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NOTES PAYABLE AND DEBT RESTRUCTURING

MEASUREMENT OF NOTES PAYABLE
Notes payable are obligations accompanied by a promise to pay a certain amount to the holder or bearer on
a specified future date. In addition, notes payable may arise from certain transactions, such as purchases
(goods or services) and financing (e.g., borrowing money from a bank).
In accounting, notes are classified as current or non-current depending on their due date and may bear an
interest.
Initial Measurement
Applying PFRS 9 Financial Instruments, notes payable that are not designated at fair value shall be measured
initially at fair value less transaction cost, which is directly attributable to the issuance of the said notes.
However, if notes are designated at fair value through profit or loss, the transaction costs shall be treated as
an expense immediately.

The fair value of the notes payable is equal to the present value of the future cash payment to settle the note
liability.
Subsequent Measurement
Applying the same standard, after initial recognition, notes payable are measured either:
• At amortized cost, using the effective interest method or
• At fair value through profit or loss.
ISSUANCES OF NOTES PAYABLE (subsequently measured at amortized cost)
Issuance of Notes for Cash
When a company issues notes payable for cash, the present value to be recognized is the cash proceeds.
Illustrative Example 1:
On November 1, 2X19, ABC Company discounted its note of P1,000,000 at 12% for one (1) year.
Computation for net cash proceeds:

Notes payable 1,000,000

Less: Discounts (12% X 1,000,000) 120,000
Net proceeds 880,000
The journal entry for the transaction is as follows:

Cash 880,000
Discount on notes payable 120,000
Notes payable 1,000,000
Note that the discount amounting to P120,000 is the total interest for the year. Hence, on December 31, 2X19,
ABC should amortize the discount on notes payable and recognize an interest expense for two (2) months
amounting to 20,000 (120,000 x 2/12).
In preparing the financial statement for 2X19, ABC would classify and report the note payable as current
liability as follows:

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Notes payable 1,000,000

Less: Discount on note payable 100,000
Carrying amount 900,000
Issuance of an Interest-Bearing Notes Payable for Cash
An entity should record an interest-bearing note at face value at initial measurement. This face value
represents the present value of the notes payable. In addition, after initial measurement, an interest-bearing
note should be measured at face value plus accrued interest.
Illustrative Example 2:
On March 1, 2X19, AB Bank agrees to lend LB Corporation a sum of money amounting to P100,000. Assuming
LB Corporation signs a P100,000, 4-month, 12% note for this transaction, the entry to record the cash received
by LB on March 1 is as follows:

Cash 100,000
Notes payable 100,000
Assuming that LB prepares its financial statement semi-annually, an adjusting entry is required to recognize
the four (4) months interest expense and payable amounting to P4,000 (P100,000 x 12% x 4/12) on June 30,
2X19. The adjusting entry is as follows:

Interest expense 4,000

Interest payable 4,000
On its due date on July 1, 2X19, LB Corporation pays P104,000, comprising the note’s face value of P100,000
and the accrued interest amounting to P4,000. The entry to record the payment of the note and accrued
interest is as follows:

Notes payable 100,000

Interest payable 4,000
Cash 104,000

Issuance of an Interest-Bearing Notes Payable for Property

When a property or noncash asset is acquired by issuing an interest-bearing promissory note, the property or
asset is recorded at the original purchase price.
Because the note issued bears interest, it is reasonable to conclude that the purchase price reflects the note's
present value and, hence, the asset's fair value.
On January 1, 20X2, an entity purchased equipment for P1,000,000, payable in five (5) equal annual
installments on December 31 of each year. The unpaid balance carries a 10% interest rate.
20X2
Jan. 1 Equipment 1,000,000
Note payable 1,000,000
Interest expense (10% x 1,000,000) 100,000
Note payable 200,000
Cash 300,000

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Dec. 31 Payment of the first installment and the interest for 2022
20X3
Dec. 31 Interest expense (10% x 800,000) 80,000
Note payable 200,000
Cash 280,000
Payment of the second installment and the interest for
2023

Issuance of a Zero-Interest-Bearing Note for Cash

A zero-interest-bearing note may be issued instead of an interest-bearing note. Despite its name, a zero-
interest-bearing note contains an interest component. The interest is not added to the note's face or maturity
value but is included in the face amount. The interest is the difference between the cash received when the
note is signed and the higher face amount due at maturity. The borrower obtains the note's present value in
cash and repays the larger maturity value (Kieso et al., 2016).
Illustrative Example 3:
On March 1, 2X19, assuming LB Corporation signs a P100,000, 4-month, 12% note for this transaction. Based
on the 12% bank discount rate, the note’s present value is P96,154. The entry to record this transaction is as
follows:

Cash 96,154
Notes payable 96,154
Assuming that LB prepares its financial statement semi-annually, then an adjusting entry is required to
recognize the four (4) months interest expense and the increase on notes payable amounting to P3,846
(P96,154 x 12% x 4/12) on June 30, 2X19. The entry for this is as follows:

Interest expense 3,846

Notes payable 3,846
The note payable balance on the due date would be P100,000 (P96,154 + P3,846). The entry to record the
payment made by LB Corporation is as follows:

Notes payable 100,000

Cash 100,000

Issuance of a Zero-Interest-Bearing Note for Property

When a zero-interest-bearing note is issued for a property, the property is recorded at its cash price. The cash
price is presumed to equal the present value of the note issued. The difference between the cash price and
the face value of the note payable is the imputed interest. The imputed interest is founded on the sound
principle that no lender would part with his money or property without interest.
Illustrative Example 5:
On January 1, 20X2, an entity acquired equipment with a cash price of P350,000 for P500,000, P100,000 down
and the balance payable in 4 equal annual installments.

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Journal Entries for 20X2:

Jan. 1 Equipment 350,000
Discount on note payable 150,000
Cash 100,000
Note payable 400,000
Dec. 31 Note payable 100,000
Cash 100,000
Payment of annual installment.

Dec. 31 Interest Expense 60,000

Discount on notes payable 60,000
Amortization of the discount for 2022

Table of Amortization

Year Note payable Fraction Amortization

20X2 P400,000 4/10 P60,000
20X3 300,000 3/10 45,000
20X4 200,000 2/10 30,000
20X5 100,000 1/10 15,000
P1,000,000 P150,000

Notes payable represent the amount outstanding every year.

The note was issued on January 1, 20X2, and the first payment was made on December 31, 20X2. Thus, for
20X2, the note payable outstanding is P400,000.

Fraction is developed from the notes payable that are outstanding every year.

Amortization is the amount of discount multiplied by the fraction developed. Thus, for 20X2, P150,000 times
4/10 equals P60,000.

Issuance of a Zero-Interest-Bearing Note for Property (If cash price is not given)
On January 1, 20X2, an entity purchased equipment for P1,000,000, payable in five equal annual installments
on December 31 of each year. Observe that the equipment has no agreed-upon interest rate or cash price. In
this scenario, the equipment's cost is equivalent to the present value of the P200,000 annual installments over
five (5) years, discounted at a 10% rate. The 10% discount rate is considered the prevailing market rate of
interest. The present value of an ordinary annuity of 1 for 5 years at 10% is 3.7908.
Therefore, the present value of five P200,000 installments is P758,160, computed by multiplying P200,000 by
the present value factor of 3.7908.
Journal entries for 20X2
Jan. 1 Equipment 758,160
Discount on note payable 241,840
Note payable 1,000,000

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Dec. 31 Note Payable 200,000

Cash 200,000
First installment payment

Dec. 31 Interest expense 75,816

Discount on note payable 75,816
Amortization of the discount on note payable for 20X2.

The effective interest method is followed in the amortization of the discount.

Table of amortization

Date Payment Interest Principal Present Value

Jan. 1, 20X2 P758,160
Dec. 31, 20X2 P200,000 P75,816 P124,184 633,976
Dec. 31, 20X3 200,000 63,398 136,602 497,374
Dec. 31, 20X4 200,000 49,737 150,263 347,111
Dec. 31, 20X5 200,000 34,711 165,289 181,822
Dec. 31, 20X6 200,000 18,178 181,822 -

The payment represents the annual installment.

Interest equals the preceding present value multiplied by the implied interest rate. Thus, for 20X2, P758,160
times 10% equals P75,816.

The principal is the payment portion after deducting interest representing a principal.

Thus, on December 31, 20X2, P200,000 minus the interest of P75,816 equals P124,184.

Present value is the balance of the preceding present value after deducting the principal payment.

Thus, on December 31, 20X2, P758,160 minus the principal payment of P124,184 equals P633,976.

On December 31, 20X2, the current portion of the note payable should be reported as current liability.
Note payable P200,000
Discount on note payable (63,398)
Carrying amount – amortized cost P136,602

The non-current portion of the note payable should be reported as non-current liability.

Note payable P600,000

Discount on note payable (102,626)
Carrying amount – amortized cost P497,374

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ISSUANCE OF NOTES PAYABLE (subsequently measured at FVPL)

According to PFRS 9, paragraph 4.2.2, at the time of initial recognition, a note payable may be irrevocably
designated as at fair value through profit or loss (FVPL).

a. The change in fair value attributable to the credit risk is recognized in other comprehensive income.
Credit risk is the possibility that the issuer of the liability will cause a financial loss to the other party
by failing to fulfill the obligation. Credit risk excludes market risks such as interest, currency, and price
risks.

b. The remaining amount of the change in fair value is recognized in profit or loss.

According to Application Guidance B5.7.9, any amount recognized in other comprehensive income resulting
from a change in fair value attributable to credit risk shall not be subsequently transferred to profit or loss.
However, the cumulative gain or loss recognized may be transferred directly to retained earnings. Under the
fair value option, any transaction costs are recorded as outright expenses. There is no amortization of the
discount or premium on the note payable. Interest expense is recognized using either the nominal or stated
interest rate.

Illustrative Example 6:

On January 1, 20X2, a company borrowed P4,000,000 from a bank on a 5-year interest-bearing note at 12%.

On January 1, 20X2, the company got P4,000,000, representing the note's fair value. The entity paid the
transaction cost of P100,000.

The note payable had a fair value of P3,500,000 on December 31, 20X2.

The entity has irrevocably chosen the fair value option for measuring the note payable.

The change in fair value included P50,000 attributable to credit risk and P450,000 attributable to interest risk.

Journal entries for 20X2

Jan. 1 Cash 4,000,000

Note payable 4,000,000

Jan. 1 Transaction cost 100,000

Cash 100,000

Dec. 31 Interest expense 480,000

(12% x 4,000,000)
Cash 480,000

Dec. 31 Note payable 500,000

Gain from change in fair value 450,000
Gain from credit risk – OCI 50,000

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Carrying amount P4,000,000

Fair value – December 31, 2022 3,500,000
Decrease in fair value of liability – gain P500,000

The gain from a change in fair value is recognized in profit or loss.

The gain from credit risk is recognized in other comprehensive income.

NATURE AND FORMS OF DEBT RESTRUCTURING

Debt restructuring refers to the alteration made by the creditor to the terms of a loan. It enables the debtor
to pay the amount owed.
The creditor's objective in a debt restructuring is to make the best out of a bad situation or maximize
investment recovery (Valix, Peralta, & Valix, 2023).
There are three (3) types of debt restructuring. These are:
1. Asset Swap - It is the transfer by the debtor to the creditor of any asset, such as real estate, inventory,
receivables, and investment, in full payment of an obligation. Under PFRS 9, an asset swap is treated as a
derecognition of a financial liability or extinguishment of an obligation. Any difference between the
carrying amount of the financial liability and the consideration given shall be recognized in profit or loss
(Valix, Peralta, & Valix, 2023).
Illustrative Example 4:
An entity provided the following balances on December 31, 2X19:

Notes payable 2,000,000

Accrued interest payable 400,000
On December 31, 2X19, the entity transferred to the creditor land with a carrying amount of P1,500,000
and a fair value of P2,200,000.

Notes payable 2,000,000

Accrued interest payable 400,000
Total liability 2,400,000
Less: Carrying amount of land 1,500,000
Gain on extinguishment of debt 900,000
The journal entry to record this transaction is as follows:

Notes payable 2,000,000

Accrued interest payable 400,000
Land 1,500,000
Gain on extinguishment of debt 900,000
2. Equity Swap - It is a transaction whereby a debtor and creditor may renegotiate the terms of a financial
liability with the result that the liability is fully or partially extinguished by the debtor issuing equity
instrument to the creditor (Valix, Peralta, & Valix, 2023). An equity swap is the issuance of shares as
payment of an obligation.

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The equity instruments issued to extinguish a financial liability shall be measured at the following amounts
in the order of priority (Valix, Peralta, & Valix, 2023):
a. The fair value of equity instrument issued;
b. The fair value of liability extinguished; and
c. Carrying amount of liability extinguished.
The difference between the carrying amount of the financial liability and the initial measurement of the
equity instruments issued shall be recognized in profit or loss. The gain or loss on extinguishment shall be
reported as a separate line item in the income statement (Valix, Peralta, & Valix, 2023).
Illustrative Example 5:
An entity showed the following data on December 31, 2X19:

Bonds payable 5,000,000

Accrued interest payable 500,000
On December 31, 2X19, the entity issued share capital with a total par value of P2,000,000 and a fair value
of P4,500,000 in full settlement of the bonds payable and accrued interest. On the other hand, the fair
value of the bonds payable is P4,700,000.
The computation for the gain on extinguishment is as follows:
Bonds payable 5,000,000
Accrued interest payable 500,000
Carrying amount of bonds payable 5,500,000
Less: Fair value of shares issued 4,500,000
Gain on extinguishment of debt 1,000,000

The journal entry for this transaction is:

Bonds payable 5,000,000

Accrued interest payable 500,000
Share capital 2,000,000
Share premium 2,500,000
Gain on extinguishment of debt 1,000,000
3. Modification of Terms is the change of interest, maturity value, or both. Applying IFRS 9, the substantial
modification of terms of an existing financial liability shall be accounted for as an extinguishment of the
old financial liability and the recognition of a new financial liability (Valix, Peralta, & Valix, 2023).
There is a substantial modification of terms if the gain or loss on extinguishment is at least 10% or more
than 10% of the old financial liability.
Illustrative Example 6:
An entity showed the following data on January 1, 2X19:

Note payable (due January 1, 2X15 at 14%) 5,000,000

Accrued interest payable 1,000,000

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The entity is granted by the creditor the following concessions on January 1, 2X19:
a. The accrued interest of P1,000,000 is forgiven.
b. The principal obligation is reduced to P4,000,000.
c. The new interest rate is 10%, payable every December 31.
d. The new date of maturity is December 31, 2X22.
Then, get the gain on extinguishment. The computation is as follows:

PV of principal (4,000,000 x .5921) 2,368,400

PV of interest payments (400,000 x 2.9137) 1,165,480
Present value of new notes payable 3,533,880
4,000,00
Discount on note payable 466,120

Note payable - old 5,000,000

Accrued interest payable 1,000,000
Carrying the amount of old liability 6,000,000
Present value of new notes payable 3,533,880
Gain on extinguishment of debt 2,466,120

References
Bragg, S. (2018, March 23). https://www.accountingtools.com. Retrieved from The proof of cash:
https://www.accountingtools.com/articles/what-is-a-proof-of-cash.html
Kieso, D. E., Weygandt, J. J., Warfield, T. D., Young, N. M., Wiecek, I. M., & McConomy, B. J. (2016).
Intermediate Accounting 11th Ed. John Wiey & Sons Canada, Ltd.
Robles, N. S., & Empleo, P. M. (2016). Intermediate Accounting Volume 1. Millenium Books, Inc.
Valix, C. T., Peralta, J. F., & Valix, C. A. (2023). Intermediate Accounting 2. GIC Enterprises & Co., Inc.

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