COLLEGE OF BUSINESS AND ACCOUNTANCY

Topic: Loans Payable

Learning Objectives:
1. Explain the accounting for origination fees on loans payable.

LOANS PAYABLE
Loans payable are obligations supported by a formal promise to pay a certain amount of money at a
specific future date(s). It is similar to note payable, however, the term “loans payable” can be used to connote
bank loans and similar types of financing.

MEASUREMENT
Financial liabilities are initially recognized at fair value minus transaction costs that are directly
attributable to the issuance, except for financial liabilities at FVPL whose transaction costs are expensed
immediately.

Loans transactions usually involve transaction costs compare to notes.

Origination Fees
Origination fee is an upfront fee charged by a lender to cover the costs of processing the loan.
Origination fee comes normally in the form of “service fee” which is a percentage of the principal amount and is
directly deducted from the loan proceeds released to borrower.
Origination fees are deducted from the carrying amount of the loan and subsequently amortized using
the effective interest method.
Origination fees are included in the calculation of the effective interest rate over the expected term of
the loan payable, meaning, on transaction date, the origination fees are treated as adjustment to the effective
interest rate.

ILLUSTRATION 1: Origination Fees

On January 1, 20x1, ABC Co. borrowed P1,000,000 from a bank. The bank charged a 3% loan origination fee.
The principal is due on January 1, 20x4 but 10% interest is due annually starting on January 1, 20x2.

Initial Measurement:
Principal Amount 1,000,000
Origination Fee (1M x 3%) (30,000)
Carrying Amount of Loan, 01/01/20x1 970,000

01/01/20x1 Cash 970,000

Discount on loan payable 30,000
Loan Payable 1,000,000

TRIAL AND ERROR APPROACH

First Trial: (using random rate of 11%)

Future Cash flows PV Factors Present value

Principal 1,000,000 PV of 1 @11%, n=3 731,191
Interest 100,000 PVOA of 1 @11%, n=3 244,371
TOTAL 975,562
Second Trial: (using random rate of 12%)

Future Cash flows PV Factors Present value

Principal 1,000,000 PV of 1 @12%, n=3 711,780
Interest 100,000 PVOA of 1 @12%, n=3 240,183
TOTAL 951,963

To perform interpolation, we will use the following formula:

𝑥% − 11% 970,000 − 975,562 (5,562)

= = = 𝟎. 𝟐𝟑𝟓𝟕
12% − 11% 951,963 − 975,562 (23,599)

The effective interest rate is 11.2357%

Subsequent Measurement
Interest Interest
Date Amortization Present value
Payments Expense
01/01/x1 970,000
01/01/x2 100,000 108,986 8,986 978,986
01/01/x3 100,000 109,996 9,996 988,982
01/01/x4 100,000 111,018 11,018 1,000,000

Comparison between Discount and Premium

DISCOUNT PREMIUM
Carrying Amount < Face Amount Carrying Amount > Face Amount
Effective Interest Rate > Nominal Rate Effective Interest Rate < Nominal Rate

ILLUSTRATION 2: Amount of loan amortization

You want to acquire a car with a cash prize of P2,000,000 through a 12-month auto-loan that requires equal
month-end payments. The effective interest rate is 12%.

Requirements:
a. Amount of monthly payment
b. Total interest expense on the loan

a. Initial measurement:
Future Cash flows (monthly payments) 177,697.58
PV ordinary annuity of ₱1 @1%, n=12 11.255077
Present Value of Loan payable 2,000,000

b. Total interest expense on the loan

Monthly payment 177,697.58
Multiply by: No. of payments on the loan 12___
Total Cash Payments 2,132,370.96
PV of loan on initial recognition (2,000,000.00)
Total interest expense 132,370.96
Amortization Table
Date Monthly Payments Interest Expense Amortization Present value
2,000,000.00
1st Month 177,697.58 20,000.00 157,697.58 1,842,302.42
2nd Month 177,697.58 18,423.02 159,274.56 1,683,027.86
3rd Month 177,697.58 16,830.28 160,867.30 1,522,160.56
4th Month 177,697.58 15,221.61 162,475.97 1,359,684.59
5th Month 177,697.58 13,596.85 164,100.73 1,195,583.85
6th Month 177,697.58 11,955.84 165,741.74 1,029,842.11
7th Month 177,697.58 10,298.42 167,399.16 862,442.95
8th Month 177,697.58 8,624.43 169,073.15 693,369.80
9th Month 177,697.58 6,933.70 170,763.88 522,605.92
10th Month 177,697.58 5,226.06 172,471.52 350,134.40
11th Month 177,697.58 3,501.34 174,196.24 175,938.16
12th Month 177,698.58 1,759.38 175,938.16 -
Totals 2,132,371.96 132,370.93 2,000,000.00

Cost of Bank Loan

Cost of bank borrowing. May be determined in several ways:

Interest
1. Simple Interest Rate for a 1-year loan Borrowed Amount

Net Interest Expense

2. Discounted Interest Rate for a 1-year loan Net Loan Proceeds

Interest
3. Add-on Installment Interest Rate for a 1-year loan Average Borrowed Amount

ILLUSTRATION 3: Cost of Bank Loan

On January 1, 20x1, ABC Co. obtained a P1,000,000, 180-day bank loan at an annual rate of 10%. The loan
agreement requires ABC to maintain a P100,000 compensating balance in its bank account at the lending bank.
ABC would otherwise maintain a balance of only P50,000 in this account. The bank account earns interest at an
annual rate of 2%.

Requirement: Based on a 360-day year, compute for the effective rate of borrowing.

Net Interest Expense

Discounted Interest Rate for a 1-year loan Net Loan Proceeds
180 180
[(1,000,000 x 10% x360)−(50,000 𝑥 2% 𝑥360)
1,000,000−50,000
49,500
= 5.21% effective rate for 180 days
950,000

5.21% x 2 = 10.42% effective rate for 360 days

ILLUSTRATION 4: Loan Payable

On January 1, 20x1, Jaco Co. obtains a P3,000,000 bank loan which is maturing on December 31, 20x3. The
requires payment of 10% interest annually every December 31. The bank charges Jaco Co. a 4.8037%
nonrefundable loan origination fee.

Requirements:
a. Carrying amount of the loan on January 1, 20x1
b. Effective Interest rate on the loan
c. Carrying amount of the loan on December 31, 20x1

Requirement (a):
Loan payable 3,000,000
Transaction costs (3M x 4.8037%) (144,111)
Carrying amount - 1/1/x1 2,855,889

Requirement (b):
Trial and error:

Working formula:
(Principal: 3,000,000 x PV of 1 @ x%, n=3) + (Interest: 300,000 x PV ordinary annuity @ x%, n=3) =
2,855,889

First trial: @12%

Future Cash flows PV Factors Present value
Principal 3,000,000 PV of 1 @12%, n=3 2,135,340
Interest 300,000 PVOA of 1 @12%, n=3 720,549
TOTAL 2,855,889

❖ The effective interest rate is 12%.

Requirement (c):
Date Payments Interest expense Amortization Present value
1/1/x1 2,855,889
12/31/x1 300,000 342,707 42,707 2,898,596
12/31/x2 300,000 347,832 47,832 2,946,428
12/31/x3 300,000 353,572 53,572 3,000,000

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References: INTERMEDIATE ACCTG 2 [by: Millan, Zeus Vernon B. (2021)]