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Ia CH 6 & 7 NR LR 2020
Ia CH 6 & 7 NR LR 2020
Interest Income =
PV * Effective Rate (10%) 300, 520 * 10% = 30,052
Unearned Interest =
99,480 – 30,052 = 69,428
Previous less Interest Income
PV-current =
PV-previous year plus interest income 300,520 + 30,052 = 330,572
Face Value less unearned interest (current)
Journal entries - 2019
Jan. 1 Cash 100,000
Note receivable 400,000
Accumulated depreciation 250,000
Equipment 600,000
Gain on sale of equipment 50,520
Unearned interest income 99,480
To record sale
• Noncurrent Asset
Note receivable 400,000
Less: Unearned interest income 69,428
Carrying amount or amortized cost 330,572
Journal entries – 2020, 2021, 2022
2020
Dec. 31 Unearned interest income 33,057
Interest income 33,057
To record amortization of interest
2021
Dec. 31 Unearned interest income 36,371
Interest income 36,371
To record amortization of interest
2022
Jan 1 Cash 400,000
Notes Receivable 400,000
To record collection
DEMONSTRATION PROBLEM
PROBLEM INFO: (DEMO PROB 1) ANALYSIS
• Persevere Company is a dealer in • Use of “SALES” account
equipment. • No CASH SALE PRICE
Regular/Ordinary Business Activity • Present Value of Note including
down payment
• On December 31, 2016, the entity sold • PRESENT VALUE OF NOTE
an equipment in exchange for a
noninterest bearing note requiring • PV of Ordinary Annuity of 1
five annual payments of P500,000. The • Effective Rate of Interest
first payment was made on December COMPUTATION:
31, 2017. NO DOWN PAYMENT Annual Payment 500,000
• The market interest for similar notes was Multiply by PV FACTOR 3.9927
8%. PV of an Ordinary Annuity Present Value SALES PRICE 1,996,350
REQUIRED: of 1 at 8% for 5 periods
• Prepare journal entries (all) FORMULA: 8% for 5 periods
• Prepare an amortization table PVF = 1 – (1 + i) ^ -n PVF = 1 – (1.08) ^ -5
i 0.08
and necessary computations.
PV OA = 3.9927
COMPUTATION: AMORTIZATION TABLE
Face Value of Note 2,500,000 Will help in preparation of journal entries and
(500,000 * 5) presentation of financial statements
Present Value of Note 1,996,350
PERSEVERE COMPANY - AMORTIZATION SCHEDULE
Unearned Interest
503, 650 Period Installment Interest Income Principal Present Value
Income
Dec 31, 2016 8% 1, 996, 350
No need to compute GAIN ON SALE Dec 31, 2017 500, 000 159, 708 1, 996, 340,350
292* 8%
1, 656, 058
because ORDINARY business
Dec 31, 2018 500, 000 132, 485 367, 515 1, 288, 543
activities (GROSS PROFIT)
Dec 31, 2019 500, 000 103, 083 396, 917 891, 626
Interest Income = PV * Eff. Rate (8%)
Dec 31, 2020 500, 000 71, 330 428, 670 462, 956
Principal = Instalment less Int. Inc.
Dec 31, 2021 500, 000 37, 044 462, 956 0
PV-current = PV-prev. year less
principal payment TOTAL (CHECK) 2, 500, 000 503,
500,000 650 1, 996, 350
– 462,956
PRESENTATION – Dec 31, 2017
CURRENT ASSET NONCURRENT ASSET
Note Receivable – current portion 500,000 Note Receivable – noncurrent portion 1,500,000
Less: Unearned Interest Income 132,485 Less: Unearned Interest Income 211,457
Carrying Amount 367,515 Carrying Amount 1,288,543
Journal entries for 2016 & 2017
2016
Dec 31 Note receivable 2,500,000
Sales 1,996,350
Unearned interest income 503,650
To record the sales
2017
Dec 31 Cash 500,000
Notes receivable 500,000
To record the first installment collection
31 Unearned interest income 159,708
Interest income 159,708
To record interest income
Journal entries for 2018 & 2019
2018
Dec 31 Cash 500,000
Notes receivable 500,000
To record the second installment collection
31 Unearned interest income 132,485
Interest income 132,485
To record interest income
2019
Dec 31 Cash 500,000
Notes receivable 500,000
To record the third installment collection
31 Unearned interest income 103,083
Interest income 103,083
To record interest income
Journal entries for 2020 & 2021
2020
Dec 31 Cash 500,000
Notes receivable 500,000
To record the fourth installment collection
31 Unearned interest income 71,330
Interest income 71,330
To record interest income
2021
Dec 31 Cash 500,000
Notes receivable 500,000
To record the fifth installment collection
31 Unearned interest income 37,044
Interest income 37,044
To record interest income
PROBLEM INFO: (DEMO PROB 2) ANALYSIS
• On January 1, 2016, Allure Company sold • Disposal (not “sales”)
an equipment with a carrying amount of • Non-interest bearing (interest
P800,000, receiving a noninterest-bearing included)
note due in three years with a face
• PRESENT VALUE OF NOTE
amount of P1,000,000. Not Ordinary
• PV of 1
LUMP SUM Business Activity
• Effective Rate of Interest
• There is no established market value for
COMPUTATION:
the equipment. The interest rate on
Face Value of Note 1,000,000
similar obligations is estimated at 12%.
Multiply by PV FACTOR 0.7118
PV of 1 at 12% for 3 periods Present Value 711, 800
REQUIRED: SALES PRICE
FORMULA: 12% for 3 periods
• Prepare journal entries (all)
PVF = (1 + i) ^ -n PVF = (1.12) ^ -3
• Prepare an amortization table and PV Factor = 0.7118
necessary computations.
COMPUTATION:
Face Value of Note 1,000,000
ALLURE COMPANY - AMORTIZATION SCHEDULE
Present Value of Note 711,800
Unearned Interest Income 288, 200 Period Interest Income Unearned Interest Present Value
Jan 1, 2016 12 % 288, 200 711, 800
Dec 31, 2016 85, 416 202, 784 797, 216
Present Value of Note 711,800 Dec 31, 2017 95, 666 107, 118 892, 882
Carrying Amount – EQMT 800,000 Dec 31, 2018 107,118 0 1,000, 000
Gain (Loss) on sale of (88, 200) TOTAL (CHECK) 288,200
equipment
Interest Income = 711, 800 * 12% = 85,416
PRESENTATION – Dec 31, 2016 PV * Effective Rate (12%)
NONCURRENT ASSET Unearned Interest = 288,200 – 85,416 = 202,784
Note Receivable 1,000,000 Previous less Interest Income
Less: Unearned Interest Income 202,784 PV-current = 1,000,000 – 202,784 = 797,216
Carrying Amount-Dec 31, 2016 797,216 Face Value less unearned interest (current)
PV-previous year plus interest income
Journal entries - 2016
Jan. 1 Note receivable 1,000,000
Loss on sale of equipment 88,200
Equipment 800,000
Unearned interest income 288,200
To record sale
• The initial carrying amount of P4, 768, 200 is still lower than P4,881,600.
This means the effective rate is higher than 13%.
INTERPOLATION APPROACH (TRIAL & ERROR)
• Using an effective rate of P14%, (TRIAL #2),
• the present value of 1 for three periods is 0.675
• the present value of an ordinary annuity of 1 for three periods is 2,322
• The present value of the cash flows is computed as follows:
PV of principal (5, 000, 000 x 0.675) 3,375,000
PV of interest (600, 000 x 2.322) 1,393,200
Total present value of cash flows 4,768,200
• The initial carrying amount of P4, 768, 200 is now the same as the
present value of the cash flows. Thus, the effective rate is 14%.
• In practice, the effective rate is easily determined through the use of a
financial calculator. Observe the following process:
1. Enter negative P5, 000, 000 (cash flow for the principal) and press FV
2. Enter negative P600, 000 (cash flow for interest) and press PMT
3. Enter 3 (maturity) and press N
4. Enter positive P4, 768, 200 (initial carrying amount) and press PV
5. Press comp (compute) and i% (effective rate)
6. Press EXE (execute)
7. The financial calculator will yield a 14% effective rate.
AMORTIZATION TABLE – Effective Interest Method
GLOBAL BANK - AMORTIZATION SCHEUDLE
Interest Interest Carrying
DATE Amortization
Received Income Amount
( ADD )
Jan 1, 2019 12 % 14 % 4, 768, 200
Dec 31, 2019 600, 000 667, 548 67, 548 4, 835, 748
Dec 31, 2020 600, 000 677, 005 77, 005 4, 912, 753
Dec 31, 2021 600, 000 687, 247 87, 247 5, 000, 000
600,000 + 87,247 5,000,000 – 4,912,753
Interest Received = Principal * Nominal Rate 5,000,000 * 12% = 600,000
Interest Income = Carrying Amount * Effective Rate 4,768,200 * 14% = 667,548
Amortization = Interest Income less Interest Received 667,548 – 600,000 = 67,548
Carrying Amount = Previous CA plus Amortization 4,768,200 + 67,548 = 4,835,748
EFFECTIVE INTEREST METHOD
• Under the effective interest method, the following formulas are necessary:
Interest received = Principal times nominal rate
Interest income = Carrying amount times effective rate
Cash 5,000,000
Loan receivable 5,000,000
To record collection of loan
( DEDUCT )
12 % 10 % 4,303,000
480,000 430,300 49,700 4,253,300
480,000 425,330 54,670 4,198,630
480,000 419,863 60,137 4,138,493
EXPENSE 480,000 413,849 66,151 4,072,342
480,000 407,658 72,342 4,000,000
2022
Dec 31 Cash 480,000
Interest Income 480,000
To record collection of interest
• The interest income is computed by multiplying the carrying amount of the loan
by the effective rate. Thus, P2, 407, 900 times 10% equals P240, 790. (can also
prepare an amortization table for 2 periods)
• Note that the recognition of interest income is charged against the allowance for
loan impairment account
• Journal entries on December 31, 2018
• To record the cash collection:
Cash 1,000,000
Loan receivable 1,000,000
• 8% times P2, 777, 328 equals P222, 186 or a difference of P486 due to rounding of present value
factors .
• Note that the allowance for loan impairment is amortized only over two years, 2017 and 20184,
because it is during these years that the borrower made a default.
• 2019
Dec. 31 Cash 240,000
Interest income 240,000
To record collection of interest
• 2020
Dec. 31 Cash 240,000
Interest income 240,000
To record collection of interest
• 2021
Dec. 31 Cash 240,000
Interest income 240,000
To record collection of interest
• 2022
Dec. 31 Cash 3,240,000
Interest income 240,000
Loan receivable 3,000,000
To record collection of interest and principal
Problem 13 - 5
• Solvent Bank loaned P10,000,000 to a borrower on January 1, 2014. The terms of
the loan require principal payments of P2,000,000 each year for 5 years plus
interest at 8%.
• The first principal and interest payment is due on December 31, 2014. The
borrower made the required payments on December 31, 2014 and December 31,
2015.
• However, during 2016 the borrower began to experience financial difficulties,
requiring the bank to reassess the collectability of the loan.
• On December 31, 2016, the bank has determined that the remaining principal
payment will be collected but the collection of the interest is unlikely. The bank
has accrued the interest for 2016.
• The present value of 1 at 8% is as follows:
For one period 0.93
For two periods 0.86
For three periods 0.79
JOURNAL ENTRIES (Separate sheet)
• Solvent Bank loaned
P10,000,000 to a borrower on 2014
January 1, 2014. The terms of Jan 1 Loan Receivable 10,000,000
the loan require principal Cash 10,000,000
payments of P2,000,000 each To record loan to borrower
year for 5 years plus interest
at 8%. Dec 31 Cash 2,800,000
Loan Receivable 2,000,000
Interest Income 800,000
• The first principal and interest To record collection of principal and interest
payment is due on December Interest = 10,000,000 * 8% = 800,000
31, 2014. The borrower made 2015
the required payments on Dec 31 Cash 2,640,000
December 31, 2014 and Loan Receivable 2,000,000
December 31, 2015. Interest Income 640,000
To record collection of principal and interest
Interest = 8,000,000 * 10% = 640,000
• However, during 2016 the
borrower began to experience Present Value of Loan
financial difficulties, requiring Dec 31, 2017 1, 000, 000 0.93 930, 000
the bank to reassess the
collectability of the loan. Dec 31, 2018 2, 000, 000 0.86 1,720, 000
• On December 31, 2016, the bank Dec 31, 2017 3, 000, 000 0.79 2,370, 000
has determined that the Present Value of Loan 5,020, 000
remaining principal payment will
be collected but the collection of
the interest is unlikely. The bank Impairment Loss
has accrued the interest for Loan Receivable – Dec 31, 2016 6,000, 000
2016. Accrued Interest – Dec 31, 2016
• The present value of 1 at 8% is as 6,000,000 * 8% 480, 000
follows:
Total Carrying Amount 6,480, 000
For one period 0.93 Present Value of Loan 5,020, 000
For two periods 0.86 Impairment Loss 1,460, 000
For three periods 0.79
SOLVENT BANK - AMORTIZATION SCHEUDLE
DATE Payments Interest Income Principal Present Value
Dec 31, 2016 8% 5, 020, 000
Dec 31, 2017 1,000, 000 401, 600 598, 400 4, 421, 600
Dec 31, 2018 2,000, 000 353, 728 1,646, 272 2, 775, 328
Dec 31, 2019 3,000, 000 224, 672 2,775, 328 0
3,000,000 – 2,775,328
2020
Dec 31 Cash 3,000,000
Loan Receivable 3,000,000
To record collection
• The effective rate of the loan after considering the direct origination
cost and origination fee received is 12%.
• The nominal rate (10%) is lower than the effective rate (12%)
PROBLEM 13-3
• Pauper Bank granted a loan to a borrower on January 1, 2016. The
interest rate on the loan is 8% payable annually starting December 31,
2016. The loan matures in three years on December 31, 2018.
Principal amount 3,000,000
Direct origination cost 260,300 DIRECT
ORIGINATION
Origination fee received from borrower 100,000 COST
PRINCIPAL is LESS THAN Amortization is DEDUCTED 160,300 (amount to
CARRYING AMOUNT from the carrying amount. be amortized)
• The effective rate of the loan after considering the direct origination cost
and origination fee received is 6%.
• The nominal rate (8%) is higher than the effective rate (6%)
Compute the Initial Carrying Amount of the Loan
Loan Receivable 3, 000, 000
Direct Origination Cost 260, 300
Origination fee charged to borrower ( 100, 000)
Initial Carrying Amount 3, 160, 300
2016
Dec 31 Cash 240,000
Interest Income 240,000
To record collection of interest
OR
Loan Receivable – Initial Carrying Amount 3, 160, 300
LESS: Amortization of Prepaid Cost-2016 50, 382
Loan Receivable - Carrying Amount Dec 31, 2016 3, 109, 918
Journal entries on December 31, 2017
2017
Dec 31 Cash 240,000
Interest Income 240,000
To record collection of interest
2018
Dec 31 Cash 3,240,000
Interest Income 240,000
Loan Receivable 3,000,000
To record collection of principal and interest