Financial Accounting

MBA-602-1
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Chapter 13
Loans Receivable
Professor:
Dr. Manuel I. Inserto

Presentor:
Anne Coriza G. Cruz
 Y S
D A
O

Technical
T

Knowledge
• To understand the initial measurement of
loan receivable
• To understand the subsequent
measurement of loan receivable
• To know the treatment of loan origination
fees
• To recognize the impairment of loan
receivable
 It is a financial asset arising
from a loan granted by a bank
or other financial institution
to a borrower or client.

The term of the loan may be

short-term but in most cases,
the repayment period cover
several years.

Loans
Receivable
 Initial
Measurement
At fair value plus transaction costs
that are directly attributable to the
acquisition of the financial asset
FAIR VALUE = Transaction price / amount of loan granted
Transaction Cost = DIRECT ORIGINATION COST
INDIRECT ORIGINATION COST is treated as outright expense
At amortized cost using
the effective interest
method
AMORTIZED COST = amount at which the loan
receivable is measured initially;
a. Minus principal repayment
b. Plus / Minus cumulative amortization
c. Minus reduction for impairment
In other words, if the initial amount recognized is lower than the
principal amount, the amortization of the difference is added to the
carrying amount.
If the initial amount recognized is higher than the principal amount,
the amortization of the difference is deducted to the carrying
amount.
Subsequent
Measurement
 • Evaluating the borrower's

Origination Fees financial condition

• Evaluating guarantees, collateral
and other security
• Negotiating the terms of the loan
• Preparing and processing the
documents related to the loan
• Closing and approving the loan
Loan Origination fees are the fees
charged by the lenders transaction
in order to be compensated upfront
for processing new loan applications.
These fees are used by the lender to
make more money and turn a higher
profit per loan and are charged based
on a percentage of the loan amount,
typically raging between 0.5% - 1%

What is Origination Understanding Compensation for the

Fees? Origination Fees following activities
Accounting
for Origination Fees
The origination fees received from borrower are
recognized as unearned interest income and Preferably, the direct origination costs are offset directly
against any unearned origination fees received.
amortized over the term of the loan.

If the origination fees are not chargeable against origination fees > direct origination costs
(the difference is unearned interest income and the
the borrower, the fees are known as "direct amortization will increase interest income)
origination costs"
direct origination costs > origination fees
(the difference is charged to "direct origination costs" and
The direct origination costs are deferred and also the amortization will decrease interest income)
amortized over
the term of the loan Accordingly, the origination fees received and the direct
origination costs are included in the measurement of the loan
receivable
 Illustration
Thus, the unearned interest income has credit balance of Accordingly, the present value of the cash flows is
Global Bank granted a loan to a borrower on January 1, 2016. The
P231,800 to be amortized over the term of the loan determined as follows:
interest on the loan is 12% payable annually starting December 31, 2016.
using the effective interest method
The loan matures in three years on December 31, 2018. The other data PV for principal (5,000,000 x 0.693) 3,465,000
related to the loan are: PV for interest ( 600,000 x 2.361 ) 1,416,600
Principal amount 5,000,000 Total present value of cash flows 4,881,600
Origination fees received from borrower 331,800
Direct origination costs incurred 100,000 The initial carrying amount of P4,768,200 is still lower
than P4,881,600, this means the effective rate is higher
Initial carrying amount than the nominal rate of 13%
Principal amount 5,000,000 Another rate is used in the interpolation process. Using
Origination fees received ( 331,800) an effective rate of 14%, the present value of 1 for three
Direct origination costs incurred 100,000 periods is 0.675, and the present value of an ordinary
Initial carrying amount of loan 4,768,200 annuity of 1 for three periods is 2.322.
The effective rate is computed through the "trial and
error" or "interpolation" approach
Journal entries on January 1, 2016 Accordingly, the present value of the cash flows is
• To record the loan: Since the initial carrying amount of the loan receivable of
P4,768,200 is lower than the principal amount, it means determined as follows:
Loan receivable 5,000,000
there is a discount and therefore the effective rate must be PV for principal (5,000,000 x 0.675) 3,375,000
Cash 5,000,000
higher than the nominal rate of 12% PV for interest ( 600,000 x 2,322 ) 1,393,200
2. To record the origination fees received from the borrower
Cash 331,800 Total present value of cash flows 4,768,200
Unearned interest income 331,800 Using an effective rate of 13%, the present value of 1 for
three periods is 0.693, and the present value of an Coincidentally, the initial carrying amount of
3. To record the direct origination costs incurred by the bank: P4,768,200 is now the same as the present value of the
ordinary annuity of 1 for three periods is 2.361.
Unearned interest income 100,000 cash flows. Thus, the effective rate is 14%.
Cash 100,000
In practice
The effective rate is easily determined through the use of financial
Effective interest method
Interest received = Principal times nominal rate
Interest income = Carrying amount times effective rate

calculator.
December 31, 2016
• Enter negative 5,000,000 (cash flow for the principal) and press FV
Interest received (5,000,000 x 12%) 600,000
• Enter negative P600,000 (cash flow for interest) and press PMT
Interest income (4,768,200 x 14%) 667,548
• Enter 3 (maturity) and press N
• Enter positive P4,768,200 (initial carrying amount) and press PV Amortization 67,548
• Pres comp (compute) and i% (effective rate) Carrying amount - January 1, 2016 4,768,200
• Press EXE (execute) 4,835,748
• The financial calculator will yield a 14% effective rate
December 31, 2017
Interest received 600,000
Interest income (4,835,748 x 14%) 677,005

Amortization 77,005
Carrying amount - December 31, 2016 4,835,748
Amortization table - effective interest method Carrying amount - December 31, 2017 4,912,753
Interest Interest Carrying
Date Amortization December 31, 2018
received income amount
Interest received 600,000
Interest income 687,247*
Jan. 1, 2016 4,768,200
Amortization 87,247
Carrying amount - December 31, 2017 4,912,753
Dec. 31, 2016 600,000 667,548 67,548 4,835,748
Carrying amount - December 31, 2018 5,000,000

Dec. 31, 2017 600,000 667,005 77,005 4,912,753 *4,912,753 x 14% equals P687,785. There is difference of P538 due to
rounding of present value factor

Dec. 31, 2018 600,000 687,247 87,247 5,000,000

 Journal entries on December 31, 2016
Cash 600,000
Interest Income 600,000

December 31, 2016 Unearned interest income 67,548

Interest received (5,000,000 x 12%) 600,000 Interest income 67,548
Interest income (4,768,200 x 14%) 667,548
Loan receivable is presented as follows:
Amortization 67,548 Loan receivable 5,000,000
Carrying amount - January 1, 2016 4,768,200 Unearned interest income (231,800 - 67,548) ( 164,252)
4,835,748 Carrying Amount 4,835,748

** The carrying amount is actually the amortized cost

December 31, 2017

Interest received 600,000
Journal entries on December 31, 2017
Cash 600,000
Interest income (4,835,748 x 14%) 677,005
Interest Income 600,000
Amortization 77,005
Carrying amount - December 31, 2016 4,835,748 Unearned interest income 77,005
Interest income 77,005
Carrying amount - December 31, 2017 4,912,753

December 31, 2018

Journal entries on December 31, 2018
Cash 600,000
Interest received 600,000
Interest Income 600,000
Interest income 687,247*

Amortization 87,247 Unearned interest income 87,247

Carrying amount - December 31, 2017 4,912,753 Interest income 87,247

Carrying amount - December 31, 2018 5,000,000 Cash 5,000,000

Loan receivable 5,000,000
*4,912,753 x 14% equals P687,785. There is difference of P538 due to
rounding of present value factor
 Impairment of Loan
A loan is considered to be impaired when it is probable that not all of the related principal and
interest payments will be collected Credit losses are the present value of all cash shortfalls

An entity shall recognize a loss allowance for expected credit losses on financial asset measured at
amortized cost Expected credit losses are an estimate of credit losses over the life of the
An entity shall measure the loss allowance for a financial instrument at an amount equal to the financial instrument
lifetime expected credit losses if the credit risk on that financial instrument has increased significally
since initial recognition

Measurement of Impairment
Probability - weighted outcome
The estimate should reflect the possibility that a credit loss
occurs and the possibility that no credit loss occurs

The amount of impairment loss can be measured as the difference between the
Time value of money
carrying amount and the present value of estimated future cash flows discounted at the
The expected credit losses should be discounted
original effective rate
Reasonable and supportable in information
Available without undue cost or effort The carrying amount of the loan receivable shall be reduced directly or through the
use of an allowance account
* PFRS 9 does not prescribe particular method of measurement

The entity may use various sources of data both internal or entity-specific and external in
measuring expected credit losses
Meaning of Credit Risk
Credit risk is the risk that one party to a financial instrument will cause a financial loss for
the other party by failing to discharge an obligation

The risk contemplated is the risk that the issuer will fail to perform a particular obligation.

The risk does not necessarily relate to the credit worthiness of the issuer.

For example, if an entity issued a collateralized liability and noncollateralized liability that
are otherwise identical, the credit risk of the two liabilities will be different.

The credit risk of the collateralized liability is surely less than

the credit risk of the noncollateralized liability.

The credit risk for a collateralized liability maybe zero.

 Illustration #1
Journal entries on December 31, 2016
Loan impairment loss 892,100
INTERNATIONAL BANK BANKARD COMPANY
Accrued interest receivable 300,000
Allowance for loan impairment 592,100
P5,000,000 January 1, 2014
Statement presentation on December 31, 2016
The terms of the loan require principal payment of P1,000,000 Loan receivable 3,000,000
each year for. 5 years plus interest at 10%. Allowance for loan impairment ( 592,100)
The first principal and interest payment Made the required payments Carrying amount 2,407,900
December 31, 2014. December 31, 2014
December 31, 2015
Unable to pay principal interest Journal entries on December 31, 2017
December 31, 2016 • To record the cash collection:

Assessed the collectability of the loan and has Cash 500,000

Using the original effective rate of 10%, the present value of 1
determined that the remaining principal payments will Loan receivable 500,000
is .9091 for one period, .8264 for two periods and .7513 for
be collected but the collection of the interest is three period.
unlikely. 2. To record the interest income using the effective interest method:
Present value of the cash flow
Loan receivable has carrying amount of P3,300,000 Accrued Allowance for loan impairment 240,790
December 31, 2017 (500,000 x .9091) 454,550
interest of P300,000 on December 31, 2016. Interest income 240,790
December 31, 2018 (1,000,000 x .8264) 826,400
International Bank projected the cash flows from the loan on December 31, 2019 (1,500,000 x .7513) 1,126,950
December 31, 2016. The interest income for 2017 is computed by multiplying and carrying
Total present value of cash flow 2,407,900
amount of the loan by the effective rate
Date of cash flow Amount projected Computation of impairment loss
December 31, 2017 500,000 Carrying amount of loan 3,300,000 Thus, 2,407,900 x 10% = 240,790
December 31, 2018 1,000,000 Present value of cash flow less 2,407,900
December 31, 2019 1,500,000 Note that the recognition of interest income is charged against the
Impairment loss 892,100
allowance for loan impairment acount
 Illustration #1 Journal entries on December 31, 2018
• To record the cash collection:
Cash 1,000,000
Loan receivable 1,000,000
INTERNATIONAL BANK BANKARD COMPANY
2. To record the interest income using the effective interest method:
P5,000,000 January 1, 2014
Allowance for loan impairment 214,869
The terms of the loan require principal payment of P1,000,000 Interest income 214,869
each year for. 5 years plus interest at 10%.

The first principal and interest payment Made the required payments Loan receivable - December 2017 2,500,000
December 31, 2014. December 31, 2014 Allowance for loan impairment (592,100- 240,790) ( 351,310)
December 31, 2015 Carrying Amount - December 31, 2017 2,148,690
Unable to pay principal interest Interest income for 2018 (10% x 2,148,690) 214,869
December 31, 2016

Assessed the collectability of the loan and has

Journal entries on December 31, 2019
Using the original effective rate of 10%, the present value of 1
• To record the final cash collection:
determined that the remaining principal payments will is .9091 for one period, .8264 for two periods and .7513 for
be collected but the collection of the interest is three period. Cash 1,500,000
unlikely. Loan receivable 1,500,000
Present value of the cash flow
Loan receivable has carrying amount of P3,300,000 Accrued 2. To record the interest income using the effective interest method:
December 31, 2017 (500,000 x .9091) 454,550
interest of P300,000 on December 31, 2016.
December 31, 2018 (1,000,000 x .8264) 826,400 Allowance for loan impairment 138,441
International Bank projected the cash flows from the loan on December 31, 2019 (1,500,000 x .7513) 1,126,950 Interest income 138,441
December 31, 2016.
Total present value of cash flow 2,407,900
Loan receivable - December 2018 1,500,000
Date of cash flow Amount projected Computation of impairment loss Allowance for loan impairment (351,310-214,869) ( 136,441)
December 31, 2017 500,000 Carrying amount of loan 3,300,000 Carrying Amount - December 31, 2018 1,363,559
December 31, 2018 1,000,000 Present value of cash flow less 2,407,900 Interest income for 2019 (10% x 1,363,559) 136,356
December 31, 2019 1,500,000
Impairment loss 892,100
There is a difference of P85 between P136,441 and P136,356 due to rounding
of present value factors
 Illustration #2 Computation
The present value of the future interest and principal
2018
Dec. 31 Allowance for loan impairment 222,672**
payments can be computed as follows:
Interest income 222,672
Loan receivable- Dec. 31, 2017 3,000,000
URBAN BANK BORROWER
December 31, 2019 ( 240,000 x .794) 190,560
Allowance for loan impairment
December 31, 2020 ( 240,000 x .735) 176,400
December 31, 2021 ( 240,000 x .681) 163,440 (428,400-205,728) ( 222,672)
P3,000,000 January 1, 2016
December 31, 2022 (3,240,000 x .630) 2,041,200 Carrying Amount - Dec. 31, 2017 2,777,328
The terms of the loan: Full payment on December 31, 2021 plus **8% x P2,777,328 = P222,186 or a difference of P486 due to
annual interest payment at 8% every December 31. The first interest Total present value of loan 2,571,600
rounding of present value factor.
payment was made on December 31, 2016.
Carrying amount of loan equal to
principal only because there is Note that the allowance for loan impairment is amortized only over
The first principal and interest payment on December 31, 2016 but the no accrued interest on two years, 2017 and 2018, because it is during these years that the
borrower informed Urban Bank that they would miss the interest December 31, 2016 3,000,000 borrower made a default.
payment for the next two years. After that, the borrower expects to Present value of loan 2,571,600
resume the annual interest payment but the principal would be paid on 2019
Impairment loss 428,400 Dec. 31 Cash 240,000
December 31, 2022 or one year late with interest paid for that
additional year. Interest income 240,000
2020

Schedule of payments from the borrower

Journal entries Dec. 31 Cash 240,000
2016 Interest income 240,000
December 31, 2017 No interest payment 0
Jan. 1 Loan receivable 3,000,000 2021
December 31, 2018 No interest payment 0
December 31, 2019 Interest payment (8% x P3,000,000) 240,000 Cash 3,000,000 Dec. 31 Cash 240,000
December 31, 2020 Interest payment 240,000 Dec. 31 Cash 240,000 Interest income 240,000
December 31, 2021 Interest payment 240,000 Interest income 240,000 2022
December 31, 2022 Interest payment 240,000 31 Loan impairment loss 428,400 Dec. 31 Cash 3,240,000
Principal payment 3,000,000 Allowance for loan impairment 428,400 Interest income 240,000
2017 Loan receivable 3,000,000
Using the original effective rate of 8%, the present value of 1 is .974 for
Dec. 31 Allowance for loan impairment 205,728
three periods, .735 for four periods and .681 for five periods, and .630 for
Interest income (8% x 2,571,600) 205,728
six periods.
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