Bond Types and Lease Agreements

• These handouts belong to the reviewer and should not shared without permission.
• The chapter covers accounting for bonds payable, leases, employee benefits, intangible assets, and business combinations and consolidations.

Accounting for Bonds Payable

• A bond is a formal unconditional promise to pay a specified sum of money at a determined future date and to make periodic payments at a stated rate until the principal sum is paid.
• A bond represents a debt contract where the issuer borrows funds from the investor.
• A bond is evidenced by a certificate, and the contractual agreement is contained in a bond indenture.
• The fair value of bonds payable is equal to the present value of future cash payments to settle the liability.
• At year-end, bonds payable are measured at amortized cost using the effective interest method.

Types of Bonds

• Serial bonds mature at different dates, for example, P5,000,000 of serial bonds with P500,000 maturing each year from 5-14 years.
• Term bonds mature at a single date, such as P5,000,000 bonds maturing at the end of year 10.
• Convertible bonds can be exchanged for a fixed number of the company's common stock, generally at the investor's discretion, but some allow the issuing company to decide.
• Registered bonds are issued in the name of a specific owner, allowing automatic interest payments.
• Secured bonds are backed by specific company assets as collateral.
• Owners of secured bonds can require assets to be sold for cash if payments are missed.
• Debenture bonds are unsecured, relying on the issuer's good name and financial stability.
• Subordinated debenture bonds are repaid after other unsecured debt.

Accounting for Leases

• A contract is or contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. [IFRS 16:9]
• Control is conveyed where the customer has both the right to direct the identified asset's use and to obtain substantially all the economic benefits from that use. [IFRS 16:B9]
• An asset is typically identified explicitly in a contract, but can also be implicitly specified when made available.
• Lessors classify each lease as an operating lease or a finance lease. [IFRS 16:61]
• A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset (aka RENT TO OWN).
• Otherwise, a lease is classified as an operating lease [IFRS 16:62]
• Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are: [IFRS 16:63]
• The lease transfers ownership of the asset to the lessee by the end of the lease term
• The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised
• The lease term is for the major part of the economic life of the asset, even if title is not transferred
• At the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset
• The leased assets are of a specialized nature such that only the lessee can use them without major modifications being made

Accounting for Intangible Assets

• An intangible asset is an identifiable non-monetary asset without physical substance.
• An asset is a resource that is controlled by the entity as a result of past events and from which future economic benefits are expected. [IAS 38.8]
• The three critical attributes of an intangible asset are: identifiability, control, and future economic benefits
• Identifiability happens when an intangible asset is separable, that is, capable of being separated and sold, transferred, licensed, rented, or exchanged, or arises from contractual or other legal rights.
• Examples of intangible assets include patented technology, computer software, trademarks, customer lists, and marketing rights.
• Charge all research cost to expense [IAS 38.54]
• Development costs are capitalized only after technical and commercial feasibility of the asset for sale or use have been established [IAS 38.57]
• If an entity cannot distinguish between the research and development phases, treat the expenditure as if it were incurred in the research phase only.
• Research costs includes costs of obtaining new knowledge and costs searching for product technicalities
• Development costs the project is technically feasible to complete, the company intends to complete the project, it is capable of being used/sold and future benefits can be generated, and resources are available to complete it.

Accounting for Employee Benefits

• The objective of IAS 19 is to prescribe the accounting and disclosure for employee benefits, requiring an entity to recognize a liability where an employee has provided service and an expense when the entity consumes the economic benefits of employee service [IAS 19(2011).2]

Short-term employee benefits

• Short-term employee benefits are expected to be settled wholly before twelve months after the end of the annual reporting period during which employee services are rendered, but do not include termination benefits [IAS 19(2011).8]
• Examples include wages, salaries, profit-sharing and bonuses and non-monetary benefits paid to current employees.

Profit-sharing and bonus payments

• An entity recognizes the expected cost of profit-sharing and bonus payments when, and only when, it has a legal or constructive obligation to make such payments as a result of past events and a reliable estimate of the expected obligation can be made [IAS 19.19]

Post-employment benefits

• Post-employment benefit plans are informal or formal arrangements where an entity provides post- employment benefits to one or more employees, e.g., retirement benefits (pensions or lump sum payments), life insurance and medical care.

Termination Benefits

• A termination benefit liability is recognized at the earlier of the following dates [IAS 19.165-168]
• When the entity can no longer withdraw the offer of those benefits - additional guidance is provided on when this date occurs in relation to an employee's decision to accept an offer of benefits on termination, and as a result of an entity's decision to terminate an employee's employment

Accounting for Business Combinations and Consolidations

• IFRS 3 provides additional guidance on determining whether a transaction meets the definition of a business combination, and so accounted for in accordance with its requirements.
• Business combinations can occur in various ways, such as by transferring cash, incurring liabilities, issuing equity instruments (or any combination thereof), or by not issuing consideration at all (i.e. by contract alone) [IFRS 3.B5]
• Business combinations can be structured in various ways to satisfy legal, taxation or other objectives, including one entity becoming a subsidiary of another, the transfer of net assets from one entity to another or to a new entity [IFRS 3.B6]
• The business combination must involve the acquisition of a business, which generally has three elements: [IFRS 3.B7]
• Inputs: an economic resource (e.g., non-current assets, intellectual property) that creates outputs when one or more processes are applied to it
• Process: a system, standard, protocol, convention or rule that when applied to an input or inputs, creates outputs (e.g., strategic management, operational processes, resource management)
• Output: the result of inputs and processes applied to those inputs.

Method of accounting for business combinations - "Acquisition method"

• Steps in applying the acquisition method are: [IFRS 3.5]
• Identification of the 'acquirer'
• Determination of the 'acquisition date'
• Recognition and measurement of the identifiable assets acquired, the liabilities assumed and any non-controlling interest (NCI, formerly called minority interest) in the acquiree
• Recognition and measurement of goodwill or a gain from a bargain purchase
• Method of Consolidation – “LINE BY LINE CONSOLIDATION"

This lesson covers the advantages of registered bonds and the priority of claims for secured and debenture bonds. It also explains the differences between finance and operating leases. It touches on lease conditions and bond valuation.