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Notes Receivable - Measurement and Determination of Interest Expense
Notes Receivable - Measurement and Determination of Interest Expense
Notes Receivable - Measurement and Determination of Interest Expense
Notes are financial assets that give the holder a contractual right to receive the principal amount which is evidenced by an
informal written promise to pay. As to financial statement presentation, notes receivable is usually reported as nontrade
receivable and noncurrent asset.
Initial measurement
Notes receivable are initially measured at present value. However, notes which are realizable within 12 months or which
are made under customary terms are initially measured at their face amount and subsequently measured using cost
method. Present value is the current value of a future sum of money or the discounted cash flow given within specified
rate of return. To compute for the present value factors, the following are the mathematical formulas:
1−(1+ er )−n
PVFA=
er
Present value of ordinary annuity calculates the current value of the equal periodic payments within a specified
number of years and at a specified interest rate.
Notes receivable can be either 1interest-bearing or 2noninterest bearing. Interest bearing notes bears a specified rate of
return called the stated rate or nominal interest rate. While noninterest bearing notes do not bear any rate at all – resulting
that this type of note must be measured at its present value. However, noninterest bearing notes made under customary
terms have present values equivalent to their face amount.
Stated rate or the nominal interest rate is the rate of return that a lender will actually receive throughout the year without
taking into account the compounding of interest. However, financial institutions use the effective interest rate in computing
total interest earned as it results to more reliable and relevant information. Effective interest rate or the prevailing market
interest rate is the rate of return actually earned in investments, loans or other financial instruments due to the result of
compounding. In computing the present value of a receivable, effective interest rate is applied.
Below is the guideline in computing the present value.
Legend:
FA =Principal amount
sr=Stated rate
er =Effective rate
n=Time( years)
Subsequent measurement
1
Notes Receivable – Measurement and Determination of Interest Expense
Notes receivable are subsequently measured using amortization thru effective interest method. Amortization is an
accounting technique in reverting back the present value into its original face amount at the maturity date. However, when
periodic principal payments are required, amortization zero-out the receivable at maturity.
When the stated rate is less than the effective rate sr <er , the note is said to be at discount, i.e. the principal amount is
greater than its present value. In this scenario, interest income gradually increases over the periods because the carrying
amount also increases.
On other hand, the note is said to be at premium when the stated interest rate is greater than the effective rate, sr >er .
The note is at premium when the computed present value is higher than its original amount. In effect, interest income
gradually decreases over time because the carrying amount also decreases.
Principal (A) Interest received (B) Interest income (C) Amortization (D) Carrying amount
FA × sr CA × er ( A+ B )−C PV −D
Above is the amortization table to calculate the carrying amount at year-end. Disregard the “Principal column” if the note
does not require principal payments.
On January 1, 2019, ABC Co. received a promissory note from DEF Co. in exchange for services rendered. The note
amounts to Php180,000 with 8% interest payable after three years. Both the principal and the interest are to be paid at
maturity. The effective interest rate is 10%. Round off decimal places into nearest ten thousandth.
Principal 180,000
+ Interest 43,200 (180,000 x 8% x 3yrs)
Maturity Value 223,200
x PVF1 0.7513
Present Value 167,690.16
In recording the opening journal entry, notes receivable should always be reported at face amount.
January 1, 2019
Notes receivable 180,000.00
Discount on notes 12,309.84
Service revenue 167,690.16
To compute the subsequent measurement of the note, i.e., using the amortization thru effective interest method:
A B C D E
Date Principal Interest received Interest income Amortization Carrying amount
A x sr E x er (A+B)-C PV-D
1/1/2019 167,690.18
12/31/201 16,769.02 -16,769.02 184,459.17
9
12/31/202 18,445.92 -18,445.92 202,905.10
0
12/31/202 20,294.90* -20,294.90 223,200.00
1
*Due to rounding off, the last year’s amortization was adjusted to bring back the note to its original face amount.
The journal entry to be recorded by the entity in relation to its notes receivable:
2
Notes Receivable – Measurement and Determination of Interest Expense
On January 1, 2019, ABC Co. received a promissory note from DEF Co. in exchange for services rendered. The note
amounts to Php180,000 with 8% interest rate. The interest is payable annually and the principal is to be paid on January
1, 2022. The effective interest rate is 10%. Round off present value factors into nearest ten thousandths.
To compute for the initial measurement of the note:
Principal 180,000.00
x PVF1 0.7513
PV of Principal 135,234.00
Interest 14,400.00
x PVFA 2.4869
PV of interest 35,811.36
January 1, 2019
Notes receivable 180,000.00
Discount on notes 8,954.64
Service revenue 171,045.36
To compute the subsequent measurement of the note, i.e., using the amortization thru effective interest method:
A B C D E
Date Principal Interest received Interest income Amortization Carrying amount
A x sr E x er (A+B)-C PV-D
1/1/2019 171,045.36
12/31/201 14,400 17,104.54 -2,704.54 173,749.90
9
12/31/202 14,400 17,374.99 -2,974.99 176,724.89
0
12/31/202 14,400 17,675.11* -3,275.11 180,000.00
1
*Due to rounding off, the last year’s amortization was adjusted to bring back the note to its original face amount.
The journal entry to be recorded by the entity in relation to its notes receivable:
3
Notes Receivable – Measurement and Determination of Interest Expense
Cash 14,400
Discount on notes 3,275.11
Interest income 17,675.11
January 1,2022
Cash 180,000
Notes receivable 180,000
CASE 1.3: Interest and principal are both payable annually. (Advanced Case)
On January 1, 2019, ABC Co. received a promissory note from DEF Co. in exchange for services rendered. The note
amounts to Php180,000 with 8% interest rate compounded annually. The principal is payable equally into three years. The
effective interest rate is 10%. Round off decimal places into nearest ten thousandths.
January 1, 2019
Notes receivable 180,000.00
Discount on notes 6,161.28
Service revenue 173,838.72
To compute the subsequent measurement of the note, i.e., using the amortization thru effective interest method:
A B C D E
Date Principal Interest received Interest income Amortization Carrying amount
A x sr E x er (A+B)-C PV-D
1/1/2019 173,838.72
12/31/201 60,000 14,400 17,383.87 57,016.13 116,822.59
9
12/31/202 60,000 9,600 11,682.26 57,917.74 58,904.85
0
12/31/202 60,000 4,800 5,895.15* 58,904.85 0
1
*Due to rounding off, the last year’s amortization was adjusted to bring back the note to its original face amount.
The journal entry to be recorded by the entity in relation to its notes receivable:
4
Notes Receivable – Measurement and Determination of Interest Expense
On January 1, 2019, ABC Co. received a promissory note from DEF Co. in exchange for services rendered. The note
amounts to Php180,000 which is payable into three equal annual installments. The effective interest rate is 12%. Round
off decimal places into nearest ten thousandths.
Principal 180,000
/ n Years / 3
Annual 60,000
x PVFA 2.4018
Present Value 144,108
January 1, 2019
Notes receivable 180,000.00
Discount on notes 35,892
Service revenue 144,108
To compute the subsequent measurement of the note, i.e., using the amortization thru effective interest method:
A B C D E
Dat Principa Interes Intere Amo Carryin
e l t st rtiza g
receiv inco tion amoun
ed me t
A x sr E x er (A+ PV-D
B)-C
1/1/ 144,10
201 8
9 Q: How much is the interest earned during each year?
12/ 60,000 17,29 42,7 101,40 A: Y1:17,292.96; Y2:12,168.12; Y3: 6,430.92
31/ 2.96 07.0 0.96
201 4 Q: What should be reported as note receivable at the end
9 of each year?
12/ 60,000 12,16 47,8 53,569. A: Y1:101,400.96; Y2:53,569.08; Y3:0
31/ 8.12 31.8 08
202 8
0
12/ 60,000 6,430. 53,5 0
31/ 92* 69.0
202 8
1
*Due to rounding off, the last year’s amortization was adjusted to bring back the note to its original face amount.
The journal entry to be recorded by the entity in relation to its notes receivable:
5
Notes Receivable – Measurement and Determination of Interest Expense
On January 1, 2019, ABC Co. received a promissory note from DEF Co. in exchange for services rendered. The note
amounts to Php180,000 and is due on January 1, 2022. The effective interest rate is 12%. Round off decimal places into
nearest ten thousandths.
Principal 180,000
x PVF1 0.7118
Present Value 128,124
January 1, 2019
Notes receivable 180,000.00
Discount on notes 51,876 Q: How much is the interest earned during each year?
Service revenue 128,124 A: Y1:15,374.88; Y2:17,219.87; Y3: 19,281.25
To compute the subsequent measurement of the note, Q: What should be reported as note receivable at the end
i.e., using the amortization thru effective interest of each year?
method: A: Y1:143,498.88; Y2:160,718.75; Y3:180,000
A B C D E
Date Principal Interest received Interest income Amortization Carrying amount
A x sr E x er (A+B)-C PV-D
1/1/2019 128,124
12/31/201 15,374.88 -15,374.88 143,498.88
9
12/31/202 17,219.87 -17,219.87 160,718.75
0
12/31/202 19,281.25* -19.281.25 180,000
1
*Due to rounding off, the last year’s amortization was adjusted to bring back the note to its original face amount.
The journal entry to be recorded by the entity in relation to its notes receivable: