14.2 Long-Term Debt and Equity Instruments: A Review
Since convertible instruments each possess a combination of debt and equity characteristics, the challenge becomes: how to separate, measure, and report the debt and equity attribute for each type of instrument required by the accounting standards.
For complex financial instruments, once an acceptable method to separate the debt from the equity component is determined, each component will follow its respective accounting standard, as discussed in previous chapters.
It is important to understand the substance of debt and equity instruments so that the classification and amounts reported reflect their true underlying economic substance, rather than simply their legal form. Therefore, a review of debt and equity instruments and their characteristics is presented below:
| Long-Term Liabilities (Debt) | Equity (Shares) | |
|---|---|---|
| Examples | Bonds and long-term notes payable | Preferred and common shares |
| Maturity | Principal and accrued interest due on various dates identified in the documentation. | Permanent capital unless repurchased by the company. |
| Secured by and seniority | Usually secured by various company assets. Debt ranks in seniority to shares in terms of windup, bankruptcy, and liquidation. | Unsecured. Shareholders are entitled to whatever assets remain after creditors are paid out. Preferred shares are also senior to common shares. |
| Advantages and disadvantages |
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The schedule below is a summary of the accounting treatment for long-term liabilities (debt) taken from an earlier chapter:
| Financial Liabilities | ASPE | IFRS |
|---|---|---|
| Initial measurement | Fair value as the present value of future cash flows. | Fair value as the present value of future cash flows. |
| Subsequent measurement | Amortized cost unless the fair-value option is chosen. Can choose to use either the effective interest rate or straight-line methods to amortize discounts and premiums. | Amortized cost unless the fair-value option is chosen because it results in more relevant information. The effective interest rate method is the only method allowed to amortize discounts and premiums. |
| Disclosure | Any principal portion of long-term debt due within one year of the reporting date is to be reported under current liabilities as the current portion of long-term debt. Long-term debt that is refinanced may be classified as long-term provided the refinancing is in place by the time the financial reports are issued. | Any principal portion of long-term debt due within one year of the reporting date is to be reported under current liabilities as the current portion of long-term debt. Long-term debt that is refinanced may be classified as long-term provided the refinancing is in place by the reporting date. |
In an earlier chapter we discussed equity—including preferred and common shares. To recap in basic terms, equity shares issuance is accounted for using historical cost, net of any direct costs of the shares issuance such as underwriting costs, accounting and legal fees, and printing costs. Additionally, disclosure includes the number of shares authorized and issued for common and preferred shares. For preferred shares, the per share dividend amount is also disclosed.
