Accounting for Debt Instruments (Liabilities) (Portfolio 5105)

BNA Tax and Accounting Portfolio 5105-2nd, Accounting for Debt Instruments (Liabilities), analyzes the accounting and reporting of long-term debt and other debt instruments. 

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This Portfolio is part of the Accounting Policy and Practice Series, an essential resource including more than 70 accounting Portfolios and the latest news and developments.


BNA Tax and Accounting Portfolio 5105-2nd, Accounting for Debt Instruments (Liabilities), analyzes the accounting and reporting of long-term debt and other debt instruments. This Portfolio is written from the standpoint of the issuer of debt instruments, i.e., the issuer of bonds, notes, and other long-term instruments promising to repay money borrowed by the issuer of the debt instrument. BNA Tax and Accounting Portfolio 5106, Kohlbeck, Accounting for Investments in Debt Securities, addresses the subject from the perspective of an investor in debt instruments.
Discussion in the Portfolio applies to companies whose accounting and financial reporting is subject to U.S. Generally Accepted Accounting Principles as promulgated by the Financial Accounting Standards Board, the FASB's predecessors, and the U.S. Securities and Exchange Commission. Each section focuses on specific pronouncements that affect the accounting for issues covered in that section, but the Portfolio highlights interrelationships among pronouncements.
The Portfolio is organized as follows: Section I and Section II discuss the common terms and economic concepts relating to debt instruments and their definitions. The terms are presented in a logical, rather than an alphabetical sequence, and are intended as a resource supporting other sections of the Portfolio. Section III distinguishes between debt liabilities and equity, Section IV discusses the classification of liabilities on the balance sheet, and Section V discusses the recording a debt liability. The final three Sections address principles and issues associated with equity-linked debt instruments, hedging of debt liabilities, and the exchange, modification, extinguishment, conversion, and restructuring of debt.
The Portfolio is designed to be a building block in the BNA Accounting Policy and Practice Series. Hence, other Portfolios may cover certain topics in greater depth. For example, Section V discusses certain aspects of ASC 815, however, BNA Tax and Accounting Portfolio 5112, Johnson & Grossman, Accounting and Disclosure for Derivative Instruments analyzes ASC 815 and related issues in greater depth.
This Portfolio may be cited as BNA Tax and Accounting Portfolio 5105-2nd, Keinan, Accounting for Debt Instruments (Liabilities) (Accounting Policy and Practice Series).


Yoram Keinan, S.J.D.

Yoram Keinan, LL.B., LL.M., M.B.A., M.P.A., S.J.D. Mr. Keinan practices in the New York City office of Greenberg Traurig. Before joining Greenberg Traurig, Mr. Keinan was with Ernst & Young, LLP (E&Y) in Washington, D.C., where he advised major investment banks and financial institutions. Mr. Keinan has also practiced law with Shearman & Sterling and worked with E&Y in Israel. Mr. Keinan has authored numerous articles and teaches at the University of Michigan Law School, Georgetown University Law Center, and American University, Washington College of Law. He has also taught at Harvard University's International Tax Program, Kennedy School of Government, and School of Arts and Sciences (Department of Economics).

With expert commentary from a CPA's perspective by Richard E. Lillie, Ed.D., CPA

Richard E. Lillie, BS, MAS, Ed.D., CPA (California), has more than 30 years of experience in local, regional, and international CPA firms. Dr. Lillie serves as an Assistant Professor of Accounting in the Department of Accounting and Finance, College of Business and Public Administration, California State University, San Bernardino. Dr. Lillie has dedicated much of his time in recent years to innovating the teaching and training of accounting students.

Table of Contents

Detailed Analysis

I. Glossary of Relevant Terms

Introductory Material

A. What is "Debt"?

B. General Definitions That Apply to All Types of Debt Instruments

1. Borrower/Issuer/Debtor

2. Lender/Holder/Creditor

C. Security

D. Debt Security

1. What is a Debt Security?

2. Debt That is Not a "Security"

E. Debt Payable/Receivable

F. Debt vs. Future Sale of Revenue

G. Different Types of Debt Instruments

1. Classification Based on the Term of the Debt

a. Bond

b. Registered/Bearer Form

c. Note (or Promissory Note)

2. Classification Based on Maturity

a. A Line of Credit (or Revolving Loan)

b. Commercial Paper

c. Term/Redeemable/Perpetual Loan

d. Refinancing, Restructuring, and Modifications of Debt Instruments

e. Installment Loan (or a Self-Amortizing Loan)

f. Demand Loan

3. Classification Based on Collateral/Security

a. Senior/Subordinated Debt

b. Secured Debt

c. Collateral

d. Recourse Debt

e. Non-Recourse Debt

f. Debenture

4. Classification Based on the Identity of the Issuer

a. Corporate Bond

b. United States Government Securities

c. Treasury Bills

d. Treasury Notes

e. Treasury Bonds

f. Municipal Bonds

5. Classification Based on Embedded Features

a. Group 1: Plain Vanilla Debt Instruments

(1) Fixed-Rate Debt Instruments

(2) Zero Coupon Bonds

(3) Combination of Discount and Current Interest

(4) Floating Rate Debt Instruments

(5) Reset Bonds

(6) Interest-Only Strips

b. Group 2: Debt With an Embedded Derivative

(1) Derivative

(a) Freestanding Derivative

(b) Embedded Derivative

(2) Convertible Instruments

(a) Convertible Security

(b) Convertible Debt

(3) Stepped (or Increasing) Interest Rate Bonds

(4) Floating Rate Debt Instruments With Embedded Features

(a) Inverse Floating Debt Instrument

(b) Inflation-Indexed Bonds

(5) Callable and Puttable Debt: Debt With an Embedded Option (Call or Put)

(a) Callable Debt (Debt With an Embedded Written Call Option)

(b) Puttable Debt (Debt With an Embedded Sold Put Option)

(c) Clearly and Closely Related Standard for Puts and Calls

(6) Exchangeable Debt Instruments

(7) Contingent Payment Debt Instruments

(a) Stock-Indexed Notes

(b) Embedded Derivatives

(c) Contingent Convertible Debt

c. Group 3: Investment Units

(1) Asset-Backed Securities

(a) Securitization

(b) Mortgage-Backed Securities

(2) Securities Lending Transactions

(3) Sale-Repurchase (Repo) Transactions

II. Economic Concepts Pertaining to Debt Instruments

Introductory Material

A. Principal

B. Interest

1. Calculation of Simple Interest

2. Payment-in-Kind

3. Coupon

4. Basis Point

C. Using Cash Flow Information and Present Value in Accounting Measurements

1. Application of CON 7

2. Discount Rate Adjustment Technique or the "Traditional Approach"

3. The Application of CON 7 to Liabilities

4. The "Interest Method"

D. Effective Rate (or Yield-to-Maturity)

E. Internal Rate of Return

F. Compounding of Interest/Future Value

1. Compounding of Interest

2. Future Value

3. Future Value of a Series of Payments

G. Present Value

1. General

2. Present Value of a Series of Payments

H. Issue Price/Carrying Amount

I. Discount and Premium

1. When Discounts or Premiums Arise

2. Discount

3. Market Discount

4. Bond Premium

5. Amortization of Discount and Premium

J. Carrying Amount of a Debt Liability

III. Distinguishing Between Debt Liabilities and Equity

A. Liability vs. Equity

B. Definitions

C. Background for Resolving More Complex Issues

D. Example: MIPS

E. Example: Surplus Notes

F. Financial Instruments Having Characteristics of Both Liabilities and Equity

1. Scope of FAS 150

a. Mandatorily Redeemable Financial Instruments

b. An Obligation to Repurchase the Issuer's Equity Shares by Transferring Assets

c. An Obligation to Issue a Variable Number of Shares

2. Mandatorily Redeemable Financial Instruments

a. What Constitutes "Mandatorily Redeemable"?

b. Measurement and Recognition of Mandatorily Redeemable Instruments

3. Example: Trust Preferred

4. Example: Redemption by Amount Differing From Book Value

5. International Standards

a. Mandatorily Redeemable Preferred Stock

b. Puttable Instruments

c. Bifurcation of Compound Financial Instruments

IV. Balance Sheet Classification of Liabilities

A. Background

1. Revised Distinction

2. Evolution of Accounting Principles

B. Implications of Classification as Current or Long-Term Liabilities

C. Current Liabilities

D. Classifying a Debt Liability as Current or Long-Term

E. Debt With a Term Exceeding One Year That Should Be Treated as Current

1. Callable Debt

2. Increasing-Rate Debt

3. Redeemable Instruments Subject to Remarketing Agreements

F. Debt With a Term of Less Than One Year That Should Be Treated as Long-Term

1. Short-Term Obligations Expected to Be Refinanced

a. General

b. Example: FIN 8

2. Long-Term Liabilities With Acceleration Clauses

V. Recording a Debt Liability

Introductory Material

A. Rules of General Application

1. Issuance

2. Unamortized Discount and Premium

B. Debt Issued at Par With Total Principal Due at Maturity

1. Debt Issued on Interest Payment Date (No Short of Long Periods)

2. Debt Issued at Par Between Interest Payment Dates (Initial Short Period)

C. Debt Issued With Discount or Premium With Total Principal Due at Maturity

1. Overview

2. Recording of Debt Issued With Discount or Premium

a. Discount

b. Premium

D. Self-Amortized Bonds

E. Debt Issue Costs

F. Debt Issued for Property, Goods, or Services

1. General

2. Arm's-Length Transaction

3. Non-Arm's-Length Transaction

VI. Equity-Linked Debt Instruments

A. Evaluation of Standards

B. Definitions

1. Convertible Security

2. Convertible Debt

C. The Benefits of Issuing Convertible Debt

1. Issuer Perspective

2. Holder Perspective

D. Variations of Convertible Debt Instruments

1. Contingent Convertibles

2. Exchangeable Debt Instruments

3. Mandatory Convertibles (Investment Units)

E. Treatment of "Traditional" Convertible Debt vs. Investment Units

1. Convertible Debt as a Single Instrument

2. Investment Units

a. Debt Plus Warrant

b. Debt Issued With a Forward Contract (Feline PRIDES)

F. The Conversion Feature as a Derivative Under FAS 133

1. Requirement to Bifurcate and Account for the Derivative Separately

2. Embedded Derivatives

G. Additional Implications Imposed by EITF Issue 00-19

1. Scope

a. Contracts Classified as Equity

b. Contracts Classified as Assets or Liabilities

2. Convertible Debt Classification

3. FAS 150's Impact on the Conclusion of EITF Issue 00-19

H. Convertible Bonds With Issuer Option to Settle for Cash Upon Conversion

1. Convertible Bonds With Issuer Option to Settle for Cash Upon Conversion Prior to December 15, 2008

2. Convertible Bonds With Issuer Option to Settle for Cash Upon Conversion After December 15, 2008

3. Convertible Securities With Beneficial Conversion Features or Contingently Adjustable Conversion Ratios

I. Exchangeable Debt

1. Debt Exchangeable Into Equity of an Unrelated Entity

a. Example in EITF 85-9

b. Example: PHONES

2. Debt Exchangeable Into a Related Party's Stock

J. Dilutive Effect of Issuing a Convertible Debt

1. General

2. Dilutive Effect of Convertible Debt

K. Contingent Payment Debt Instruments

1. General

2. Stock-Indexed Notes

3. Debt Instruments With Variable Principal Amount

4. Contingent Convertible Debt

a. In General

b. Debt Instrument Convertible When Issuer Calls the Debt

L. Disclosure of Equity-Linked Debt Instruments

VII. Hedging of Debt Liabilities

Introductory Material

A. Hedging Principles

1. General

a. Derivative

b. Hedging Effectiveness

2. Treatment of Hedging Transactions

a. Fair Value Hedges

b. Cash Flow Hedges

3. Types of Risks That Can Be Hedged

a. Market Price Risk

b. Market Interest Rate Risk

4. Summary of the Basic Hedging Principles

B. Hedging of Debt Liabilities

1. General

2. Hedging Existing Debt Liability

3. Hedging of Future Debt Liability

a. General

b. Hedging of Interest Rate Risk

c. Hedges of Debt Liabilities

VIII. Exchange, Modification, Extinguishment, Conversion, and Restructuring of Debt

Introductory Material

A. Definitions

B. Extinguishment of Debt

1. General

2. Early Extinguishment of Debt

a. Scope

b. Measuring Gains and Losses Upon Extinguishments

(1) In General

(2) Accounting for the Conversion of an Instrument That Became Convertible by the Issuer's Exercise of a Call Option

c. Timing of Recognition of Gains and Losses

d. Extinguishment of Convertible Debt

e. Conversion of Convertible Debt

f. Classification of Gains and Losses Upon Non-Refunding of Debt Instruments

(1) General Rule

(2) Extraordinary Items

g. Extinguishment of Hedged Debt

C. Exchange and Modification ("Refunding") of Debt Instruments

1. General

2. Debtor's Accounting for a Modification or Exchange of Debt Instruments

a. The Issues

b. Background

c. Similar Treatment of Exchanges and Substantial Modifications

d. "Substantial" Modification

e. Non-Substantial Modification

3. Modifications: Special Situations

a. Debtor's Accounting for a Modification of Debt Terms

b. Modification of a Line of Credit

c. Modifications of Convertible Debt

d. Previously Bifurcated Conversion Option No Longer Meeting the Bifurcation Criteria for a Derivative

4. Timing of Gain or Loss Recognition in Refunding Situations

a. Amortization Over the Remaining Original Life of the Extinguished Debt

b. Amortization Over the Life of the New Debt

c. Recognition Currently in Income as a Loss or Gain

D. Troubled Debt Restructuring

1. Background

2. Economic Characteristics

3. What Constitutes a Troubled Debt Restructuring

4. Accounting for Debt Restructuring: Fundamental Principles

5. Accounting by Debtors

a. Transfer of Assets in Full Settlement

b. Grant of Equity Interest in Full Settlement

c. Classification of the Gain

d. Modification of Terms: Yield Adjustment

e. Contingent Payments

f. Fees and Other Costs

g. Disclosure

6. Exchanging of Old Debt for New Debt With the Same Creditors

7. Determining Whether a Debtor's Modification or Exchange of Debt Instruments Falls Within FAS 15

a. Determinative Factors

b. Determining Whether the Debtor is Experiencing Financial Difficulties

c. Determining Whether the Creditor Granted a Concession

Working Papers

Working Papers


Worksheet 1 Glossary, Abbreviations, and Acronyms

Worksheet 2 EITF Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock

Worksheet 3 EITF Issue No. 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments

Worksheet 4 EITF Issue No. 96-19, Debtor's Accounting for a Modification or Exchange of Debt Instruments

Worksheet 5 EITF Issue No. 86-30, Classification of Obligations When a Violation Is Waived by the Creditor

Worksheet 6 EITF Issue No. 86-15, Increasing-Rate Debt

Worksheet 7 EITF Issue No. 90-19, Convertible Bonds With Issuer Option to Settle for Cash Upon Conversion

Worksheet 8 Excerpt (from APB Opinion 21, ¶ 18)

Worksheet 9 Fair Value Hedge of Fixed-Rate Debt With an Interest Rate Swap (FAS 133, ¶ 111-120)

Worksheet 10 Fair Value Hedge of a Fixed-Rate Non-Callable Debt With an Interest Rate Swap (FAS 133, ¶ ¶ 120A-120D)

Worksheet 11 Cash Flow Hedge of Forecasted Floating Rate Debt With an Interest Rate Swap (FAS 133, ¶ ¶ 153-61)

Worksheet 12 Yield Adjustments (FAS 15, ¶ ¶ 117-18)

Worksheet 13 Contingent Convertible Debt With a Market Price Trigger (EITF Issue No. 04-8)

Worksheet 14 Contingently Convertible Debt With a Market Price Trigger That Requires Settlement of the Principal Amount of the Debt in Cash Upon Conversion (EITF Issue No. 04-8)

Worksheet 15 List of Significant Accounting Pronouncements Principally Discussed

Worksheet 16 FASB Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement)



Securities and Exchange Commission

SEC Accounting Series Releases

SEC Staff Accounting Bulletins


American Institute of Certified Public Accountants

Accounting Research Bulletins

Accounting Principles Board Opinions

Accounting Principles Board Statements

Audit and Accounting Guides

Emerging Issues Task Force

EITF Issues

EITF Abstract Topics

Financial Accounting Standards Board

FASB Concept Statements

FASB Financial Accounting Standards

FASB Interpretations

FASB Preliminary Views

FASB Staff Positions

FASB Statement No. 133 Implementation Issues

FASB Technical Bulletins

International Accounting Standards



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