COLLEGE OF BUSINESS AND ACCOUNTANCY

Topic: Notes Receivable

Learning Outcomes:
1. State the initial and subsequent measurements of notes receivable.
2. Compute for present value factors and apply them properly.
3. Prepare amortization tables.
4. Compute for the effective interest rate.

Core Value/Biblical Principles:

Leviticus 25:35-37 ESV
“If your brother becomes poor and cannot maintain himself with you, you shall support him as though he were a
stranger and a sojourner, and he shall live with you. Take no interest from him or profit, but fear your God, that
your brother may live beside you. You shall not lend him your money at interest, nor give him your food for
profit.

Learning Activities and Resources:

So far, our discussion of receivables has focused solely on accounts receivable. Companies, however, can
expand their business models to include more than one type of receivable. This receivable expansion allows a
company to attract a more diverse clientele and increase asset potential to further grow the business.

Introduction:
Notes receivable are a balance sheet item that records the value of promissory notes that a business is owed
and should receive payment for. A written promissory note gives the holder, or bearer, the right to receive the
amount outlined in the legal agreement.

Body:

NOTES RECEIVABLE
Notes receivable is a claim supported by a formal promise to pay a certain sum of money at a specific
future date usually in the form of a promissory note.
A note can be a negotiable instrument that a maker signs in favor of a designated payee who may
legally and readily sell or otherwise transfer the note to others.

MEASUREMENT
Financial assets are initially recognized at fair value plus transaction costs.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.

Transaction costs are incremental costs that are directly attributable to the issue of a financial liability. An
incremental cost is one that would not have been incurred if the entity had not issued the instrument.

CLASSIFICATION OF NOTES RECEIVABLE

TYPES OF RECEIVABLES Initial Measurement Subsequent Measurement

Face Amount
Recoverable Historical Cost
Present Value (w/ significant financing)
Short Term Amortized Cost
Transaction Price (Trade Rec. w/
Transaction Price (PFRS 15)
practical expedient)
Long-term bearing
Face Amount Recoverable Historical Cost
reasonable interest rate
Long-term noninterest-
Present Value Amortized Cost
bearing receivables
Long-term bearing
Present Value Amortized Cost
unreasonable interest rate
If the initial measurement is cash price equivalent of the non-cash asset given up, the subsequent measurement is
amortized costs.
PFRS 15: Exceptions on trade receivables
1. Trade receivables that do not have a significant financing component shall be measured at their
transaction price.
2. As a practical expedient, a trade receivable may not be discounted if it is due within 1 year.

Cash price equivalent is the amount that would have been paid if the transaction was settled outright on
cash basis, as opposed to installment basis or other deferred settlements.

Recoverable Historical Cost (Net Realizable Value)

Represents the amount of cash expected to be recovered from the principal amount of the receivable.
It is computed as the face amount of the receivable minus subsequent repayments of principal and minus any
reduction (directly or through the use of allowance account) for impairment or uncollectability.

Amortized Cost
the amount at which the financial asset or financial liability is measured at initial recognition minus
the principal repayments, plus or minus the cumulative amortization using the effective interest method of
any difference between that initial amount and the maturity amount and, for financial assets, adjusted for any
loss allowance.

Effective interest rate (imputed rate of interest, current market rate or yield rate) more determinable of
either:
a. The prevailing interest rate for a similar instrument of an issuer with a similar credit rating; or
b. A rate of interest that discounts the face (nominal) amount of the receivable to the current cash
sales price of the goods or services.

Stated interest rate (nominal rate, coupon rate, or face rate)

the rate appearing on the face of an interest-bearing note.

The difference between the present value and the face amount of the receivable is initially recognized as
unearned interest and subsequently amortized as interest income under the effective interest method.

Effective Interest Method is a method of calculating the amortized cost of financial asset or financial liability
and of allocating the interest income or interest expense over the relevant period.

TIME VALUE OF MONEY

1. Future Value of an Amount vs. (FV of ₱1)

 The FV of ₱1 and PV of ₱1 are opposites.
 The FV of ₱1 answers the question “If I invest ₱100,000 today at 10% interest, how much money
do I have in three-years’ time?”
 FV of ₱1 = (1 + i) n = (1 + 10%)3 = 1.331
Answer: (₱100,000 x 1.331) = ₱133,100 or (₱100,000 x 110% x 110% x 110%) = ₱133,100

2. Present Value of Future Amount (PV of ₱1)

 The PV of ₱1 answers the question “If I want to have ₱133,100 in three-years’ time, how much
money do I have to invest today (at 10% interest)?
 PV of ₱1 = (1 + i)-n = (1 + 10%)-3 = 0.751315
Answer: (₱133,100 x 0.751315) = ₱100,000
  In the second example, the ₱133,100 to be received in 3-years’ time includes an unspecified
principal and unspecified interest. These elements are separated through present value
computations.
₱100,000
1₱133,100 PV computation
₱33,100

Therefore, assuming the ₱133,100 is a receivable, it should be recorded today only at ₱100,000 (the
present value) because the ₱33,100 is unearned interest. The interest will be recorded only when it is
earned, i.e., through passage of time.

Time Value of Money Factor

1. PV of ₱1 is used when the cash flow is lump sum or when cash flows are non-uniform.
PV of ₱1 = (1 + i)-n

2. PV of ordinary annuity ₱1 is used when the cash flows are in installments and the first installment
does not begin immediately.

3. PV of an annuity due of ₱1 is used when the cash flows are in installments and the first installment
begins immediately.

TIME VALUE OF MONEY APPLICATION

Present Value of ₱1 (PV of ₱1)
Present Value of ordinary annuity ₱1 (PVOA)
Present Value of an annuity due of ₱1 (PVAD)
Future cash flow is lump sum.
Future cash flows are in installments and the first
installment does not begin immediately.
Future cash flows installments and the first
installment begins immediately.

PV OF ₱1 AMORTIZATION TABLE

Date Interest income Unearned interest Present value

(a) = (c) x EIR (b) = previous bal. - (a) (c) = previous balance + (a)
1/1/x1
12/31/x1

PV OF ANNUITY AMORTIZATION TABLE

Interest Present
Date Collections income Amortization value
(d) = prev. bal.
(a) (b) = (d) x EIR (c) = (a) - (b) - (c)
1/1/x1
ILLUSTRATION 1: Initial measurement at face amount

ABC Co. received the following notes receivable on Jan. 1, 20x1

9-month, 10% note from Alpha Company 5,000

6-month, noninterest bearing note from Beta Inc. (the effect of discounting is
10,000
immaterial)
14%, 3-year note from Charlie Corp. 20,000
Market rate of interest on Jan. 1, 20x1 10%

Requirement: At what amount will be the notes be initially recognized?

Solution: (5,000 + 10,000 + 20,000) = 35,000

ILLUSTRATION 2: Simple Interest

On April 1, 20x1, ABC Co. received a P1,500,000, 10%, 3-year note receivable in exchange for land with
carrying amount of P850,000. Principal, in three equal installments, plus interest rate are due annually
starting April 1, 20x2. Current market rates as of April 1, 20x1, December 31, 20x1, and December 31, 20x2
are 10%, 12% and 13%, respectively.

04/01/20x1 Notes Receivable 1,500,000

Land 850,000
Gain on Sale 650,000

12/31/20x1 Interest Receivable (1.5M x 10% x 9/12) 112,500

Interest Income 112,500

04/01/20x2 Cash 650,000

Notes Receivable (1.5M/3) 500,000
Interest Income (1.5M x 10% x 3/12) 37,500
Interest Receivable 112,500

12/31/20x2 Interest Receivable (1M x 10% x 9/12) 75,000

Interest Income 75,000

04/01/20x3 Cash 600,000

Notes Receivable (1.5M/3) 500,000
Interest Income (1M x 10% x 3/12) 25,000
Interest Receivable 75,000

12/31/20x3 Interest Receivable (500k x 10% x 9/12) 37,500

Interest Income 37,500

04/01/20x4 Cash 550,000

Notes Receivable (1.5M/3) 500,000
Interest Income (500k x 10% x 3/12) 12,500
Interest Receivable 37,500
ILLUSTRATION 2: Compounded Interest

On January 1, 20x1, ABC Co. extended a P1,000,000 loan to one of its officers. The note received is due on
January 1, 20x4 and bears 10% interest compounded annually.

01/01/20x1 Notes Receivables 1,000,000

Cash 1,000,000

12/31/20x1 Interest Receivable (1M x 10%) 100,000

Interest Income 100,000

12/31/20x2 Interest Receivable (1.1M x 10%) 110,000

Interest Income 110,000

12/31/20x3 Interest Receivable (1.21M x 10%) 121,000

Interest Income 121,000

01/01/20x4 Cash 1,331,000

Notes Receivable 1,000,000
Interest Receivable (100k +110k + 121k) 331,000

ILLUSTRATION 3: Noninterest-bearing note – lump sum

On January 1, 20x1, Candle Co. received a 3-year noninterest-bearing note of P133,100 in exchange for land
with carrying amount of P100,000. The note is due on December 31, 20x3. The effective interest rate is 10%.

Requirements:
a. Prepare the amortization table
b. Provide all necessary journal entries

Initial measurement:
Future Cash flows 133,100
PV of ₱1 @10%, n= 3 = .751315
Present Value of Notes Receivable 100,000

Requirement (a):
Date Interest income Unearned interest Present value
1/1/x1 33,100 100,000
12/31/x1 10,000 23,100 110,000
12/31/x2 11,000 12,100 121,000
12/31/x3 12,100 - 133,100

Requirement (b):
1/1/x1 Note receivable 133,100
Unearned interest 33,100
Land 100,000

12/31/x1 Unearned interest 10,000

Interest income 10,000

12/31/x2 Unearned interest 11,000

 Interest income 11,000

12/31/x3 Unearned interest 12,100

Interest income 12,100

12/31/x3 Cash 133,100

Note receivable 133,100

ILLUSTRATION 4: Noninterest-bearing note – installments

On January 1, 20x1, Stand Co. received a 3-year noninterest-bearing note of P300,000 in exchange for
equipment with historical cost of P1,000,000 and accumulated depreciation of P700,000. The note is due in
three equal annual instalments of P100,000 every December 31. The effective interest rate is 10%.

Requirements:
c. Prepare the amortization table
d. Determine the current and non-current portion of the note on December 31, 20x1
e. Determine the balance of unearned interest income (discount on notes receivable) on December
31, 20x1.
f. Provide all necessary journal entries
g. What is the effect of the transaction in Stand Co.’s 20x1 profit or loss.

Initial measurement:
Future Cash flows ₱100,000
PV ordinary annuity of ₱1 @10%, n=3 2.486852
Present Value of Notes Receivable ₱248,685

Requirement (a):
Date Collections Interest income Amortization Present value
1/1/x1 248,685
12/31/x1 100,000 24,869 75,131 173,554
12/31/x2 100,000 17,355 82,645 90,909
12/31/x3 100,000 9,091 90,909 0

Requirement (b):
Current portion = 82,645 (see table above)
Noncurrent portion = 90,909 (see table above)

Requirement (c):
Outstanding balance of face amount (100K x 2) 200,000
Carrying amt. on 12/31/x1 (173,554)
Unearned interest on 12/31/x1 26,446
OR
Unearned interest on 12/31/x1 = Interest income in 20x2 and 20x3: (17,355 + 9,091) = 26,446

Requirement (d):
01/01/20x1 Note receivable 300,000
Accum. depreciation 700,000
Loss 51,315
Unearned interest (300,000 – 248,685) 51,315
 Equipment 1,000,000

12/31/x1 Unearned interest 24,869

Interest income 24,869

Cash 100,000
Note receivable 100,000

12/31/x2 Unearned interest 17,355

Interest income 17,355

Cash 100,000
Note receivable 100,000

12/31/x3 Unearned interest 9,091

Interest income 9,091

Cash 100,000
Note receivable 100,000

Requirement (e):
Interest income 24,869
Loss on sale of equipment (51,315)
Net effect on P/L - decrease (26,446)

ILLUSTRATION 5: Noninterest-bearing note – installment in advance

On January 1, 20x1, Otters Co. received a 3-year noninterest-bearing note of P1,200,000 in exchange for
equipment with historical cost of P2,000,000 and accumulated depreciation of P700,000. The note is due in
three equal annual instalments beginning on January 1, 20x1 and every January thereafter. The effective
interest rate is 10%.

Requirements:
a. Prepare the amortization table
b. How much is the interest income in 20x1?
c. How much is the carrying amount of the receivable on Dec. 31, 20x1?

Initial Measurement
Future Cash flows (1.2M ÷ 3) = 400,000;
PV of an annuity due of ₱1 @10%, n=3 = 2.735537
Present Value of Notes Receivable 1,094,215

Requirement (a):
Date Collections Interest income Amortization Present value
1/1/x1 1,094,215
1/1/x1 400,000 - 400,000 694,215
1/1/x2 400,000 69,422 330,578 363,637
1/1/x3 400,000 36,363 363,637 (0)

Requirement (b):
 69,422 – see table above.

Requirement (c):
363,63
Carrying amt. on 1/1/x2
7
400,00
Add back: Collection on 1/1/x2
0
763,63
Carrying amt. on 12/31/x1
7

ILLUSTRATION 6: Noninterest-bearing note – semi-annual cash flows

On January 1, 20x1, ABC Co. sold machinery with historical cost od P2,000,000 and accumulated depreciation
of P1,100,000 in exchange for a 3-year P1,200,000 noninterest-bearing note receivable due in equal semi-
annual installments every July 1 and December 31 starting on July 1, 20x1. The prevailing rate of interest for
this type of note is 10%.

Initial Measurement
Future Cash flows (1.2M ÷ 6) = 200,000;
PV of ordinary annuity of ₱1 @5%, n=6 5.075692
Present Value of Notes Receivable 1,015,138

Subsequent Measurement
Date Collections Interest income Amortization Present value
01/01/x1 1,015,138
07/01/x1 200,000 50,757 149,243 865,895
12/31/x1 200,000 43,295 156,705 709,190
07/01/x2 200,000 35,460 164,540 544,650
12/31/x2 200,000 27,233 172,767 371,883
07/01/x3 200,000 18,594 181,406 190,477
12/31/x3 200,000 9,523 190,477 0

01/01/20x1 Note Receivable 1,200,000

Accumulated Depreciation 1,100,000
Machinery 2,000,000
Unearned Interest Income 184,862
Gain on sale of machinery 115,138

Discounting semiannual cash flows

When discounting cash flows that are due in semiannual installments, the “n” (period) used in the
present value factor is multiplies by 2 because there are two semiannual installments per year.
Furthermore, the effective interest rate is divided by 2 because interest rates are normally
expressed on a per annum basis.

ILLUSTRATION 7: Noninterest-bearing note – non-uniform cash flows

On January 1,20x1, ABC Co. sold machinery costing P2,000,000 with accumulated depreciation of P1,100,000
in exchange for a 3-year, P1,200,000 noninterest-bearing note payable due as follows:

DATE AMOUNT OF INSTALLMENT

 December 31, 20x1 600,000
December 31, 20x2 400,000
December 31, 20x3 200,000
TOTAL 1,200,000

The prevailing rate of interest is 10%

Initial Measurement
Date Cash flows PV of P1 at 10%, n=1 to 3 Present value
12/31/x1 600,000 0.90909 545,454
12/31/x2 400,000 0.82645 330,580
12/31/x3 200,000 0.75131 150,262
TOTAL 1,200,000 1,026,296

Subsequent Measurement
Date Collections Interest income Amortization Present value
01/01/x1 1,026,296
12/31/x1 600,000 102,630 497,370 528,926
12/31/x2 400,000 52,893 347,107 181,819
12/31/x3 200,000 18,181 181,819 0

01/01/20x1 Note Receivable 1,200,000

Accumulated Depreciation 1,100,000
Machinery 2,000,000
Unearned Interest Income 173,704
Gain on sale of machinery 126,296

12/31/20x1 Cash 600,000

Unearned Interest Income 102,630
Notes Receivable 600,000
Interest Income 102,630

Discounting non-uniform cash flows

Annuity factors are applicable only when the series of cash flows are uniform or equal. When the cash flows vary,
the PV of P1 should be used. A cash flow that is due one period from initial recognition is discounted using an “n”
of 1. A cash flow that is due two periods from initial recognition is discounted using an “n” of 2, and so on

ILLUSTRATION 8: Receivable with cash price equivalent

On January 1, 20x1, ABC Co. sold an inventory costing P800,000 with a list price of P1,100,000 and a cash
price of P1,000,000 in exchange for a P1,200,000 noninterest-bearing note due on December 31, 20x3.

01/01/20x1 Note Receivable 1,200,000

Sales 1,000,000
Unearned Interest Income 200,000

TRIAL AND ERROR APPROACH

First Trial: (using random rate of 10%)

Future Cash flows 1,200,000 We need a substantially higher amount of present value.
PV of 1 @10%, n=3 0.751311 Therefore, we need to decrease substantially the interest rate.
Present value - 1/1/x1 901,578
Second Trial: (trial rate of 6%)
Future Cash flows 1,200,000 We need a slightly lower amount of present value. Therefore,
PV of 1 @6%, n=3 0.839619 we need to increase slightly the interest rate.
Present value - 1/1/x1 1,007,543

Second Trial: (trial rate of 7%)

Future Cash flows 1,200,000 In here, we need to perform interpolation. Looking at the
PV of 1 @7%, n=3 0.816298 values derived, we can reasonably expect that the Effective
Present value - 1/1/x1 979,558 Interest Rate is a rate between 6% and 7%.

To perform interpolation, we will use the following formula:

x %−6 % 1,000,000−1,007,543 ( 7,543)

= = =0.2695
7 %−6 % 979,558−1,007,543 (27,985)

The effective interest rate is 6.2695%

12/31/20x1
Unearned
Unearned
Date Interest Income
Interest income Present value
Interest Income
Interest Income
1/1/20x1 200,000 1,000,000
12/31/x1 62,695 137,305 1,062,695
12/31/x2 66,626 70,679 1,129,321 Subsequent Measurement
12/31/x3 70,679 0 1,200,000

01/01/20x1 12/31/20x1 12/31/20x2 12/31/20x3

Notes Receivable 1,200,000 1,200,000 1,200,000 1,200,000
Unearned Interest (200,000) (137,305) (70,679) 0
Income
Carrying Amount 1,000,000 1,062,695 1,129,321 1,200,000

ILLUSTRATION 9: Note with below-market rate of interest – simple interest

(Principal due at maturity, interests due periodically)
Future Cash flows PV Factors Present value
On Principal 1,000,000 PV of 1 @12%, n=3 711,780
Interest 30,000 PVOA of 1 @12%, n=3 72,055
TOTAL 783,835
January 1, 20x1, ABC Co. sold a machinery with historical cost of P2,000,000 and accumulated depreciation of
P950,000 in exchange for a 3-year, P1,000,000, 3% note receivable. Principal is due on January 1, 20x4 but
interest is due annually every January 1. The prevailing interest rate for this type of note is 12%.

Initial Measurement
Subsequent Measurement
Collections on Interest
Date Amortization Present value
interests income
01/01/x1 783,835
01/01/x2 30,000 94,060 64,060 847,895
01/01/x3 30,000 101,747 71,747 919,642
01/01/x4 30,000 110,358 80,358 1,000,000

01/01/20x1 Notes Receivable 1,000,000

Accumulated Depreciation 950,000
Loss on sale of machinery 266,165
Machinery 2,000,000
Unearned interest income 216,165

12/31/20x1 Interest Receivable 30,000

Unearned Interest income 64,060
Interest income 94,060

01/01/20x2 Cash 30,000

Interest Receivable 30,000

ILLUSTRATION 10: Note with below-market rate of interest – simple interest

(Principal due at maturity, interests is due semi-installments)

Use the same information in Illustration 9 except that the interest is payable semi-annually.

Initial Measurement
Future Cash flows PV Factors Present value
Principal 1,000,000 PV of 1 @6%, n=6 704,961
Interest 15,000 PVOA of 1 @6%, n=6 73,760
TOTAL 778,720

Subsequent Measurement
Collections on Interest
Date Amortization Present value
interests income
01/01/x1 778,720
07/01/x1 15,000 46,723 31,723 810,443
01/01/x2 15,000 48,627 33,627 844,070
07/01/x2 15,000 50,644 35,644 879,714
01/01/x3 15,000 52,783 37,783 917,497
07/01/x3 15,000 55,050 40,050 957,547
01/01/x4 15,000 57,453 42,453 1,000,000

ILLUSTRATION 11: Note with below-market rate of interest – simple interest

(Principal and interests collectible in installments)

On January 1, 20x1, ABC Co. sold a machinery with historical cost of P2,000,000 and accumulated
depreciation of P950,000 in exchange for a 3-year, P1,200,000, 3% note receivable. Principal is due in three
equal annual installments. Interests on the outstanding principal balance are also due annually and are to be
collected together with the principal. The prevailing interest rate for this type of note is 12%.
Initial Measurement
Collections Interest on outstanding Total cash PV of 1 @12%,
Date on Principal Principal balance flows n=3
Present Value
12/31/x1 400,000 (1.2 M x 3%) = 36,000 436,000 0.892857 389,287
12/31/x2 400,000 (800k x 3%) = 24,000 424,000 0.797194 338,009
12/31/x3 400,000 (400k x 3%) = 12,000 412,000 0.711780 293,253
TOTAL 1,272,000 1,020,549

Subsequent Measurement
Collections Interest
Date Amortization Present value
income
01/01/
1,020,549
x1
12/31/
436,000 122,466 313,534 707,015
x1
12/31/
424,000 84,842 339,158 367,857
x2
12/31/
412,000 44,143 367,857 0
x3

01/01/20x1 Note Receivable 1,200,000

Accumulated Depreciation 950,000
Loss on Sale of machinery 29,451
Machinery 2,000,000
Unearned interest income 179,451

12/31/20x1 Cash 436,000

Unearned Interest (400k – 313,534) 86,466
Note Receivable 400,000
Interest Income 122,466

12/31/20x2 Cash 424,000

Unearned Interest (400k – 339,158) 60,842
Note Receivable 400,000
Interest Income 84,842

12/31/20x2 Cash 412,000

Unearned Interest (400k – 367,857) 32,143
Note Receivable 400,000
Interest Income 44,143

ILLUSTRATION 12: Note with below-market rate of interest – compound interest

(Principal and interests due at maturity)

On January 1, 20x1, ABC Co. sold a machinery with historical cost of P2,000,000 and accumulated
depreciation of P950,000 in exchange for a 3-year, P1,000,000, note receivable. Principal and interests at 3%
are due on January 1, 20x4. The prevailing interest rate for this type of note is 12%.

Initial Measurement
Face amount of note 1,000,000 Future Cash flows 1,092,727
FV of ₱1 @3%, n=3 1.092727 PV of ₱1 @12%, n=3 .711780
Future Cash flows 1,092,727 Present Value of Notes 777,781
 01/01/20x1 Note Receivable 1,000,000
Accumulated Depreciation 950,000
Loss on sale of machinery 272,219
Machinery 2,000,000
Unearned Interest Income 222,219

Subsequent Measurement
Unearned
Interest Present Cumulative PV of notes
Date Interest
income value interest rec. receivable
Income
01/01/
777,781 777,781
x1
12/31/
93,334 871,115 30,000 841,115
x1
IGNORED
12/31/
104,534 975,649 60,900 914,749
x2
12/31/
117,078 1,092,727 92,727 1,000,000
x3

Amortization table that shows all of the amounts needed when preparing journal entries:
Interest Present value Cumulative Unearned PV of notes
Date Amortization
income of future CF interest rec. interest receivable
b = prev.bal +
a = EIR x b c = NR x OB d=a–c e = prev.bal - d f = prev.bal + d
a
01/01/x1 777,781 222,219 777,781
12/31/x1 93,334 871,115 30,000 63,334 158,885 841,115
12/31/x2 104,534 975,649 60,900 73,634 85,251 914,749
12/31/x3 117,078 1,092,727 92,727 85,251 0 1,000,000

12/31/20x1 Interest Receivable 30,000

Unearned Interest 63,334
Interest Income 93,334

12/31/20x2 Interest Receivable 60,900

Unearned Interest 73,634
Interest Income 104,534

12/31/20x3 Interest Receivable 92,727

Unearned Interest 85,251
Interest Income 117,078

01/01/20x4 Cash 1,092,727

Interest Receivable 92,727
Notes Receivable 1,000,000

ILLUSTRATION 13: Total Interest Income over the life of note

ABC Co. received a P100,000, 8%, 5-year note that requires five equal annual year-end payments. The
effective interest rate on the note is 9%.

Requirement: Compute for the total interest revenue to be earned over the term of the note?
Solution:
Cash Flows x PVF = Present Value
CF x PVOA = PV
CF x 3.992710 = 100,000
CF = 100,000 / 3.993710
CF = 25,046 (equal annual year-end payments)

Total Cash Flows (25,046 x 5 years) 125,225

LESS: (PVOA @9%, n=5)(25,046) 97,420
Total Interest revenue over the life of the note 27,805

DEFERRED ANNUITIES
A deferred annuity is an annuity in which periodic cash flows begin only after two or more periods
have passed.

Future Value of Deferred Annuity – the deferral period is simply ignored because there is no accumulation
of cash flows on which interest may accrue.

Present Value of Deferred Annuity – recognizes interest that accrues during the deferral period.

ILLUSTRATION 14: Present value of a Deferred annuity

An entity has developed a patent. On January 1, 20x1, the patent was sold in exchange for a P60,000
noninterest-bearing note collectible in six annual installments of P10,000 each beginning on January 1, 20x6
and every January 1 thereafter. The last installment is due on January 1, 20x11. The appropriate discount rate
is12%.

Requirement: What is the present value of the note received by ABC Co.?

Solution: The full term is 10 years and the deferred period is 4 years
PV of OA of P1@12%, n = 10 5.650223
PV of OA of P1@12%, n = 4 (3.037349)
PV factor for the payment period 2.612874

Initial measurement:
Annual Cash flows 10,000
PV factor for the payment period 2.612874
Present Value of Notes Receivable 26,129

Collections PV of P1
Date Present value
@12%, n = 5 to 10
01/01/x6 10,000 0.56743 5,674
01/01/x7 10,000 0.50663 5,066
01/01/x8 10,000 0.45235 4,524
01/01/x9 10,000 0.40388 4,039
01/01/x10 10,000 0.36061 3,606
01/01/x11 10,000 0.32197 3,220
TOTAL 26,129

ILLUSTRATION 15: Present value of a Deferred annuity

On January 1, 20x1, ABC Co. sold a used equipment in exchange for a P3,000,000 noninterest-bearing note
due in three annual installments as follows:
 Jan. 1, 20x4 1,500,000
Jan. 1, 20x5 1,000,000
Jan. 1, 20x6 500,000
TOTAL 3,000,000

The current market rate of interest on January 1, 20x1 is 12%.

Requirement: Compute for the present value of the note on January 1, 20x1.

Initial Measurement

Date Cash flows PV of P1 PV Factors Present value

01/01/x4 1,500,000 PV of P1 @ 12%, n=3 0.711780 1,067,670

01/01/x5 1,000,000 PV of P1 @ 12%, n=4 0.635518 635,518
01/01/x6 500,000 PV of P1 @ 12%, n=5 0.567427 283,713
1,986,902

Subsequent Measurement
Date Collections Interest income Amortization Present value
01/01/x1 1,986,902
01/01/x2 238,428 238,428 2,225,330
01/01/x3 267,040 267,040 2,492,370
01/01/x4 1,500,000 299,084 1,200,916 1,291,454
01/01/x5 1,000,000 154,974 845,026 446,429
01/01/x6 500,000 53,571 446,429 0

Pre-acquisition Accrued Interest

When an interest has accrued before the acquisition of an interest-bearing receivable, the
subsequent receipt of interest is allocated between the pre-acquisition and post-acquisition periods. Only the
portion pertaining to the post-acquisition period is recognized as interest income.

ILLUSTRATION 16: Pre-acquisition Accrued Interest

On March 1, 20x1, ABC Co. received a P500,000, 12%, one-year note dated January 1, 20x1 from XYZ, Inc. in
exchange for a P500,000 past due account.

03/01/20x1 Notes Receivable 500,000

Interest income (500k x 12% x 2/12) 10,000
Accounts Receivable 500,000
Gain on receipt of note 10,000

07/01/20x1 Cash 530,000

Interest income 30,000
Notes receivable 500,000

The interest that has accrued prior the acquisition period is not recognized as interest income but a gain.

Life Application:
Notes Receivable vs Notes Payable
It is not unusual for a company to have both a Notes Receivable and a Notes Payable account on their
statement of financial position. Notes Payable is a liability as it records the value a business owes in
promissory notes. Notes Receivable are an asset as they record the value that a business is owed in
promissory notes. A closely related topic is that of accounts receivable vs. accounts payable.

Summary:
 A note receivable is also known as a promissory note.
 When the note is due within less than a year, it is considered a current asset on the balance sheet of
the company the note is owed to. If its due date is more than a year in the future, it is considered a
non-current asset.
 The interest income on notes receivable is recognized on the income statement. Therefore, when
payment is made on a note receivable, both the balance sheet and the income statement are affected.

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References: INTERMEDIATE ACCTG 1A [by: Millan, Zeus Vernon B. (2021)]
Financial Accounting Volume 1 [by: Valix, C. T., Peralta, Jose F., Valix, C A M. (2015).]
https://opentextbc.ca/principlesofaccountingv1openstax/chapter/explain-how-notes-receivable-and-
accounts-receivable-differ/
https://corporatefinanceinstitute.com/resources/knowledge/accounting/notes-receivable/