Accounting for Receivables (Part 3 - Interest-bearing note)

A note or draft that provides for the payment of interest for the period between the issuance
date and the due date is called an interest-bearing note. On the date of the receipt of the note,
the present value of the interest-bearing note which bears a realistic interest rate is equal to the
face value. Subsequent to the date of the note or the draft, the present value of an interest-
bearing note is equal to its face value plus accrued interest. An entity shall assess at each
reporting date whether there is objective evidence that its receivable or group of receivables is
impaired. Impairment losses are incurred and impairment loss is recognized in profit or loss in
the statement of comprehensive income if there is an objective evidence of impairment as a
result of one or more events that occurred after the initial recognition of the receivable; and the
impact on the estimated future cash flows of the receivable can be reliably measured.

At the end of this module, you will be able to:

1. Understand the accounting for interest-bearing note
2. Explain notes/loans receivable impairment and uncollectibility
The common application of the lessons that are under this module is in connection with how to
account for note that bears interest. You will be exposed to notes with discount and premium.

Accounting for notes/loans receivable (Interest-bearing note)

Notes receivable is a formal claim against another that is evidenced by a written promise, called
promissory note, or a written order to pay at a later time, called time draft.
A promissory note is an unconditional written agreement to pay a certain sum of money on a
specific or determinable date to order of the payee or to bearer.

Initial Measurement
Notes receivable shall be measured initially at present value. Present value is the sum of all
future cash flows discounted using the prevailing market rate of interest for similar notes. The
prevailing market rate if interest is actually the effective interest rate.

Short Term - at face value

Long Term
Interest bearing - measured at face value.
Non interest-bearing - measured at present value which is the discounted value of future cash
flows using the effective interest rate.

Rate Note is at
Stated = Effective Rate Face value
Stated > Effective Rate Premium
Stated < Effective Rate Discount

Subsequent Measurement
Based on IAS 39, loans and receivables shall be measured in the statement of financial position
at amortized cost using the effective interest method. The amortized cost is the ledger balance
of Notes receivable plus any remaining balance of Premium on Notes Receivable or minus
remaining balance of Discount on Notes Receivable.

Interest-bearing noted
A note or draft that provides for the payment of interest for the period between the issuance
date and the due date is called an interest-bearing note.

On the date of the receipt of the note, the present value of the interest-bearing note which bears
a realistic interest rate is equal to the face value. Subsequent to the date of the note or the draft,
the present value of an interest-bearing note is equal to its face value plus accrued interest.

Formula for computing interest

The formula for computing interest on an interest-bearing note is (PRT):

Principal of the note x Rate of interest x Term of the note = Interest

Principal - is the face value of the note.

Rate of Interest - percentage specified on the note in an annual basis.
Term - is the period of time the interest will run. It is usually based on a 360-day year unless it
was stated in the problem to find the weighted average interest.

Example 1: Note Issued at Face Value

On January 1, 2017, Allan Manufacturing sells an equipment costing P800,000 with
accumulated depreciation of P450,000. The company receives as consideration P100,000 and
a 15% interest-bearing note for P400,000 due on Dec. 31, 2017. The prevailing interest rate for
a note of this type is 15%.

2017
Jan. 1 Cash 100,000
Notes receivable 400,000
Accumulated Dep.- Equipment 450,000
Equipment 800,000
Gain on Sale of Equipment 150,000

Sales Price (100,000+400,000) 500,000

Carrying Value (800,000-450,000) 350,000
Gain on Sale 150,000

The following are the entries relating to the note:

2017
Dec. 31 Cash 60,000
Interest Revenue 60,000
2018
Dec. 31 Cash 60,000
Interest Revenue 60,000

2019
Dec. 31 Cash 460,000
Notes Receivable 400,000
Interest Revenue 60,000

On the statement of financial position on Dec. 31, 2017, the Notes receivable of P400,000
would be shown as part of non-current financial assets, because it is scheduled for collection
two years from the end of the reporting period.

On Dec.31, 2018, the same note will be classified as part of current assets because it is
expected to be collected within 12 months from the date.

Example 1: Interest-bearing note

Long-term installment note receivable (stated rate<market rate)
On January 1, 2017, Allan Manufacturing sells a tract of land that originally cost P400,000 with
accumulated depreciation of P450,000. Allan received a P600,000 note as payment for this
transaction. The note is payable in 3 annual installments of P200,000 beginning Dec. 31, 2017
plus interest at the rate of 4% based on the outstanding balance. At Jan. 1, 2017, the prevailing
rate of interest for a similar obligation is 10%.

The computation of the present value of the note on Jan. 1, 2017 is as follows:
PV of the Note:
200,000+ (600,000X4%) x 0.90909 = 203,636
200,000+ (400,000X4%) x 0.82645 = 178,513
200,000+ (200,000X4%) x 0.90909 = 156,275
Total 538,424

Face Value of the Note 600,000

Present Value of the Note 538,424
Discount 61,576

Sales Price 538,424

Carrying Value 400,000
Gain on Sale 138,424

The following are the entries relating to the note:

2017
Jan. 1 Notes Receivable 600,000
Discount on Notes 61,576
 Land 400,000
Gain on sale 138,424

2017
Dec.31 Cash 224,000
Discount on Notes 29,842
Notes Receivable 200,000
Interest Revenue 53,842

2018
Dec.31 Cash 216,000
Discount on Notes 20,827
Notes Receivable 200,000
Interest Revenue 36,827

2019
Dec.31 Cash 208,000
Discount on Notes 10,907
Notes Receivable 200,000
Interest Revenue 18,907

Amortization Table
Date Principal Effective Nominal Discount Carrying
Payment Interest Amount Amortization Value__
Jan. 1, 2017 538,424
Dec. 31, 2017 200,000 53,842 24,000 29,842 368,266
Dec. 31, 2018 200,000 36,827 16,000 20,827 189,093
Dec. 31, 2019 200,000 18,907 8,000 10,907 -

The balance of the Notes Receivable and the related Discount on Notes on Dec. 31, 2017 is as
follows:
Total Current Non-current
Notes Receivable 400,000 200,000 200,000
Discount on Notes 36,734 20,827 10,907
Carrying Amount 368,266 179,173 189,093

Example2: Interest-bearing note

Long-term installment note receivable (stated rate>market rate)
On January 1, 2017, Allan Manufacturing sells a tract of land that originally cost P400,000 with
accumulated depreciation of P450,000. Allan received a P600,000 note as payment for this
transaction. The note is payable in 3 annual installments of P200,000 beginning Dec. 31, 2017
plus interest at the rate of 14% based on the outstanding balance. At Jan. 1, 2017, the
prevailing rate of interest for a similar obligation is 10%.
The computation of the present value of the note on Jan. 1, 2017 is as follows:
PV of the Note:
200,000+ (600,000X14%) x 0.90909 = 258,182
200,000+ (400,000X14%) x 0.82645 = 211,571
200,000+ (200,000X14%) x 0.90909 = 171,301
Total 641,054

Present Value of the Note 641,054

Face Value of the Note 600,000
Premium 41,054
Sales Price 641,054
Carrying Value 400,000
Gain on Sale 241,054

The following are the entries relating to the note:

2017
Jan.1 Notes Receivable 600,000
Premium on Notes 41,054
Land 400,000
Gain on sale 241,054

2017
Dec.31 Cash 284,000
Notes Receivable 200,000
Interest Revenue 64,105
Premium on Notes 19,895

2018
Dec.31 Cash 256,000
Notes Receivable 200,000
Interest Revenue 42,116
Premium on Notes 13,884

2019
Dec.31 Cash 228,000
Notes Receivable 200,000
Interest Revenue 20,725
Premium on Notes 7,275

Amortization Table
Date Principal Effective Nominal Premium Carrying
Payment Interest Amount Amortization Value__
Jan. 1, 2017 641,054
Dec.31, 2017 200,000 64,105 84,000 19,895 421,159
Dec.31, 2018 200,000 42,116 56,000 13,884 207,725
Dec.31, 2019 200,000 20,725 28,000 7,275 -

The balance of the Notes Receivable and the related Premium on Notes on Dec. 31, 2017 is as
follows:
Total Current Non-current
Notes Receivable 400,000 200,000 200,000
Premium on Notes 21,159 13,884 7,725
Carrying Amount 421,159 213,884 207,725

Notes/loans receivable impairment and uncollectibility

An entity shall assess at each reporting date whether there is an objective evidence that its
receivable or group of receivables is impaired. Impairment losses are incurred and impairment
loss is recognized in profit or loss in the statement of comprehensive income if
1. There is objective evidence of impairment as a result of one or more events that occurred
after the initial recognition of the receivable; and
2. The impact on the estimated future cash flows of the receivable can be reliably measured.

Dishonor
When a promissory note matures and is not paid, it is said to be dishonored. Theoretically,
dishonored notes shall be removed from the notes receivable account and transferred to
accounts receivable at an amount to include, if any, interest and other charges.
Accounts receivable XXX
Notes receivable XXX

Glossary
Discount on Notes Payable: Contra-asset account that arises when market rate is greater than
stated rate.
Impairment Loss: the decline in value of an asset due to a loss event that indicates a negative
effect on the estimated cash flows to be received from the customer.
Premium on Notes Payable: account that arises when market rate is less than stated rate.
Principal: is the face value of the note.
Rate of Interest: percentage specified on the note in an annual basis.
Term: is the period of time the interest will run. It is usually based on a 360-day year unless it
was stated in the problem to find the weighted average interest.