will have fully amortized any premium or discount and any
issue costs at the date the bonds mature. As a result, the carrying amount, the maturity (face) value, and the fair
value of the bond are the same. Therefore, no gain or loss exists. In this section, we discuss extinguishment of
debt under three common additional situations:
1. Extinguishment with cash before maturity,
2. Extinguishment by transferring assets or securities, and
3. Extinguishment with modification of terms.
Extinguishment with Cash before Maturity
In some cases, a company extinguishes debt before its maturity date. The amount paid on extinguishment or
redemption before maturity, including any call premium and expense of reacquisition, is called the
reacquisition price. On any specified date, the carrying amount of the bonds is the amount payable at
maturity, adjusted for unamortized premium or discount. Any excess of the net carrying amount over the
reacquisition price is a gain from extinguishment. The excess of the reacquisition price over the carrying
amount is a loss from extinguishment. At the time of reacquisition, the unamortized premium or discount
must be amortized up to the reacquisition date.
Note that it is often advantageous for the issuer to acquire the entire outstanding bond issue and replace it with a
new bond issue bearing a lower rate of interest. The replacement of an existing issuance with a new one is called
refunding. Whether the early redemption or other extinguishment of outstanding bonds is a non-refunding or a
refunding situation, a company should recognize the difference (gain or loss) between the reacquisition price
and the carrying amount of the redeemed bonds in income of the period of redemption.
Extinguishment by Exchanging Assets or Securities
In addition to using cash, settling a debt obligation can involve either a transfer of noncash assets (real estate,
receivables, or other assets) or the issuance of the debtor’s shares. in these situations, the creditor should
account for the non-cash assets or equity interest received at their fair value.

The debtor must determine the excess of the carrying amount of the payable over the fair value of the assets or
equity transferred (gain).The debtor recognizes a gain equal to the amount of the excess. In addition, the debtor

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recognizes a gain or loss on disposition of assets to the extent that the fair value of those assets differs from their
carrying amount (book value).

Transfer of Assets. Assume that Hamburg Bank loaned €20,000,000 to Bonn Mortgage Company. Bonn, in
turn, invested these monies in residential apartment buildings. However, because of low occupancy rates, it
cannot meet its loan obligations. Hamburg Bank agrees to accept from Bonn Mortgage real estate with a fair
value of €16,000,000 in full settlement of the €20,000,000 loan obligation. The real estate has a carrying value
of €21,000,000 on the books of Bonn Mortgage. Bonn (debtor) records this transaction as follows.

Notes Payable (to Hamburg Bank)…...... 20,000,000

Loss on Disposal of Real Estate
(€21,000,000 2 €16,000,000)…………. 5,000,000
Real Estate …………………..21,000,000
Gain on Extinguishment of Debt
(€20,000,000 2 €16,000,000)…4,000,000
Bonn Mortgage has a loss on the disposition of real estate in the amount of €5,000,000 (the difference between
the €21,000,000 book value and the €16,000,000 fair value). In addition, it has a gain on settlement of debt of
€4,000,000 (the difference between the €20,000,000 carrying amount of the note payable and the €16,000,000
fair value of the real estate).

Granting of Equity Interest. Now assume that Hamburg Bank agrees to accept from Bonn Mortgage 320,000
ordinary shares (€10 par) that have a fair value of €16,000,000, in full settlement of the €20,000,000 loan
obligation. Bonn Mortgage (debtor) records this transaction as follows.
Notes Payable (to Hamburg Bank)……….20,000,000
Share Capital—Ordinary…….. 3,200,000
Share Premium—Ordinary …...12,800,000
Gain on Extinguishment of Debt..4,000,000
It records the ordinary shares issued in the normal manner. It records the difference
between the par value and the fair value of the shares as share premium.
Extinguishment with Modifi cation of Terms
Practically every day, the Wall Street Journal or the Financial Times runs a story about some company in
financial difficulty, such as Nakheel (ARE) or Parmalat (ITA). In many of these situations, the creditor may
grant a borrower concessions with respect to settlement. The creditor offers these concessions to ensure the
highest possible collection on the loan. For example, a 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.

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As with other extinguishments, when a creditor grants favourable concessions on the terms of a loan, the debtor
has an economic gain. Thus, the accounting for modifications is similar to that for other extinguishments. That
is, the original obligation is extinguished, the new payable is recorded at fair value, and a gain is recognized for
the difference in the fair value of the new obligation and the carrying value of the old obligation.

To illustrate, assume that on December 31, 2015, Morgan National Bank enters into a debt modification
agreement with Resorts Development Company, which is experiencing financial difficulties. The bank
restructures a ¥10,500,000 loan receivable issued at par (interest paid to date) by:
• Reducing the principal obligation from ¥10,500,000 to ¥9,000,000;
• Extending the maturity date from December 31, 2015, to December 31, 2019; and
• Reducing the interest rate from the historical effective rate of 12 percent to 8 percent.
Given Resorts Development’s financial distress, its market-based borrowing rate is 15 percent.
IFRS requires the modification to be accounted for as an extinguishment of the old note
and issuance of the new note, measured at fair value.
Present value of restructured cash flows:
Present value of 9,000,000 due in 4 years at 15%,
interest payable annually P(PVF4,15%);
(9,000,000 x .57175) ………………………………………………..5,145,750
Present value of 720,000 interest payable annually
for 4 years at 15% R(PVF-OA4,15%);
(720,000 x 2.85498)…………………………………………………2,055,586
Fair value of note ……………………………………………………..7,201,336

An exception to the general rule is when the modification of terms is not substantial. A substantial
modification is defined as one in which the discounted cash flows under the terms of the new debt (using the
historical effective-interest rate) differ by at least 10 percent of the carrying value of the original debt. If a
modification is not substantial, the difference (gain) is deferred and amortized over the remaining life of the debt
at the (historical) effective-interest rate. In the case of a non-substantial modification, in essence, the new loan
is a continuation of the old loan. Therefore, the debtor should record interest at the historical effective-interest
rate. The gain on the modification is ¥3,298,664, which is the difference between the prior carrying value
(¥10,500,000) and the fair value of the restructured note, as computed in.
Resorts Development makes the following entry to record the modification.
Notes Payable (old)………………. 10,500,000
Gain on Extinguishment of Debt ……..3,298,664
Notes Payable (new)…………………. 7,201,336

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