CHAPTER 8

Notes Payable

.
E.F.M
Notes Payable
(References: PAS32, PFRS9)

“A promissory note is an unconditional promise in writing made by one

person to another, signed by the maker, engaging to pay on demand or at a
fixed or determinable future time a sum certain in money to order or to
bearer .”

• Notes payable are obligations supported by debtor promissory notes.

• The accounting for notes payable is similar to accounting for notes

receivable.
 Measurement of Notes Payable

Initial measurement (PFRS9,p. 5.1.1)

• Note payable not designated at fair value through profit or loss shall
be measured initially at fair value minus transaction costs that are
directly attributable to the issue of note payable. (PFRS9, p.5.1.1.)

• Transaction costs are included in the measurement of note payable.

• If the note payable is irrevocably designated at fair value through

profit or loss, the transaction costs are expensed immediately.

• The fair value of the note payable is equal to the present value of
the future cash payments to settle the note liability.
For measurement purposes, notes payable are classified into the
following:
1. Short term payable
2. Long term payable that bears reasonable interest rate
3. Long term payable that bears no interest rate (non interest bearing)
4. Long term payable that bears an unreasonable interest rate
(below-market interest rate)
A short term payable matures in one year or less, while a long term
payable matures beyond one year.
 Subsequent measurement: (PFRS9,p5.3.1)
• After initial recognition, a note payable shall be measured either:

a. At fair value through profit or loss if the note payable is designated

irrevocably at fair value through profit or loss.

a. At amortized cost, using the effective interest method

Amortized cost of note payable

• is the amount at which the note payable is measured initially minus
principal repayment,
• plus or minus the cumulative amortization using the effective interest
method of any difference between the face amount and the present value
of the note payable. PFRS9

The difference between the face amount and present value is either discount or
premium on the issue of the note payable
Notes payable are initially measured at fair value minus transaction
costs. The fair value - present value is determined as follows:

Types of payable Initial measurement Subsequent measurement

1. Short term a. Face amount; or
payable b. Present value
(if the transaction clearly
constitute financing and the
imputed interest rate can be
clearly determined without
undue cost or effort)
2. Long term Face amount
payable with
reasonable interest
rate
a. Face amount or expected
settlement amount if the
initial measurement is
face amount.
b. Amortized cost if the
initial measurement is
present value.
Face amount or expected
settlement amount if the
initial measurement is face
amount
Types of payable Initial measurement Subsequent measurement
3. Long term non Present value Amortized cost
interest bearing payable
4. Long term payable Present value Amortized cost
with unreasonable
interest rate

• If the cash price equivalent is determinable, the note is initially measured at

this amount. The subsequent measurement is amortized cost.

• A note payable may be issued for cash, purchase of goods or services, or

other non cash consideration. Regardless of the consideration received, the
accounting depends on the note’s classification for measurement purposes.
Short term note-note issued solely for cash

Illustrative problem 1:
On April 1, 2020, an entity borrowed P2,000,000 and issued a one
year, note payable. The lender discounted the note at 12%.
(*The term discounted means the lender deducted the 12% interest in advance from the
note. The proceeds from the note are net of the interest deducted in advance.)

The note is due on March 31, 2021.

Analysis: The note is short term and the effect of discounting is

immaterial, therefore the note is initially measured at face amount net
of the advanced interest.
Journal Entries:
April 1, Cash P1,760,000
2020 Discount on Notes Payable(2M x 12%) 240,000
Notes Payable P2,000,000
To record the note payable

Dec. 31, Interest Expense (2M x 12% x 9/12) 180,000

2020 Discount on Bonds Payable 180,000
To record interest expense

March. 31, Interest Expense (2M x 12% x 3/12) 60,000

2021 Discount on Bonds Payable 60,000
To record interest expense

March. 31 Notes Payable 2,0000,000

2021 Cash 2,000,000
To record the settlement of note payable
 Presentation on December 31, 2020

Current Liabilities:
Notes Payable P2,000,000
Less: Discount on Notes Payable 60,000
Carrying amount of Notes Payable P1,940,000

Note:
1. Discount on Notes Payable P240,000
Less: Amortization 180,000
Balance of Discount on Notes Payable P 60,000

2. The note is classified under current liabilities because the note is due 12 months after the
reporting period.
Long term note-Interest bearing note issued for property

Illustrative problem 2:
On April 1, 2020, an entity issued a two year, 12%, P2,000,000 note
payable in exchange for a piece of land. Principal is due on March 31,
2022 but interest is payable annually.

Analysis:
• Type of payable- long term with reasonable interest. The nominal rate of
12% is assumed to be equal to the current market rate on initial recognition
because there is no additional information given in the problem.

Question: What is the initial measurement of the note?

 Journal Entries:

April 1, Land P2,000,000

2020 Notes Payable P2,000,000
To record the note payable

Dec. 31, Interest Expense (2M x 12% x 9/12) 180,000

2020 Interest Payable 180,000
To record the accrued interest

March. 31, Interest Expense (2M x 12% x 3/12) 60,000

. 2021 Interest Payable 180,000
Cash 240,000
To record interest expense

Dec. 31, Interest Expense (2M x 12% x 9/12) 180,000

2021 Interest Payable 180,000
To record the accrued interest
Continuation:
March. 31, Interest Expense (2M x 12% x 3/12) 60,000
2022 Interest Payable 180,000
Cash 240,000
To record interest expense

March. 31 Notes Payable 2,0000,000

2022 Cash 2,000,000
To record the settlement of note payable
 Presentation on December 31, 2020

Current Liabilities:
Interest Payable P 180,000

Non current Liabilities:

Notes Payable P2,000,000

Note: The note is classified under non current liabilities because it is due more than
12 months after the reporting period. The interest is classified under current liabilities
because it is payable annually.
Long term note- Non interest bearing note issued for property

Illustrative problem 3: (lump sum)

On January 1, 2020, an entity acquired a machinery in exchange for

P500,000 cash and a three year, noninterest bearing, P2,000,000 note
payable due on January 1, 2023. The prevailing interest rate is 12%.

Analysis:
• Type of payable- long term non interest bearing (lump sum).

Question: What is the initial and subsequent measurement of the note?

• Initial measurement
Computation of present value of the note:
Face amount P2,000,000
Multiplied by: Present value of P1@12%for 3 periods .71178
Present value of note payable on Jan.1, 2020 P1,423,560

Face amount of the note P2,000,000

Less: Present value of the note 1,423,560
Discount on notes payable P 576,440

Journal entry
Jan. 1, Machinery(cash + PV) P1,923,560
2020 Discount on Notes Payable 576,440
Cash 500,000
Notes Payable P2,000,000
To record the note payable
Analysis:

• The difference between the present value and face amount represents the
discount on notes payable.
• The unamortized balance of the discount is deducted from the face amount when
determining the carrying value of the note.
• The discount on the note payable on initial recognition of a non interest bearing
note represents the total interest expense to be recognized over the term of the
note.
• The machinery is measured at the amount of cash paid plus the present value of
the note issued.
Subsequent measurement
Amortization table

Date Interest Discount on Carrying

expense (A) notes payable (B) amount/PV (C)
Jan. 1, 2020 576,440 1,423,560
Dec. 31, 2020 170,827 405,613 1,594,387
Dec. 31, 2021 191,326 214,287 1,785,713
Dec. 31, 2022 214,287 - 2,000,000

Notes:
• The total interest expense is equal to the total discount on notes payable on initial recognition.
• A= Carrying amount x 12%
• B = Previous balance of discount on notes payable less A
• C = Previous balance of carrying amount plus A or Face amount of 2M less B
Journal entries

Dec. 31, Interest Expense 170,827

2020 Discount on Notes Payable 170,827

Dec. 31, Interest Expense 191,326

2021 Discount on Notes Payable 191,326

Dec. 31, Interest Expense 214,287

2022 Discount on Notes Payable 214,287

Jan. 1, Notes Payable 2,000,000

2023 Cash 2,000,000
Presentation on December 31, 2020

Non current Liabilities:

Notes Payable P2,000,000
Less: Discount on Notes Payable 405,613
Carrying amount of the Notes Payable P1,594,387

Note: The note is classified under non current liabilities because the
note is long term. The subsequent measurement of the note is
amortized cost.
Long term note- Non interest bearing note issued for property

Illustrative problem 4: (installment)

On January 1, 2020, an entity acquired a machinery in exchange for

P500,000 cash and a four year, noninterest bearing, P2,000,000 note payable
due in 4 equal installment payable every December 31. The prevailing
interest rate is 12%.

Analysis:

• Type of payable- long term non interest bearing (installment).

Question: What is the initial and subsequent measurement of the note?

• Initial measurement
Computation of present value of the note:
Annual installment (2M÷ 4 years) P500,000
Multiplied by: Present value of an ordinary
annuity of P1@12%for 4 periods 3.03735
Present value of note payable on Jan.1, 2020 P1,518,675

Face amount of the note P2,000,000

Less: Present value of the note 1,518,675
Discount on notes payable P 481,325

Journal entry
Jan. 1, Machinery(cash + PV) P2,018,675
2020 Discount on Notes Payable 481,325
Cash P 500,000
Notes Payable 2,000,000
Subsequent measurement
Amortization table
(A) (B) (C) (D)
Interest Present value(carrying
Date Payment Expense Amortization amount)

Jan. 1, 2020 1,518,675

Dec. 31, 2020 500,000 182,241 317,759 1,200,916
Dec. 31, 2021 500,000 144,110 355,890 845,026
Dec. 31, 2022 500,000 101,403 398,597 446,429
Dec. 31, 2023 500,000 53,571 446,429 -
Notes:
• The total interest expense is equal to the total discount on notes payable on initial
recognition.
• A= Annual installment of the note
• B = Present value x 12%
• C = A minus B
• D = Previous balance (present value) minus C
Journal entries

Dec. 31, Notes Payable 500,000

2020 Interest Expense 182,241
Cash 500,000
Discount on Notes Payable 182,241

Dec. 31, Notes Payable 500,000

2021 Interest Expense 144,110
Cash 500,000
Discount on Notes Payable 144,110

Dec. 31, Notes Payable 500,000

2022 Interest Expense 101,403
Cash 500,000
Discount on Notes Payable 101,403

Dec. 31, Notes Payable 500,000

2023 Interest Expense 53,571
Cash 500,000
Discount on Notes Payable 53,571
Presentation on December 31, 2020

Current Liabilities:
Notes Payable P 500,000
Less: Discount on Notes Payable 144,110
Carrying amount of the Notes Payable P 355,890

Non current Liabilities:

Notes Payable P1,000,000
Less: Discount on Notes Payable 154,974
Carrying amount of the Notes Payable P 845,026
Note:
• When the principal amount of the note is due on installments, the carrying amount of the note includes
both current and non current portions. These portions are presented separately on the financial
statements
• To determine the current portion, refer to the amortization table. The current portion is the amortization
in the immediately following year.
• The non current portion is the present value in the immediately following year
Long term note- Non interest bearing note issued for property

Illustrative problem 4: (installments due at the start of each year)

On January 1, 2020, an entity acquired a machinery in exchange for

P500,000 cash and a four year, noninterest bearing, P2,000,000 note payable.
The first installment is due January 1, 2020 and the succeeding
installment payable every January 1. The prevailing interest rate is
12%.

Analysis:
• Type of payable- long term non interest bearing (installment in
advance).
• Initial measurement: Present value ( using PV of an annuity due of P1)
• Subsequent measurement: Amortized cost

Question: What is the initial and subsequent measurement of the note?

• Initial measurement
Computation of present value of the note:
Annual installment (2M÷ 4 years) P500,000
Multiplied by: Present value of an annuity due
of P1@12%for 4 periods 3.401830
Present value of note payable on Jan.1, 2020 P1,700,915

Face amount of the note P2,000,000

Less: Present value of the note 1,700,915
Discount on notes payable P 299,085

Journal entry
Jan. 1, Machinery(cash + PV) P2,200,915
2020 Discount on Notes Payable 299,085
Cash P 500,000
Notes Payable 2,000,000
Subsequent measurement
Amortization table
(A) (B) (C) (D)
Interest Present value(carrying
Date Payment Expense Amortization amount)

Jan. 1, 2020 1,700,915

Jan. 1, 2020 500,000 - 500,000 1,200,915
Jan. 1, 2021 500,000 144,110 355,890 845,025
Jan. 1, 2022 500,000 101,403 398,597 446,428
Jan. 1, 2023 500,000 53,572 446,428 -

Notes:
• No interest is recognized on the first installment because interest is incurred only after passage of time.
• The total interest expense is equal to the total discount on notes payable on initial recognition.
• A= Annual payment of the note at the start of each year
• B = Present value x 12%
• C = A minus B
• D = Previous present value minus C
Presentation on December 31, 2020

Non current Liabilities:

Notes Payable P1,500,000
Less: Discount on Notes Payable 154,975
Carrying amount of the Notes Payable P1,345,025

Note:
The carrying amount of the note on Dec. 31, 2020 can be computed also by adding
back the amount of payment on the following day to the Jan. 1 present value:
Carrying amount of note payable, Jan. 1, 2021 P845,025
Add back: Payment on Jan. 1, 2021 500,000
Carrying amount of note payable, Dec. 31, 2020 P1,345,025
Long term note- Note with below-market rate of interest

Illustrative problem 5:

On January 1, 2020, an entity issued a three year, 4%, P2,000,000

note payable in exchange for an equipment. Principal is due on
January 1, 2023 but interest is payable annually every January 1.
The prevailing interest rate is 12%.

Analysis:

• Type of payable- long term payable with unreasonable rate of interest,

the nominal rate of 4% is below the current rate of 12%

• Question: What is the initial and subsequent measurement of the note?

Initial measurement –present value
• Present value factors - PV of P1 for the principal because it is due in lump sum at
maturity date. PV of ordinary annuity of P1 for the interest because they are due
periodically.
Principal P2,000,000
Multiplied by: Present value of P1 @ 12% for 3 periods .71178
Present value of the principal P1,423,560

Periodic Interest (annual Interest payments) P 60,000

Multiplied by: PV of ordinary annuity of P1
@ 12% for 3 periods 2.40183
Present value of annual interest payments 144,110
Total present value (issue price) P1,567,670

Face amount of the note P2,000,000

Less: Present value of the note 1,567,670
Discount on notes payable P 432,330
Subsequent measurement: Amortized cost
Amortization table

(A) (B) (C) (D)

Interest Present value(carrying
Date Payment Expense Amortization amount)

Jan. 1, 2020 1,567,670

Jan. 1, 2021 60,000 188,120 128,120 1,695,790
Jan. 1, 2022 60,000 203,495 143,495 1,839,285
Jan. 1, 2023 60,000 220,715 160,715 2,000,000

Note:
• A= Annual interest payment
• B = Present value x 12%
• C = B minus A
• D = Previous present value plus C
Journal entries

Jan. 1, Equipment P1,567,670

2020 Discount on Notes Payable 432,330
Notes Payable 2,000,000

Dec. 31, Interest Expense 188,120

2020 Discount on Notes Payable 128,120
Interest Payable 60,000

Jan. 1, Interest Payable 60,000

2021 Cash 60,000

Dec. 31, Interest Expense 203,495

2021 Discount on Notes Payable 143,495
Interest Payable 60,000

Jan. 1, Interest Payable 60,000

2022 Cash 60,000

Dec. 31, Interest Expense 220,715

2022 Discount on Notes Payable 160,715
Interest Payable 60,000

Jan. 1, Interest Payable 60,000

2023 Cash 60,000

Jan. 1, Notes Payable 2,000,000

2023 Cash 2,000,000
Presentation on December 31, 2020

Current Liabilities:
Interest Payable P 60,000

Non current Liabilities:

Notes Payable P2,000,000
Less: Discount on Notes Payable 304,210
Carrying amount of the Notes Payable P 1,695,790
 God Bless!
Stay Safe and Healthy!

Sources:
Valix, Conrado T., Peralta, Jose F. and Valix, Christian Aries M. (2020) Intermediate Accounting Volume 2/
Phils: GIC Enterprises (prescribed textbook)
Milan, Zeus Vernon B., Intermediate Accounting 2(2019) (reference textbook)