Notes Receivable

Chapter 6

Maria Jessalen B. Azul

Notes Receivable
 Notes receivable are claims supported by formal promises to pay usually in the form of
notes.
 A negotiable promissory note is an unconditional promise in writing made by one person to
another, signed by the maker, engaging to pay on demand or at a fixed determinable
future time a sum certain in money to order or to bearer.
 Simply stated, a promissory note is a written contract in which one person, known as the
maker, promises to pay another person, known as the payee, a definite sum of money.
 The note may be payable on demand or at a definite future date.
 Standing alone, the term notes receivable represents only claims arising from sale of
merchandise or service in the ordinary course of business.
 Thus, notes received from officers, employees, shareholders and affiliates shall be
designated separately.
Dishonored Notes
When a promissory note matures and is not paid, it is said to be dishonored.
Theoretically, dishonored notes receivable should be removed from the notes
receivable account and transferred to accounts receivable.
The amount debited to accounts receivable should include the face amount,
interest and other charges.
Such approach is defended on the ground that the overdue note has lost part of
its status as a negotiable instrument and really represents only an ordinary
claim against the maker.
Initial Measurement Of Notes Receivable

Conceptually, notes receivable shall be measured initially at present value.

The 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 of interest is actually the effective interest rate.
However, short-term notes receivable shall be measured at face amount.
Cash flows relating to short-term notes receivable are not discounted because
the effect of discounting is usually not material.
Interest-bearing notes receivable
• The initial measurement of long-term notes will depend on whether the notes are
interest-bearing or noninterest bearing.
• Interest-bearing long-term notes are measured at face amount which is actually
the present value upon issuance.

Noninterest-bearing notes receivable

• Noninterest-bearing long-term notes are measured at present value which is the
discounted value of the future cash flows using the effective interest rate.
• Actually, the term "noninterest-bearing" is a misnomer because all notes
implicitly contain interest.
• It is simply a case of the interest being included in the face amount rather than
being stated as a separate rate.
Subsequent Measurement
Subsequent to initial recognition, long-term notes receivable shall be measured at amortized cost
using the effective interest method.
The amortized cost measurement is in accordance with PFRS 9, paragraph 5.2.1.
The amortized cost is the amount at which the note receivable is measured initially:
a. Minus principal repayment
b. Plus or minus cumulative amortization of any difference between the initial carrying amount
and the principal maturity amount
c. Minus reduction for impairment or uncollectibility.
In other words, for long-term noninterest-bearing notes receivable, the amortized cost is the present
value plus amortization of the discount, or the face amount minus the unamortized unearned interest
income.
Accordingly, only long term interest bearing and noninterest bearing notes receivable will be discussed
in conjunction with the present value concept.
Illustration - Interest Bearing Note
An entity owned a tract of land costing P800,000 and sold the land for
P1,000,000.
The entity received a 3-year note for P1,000,000 plus interest of 12%
compounded annually.
When interest is compounded, in the mathematical parlance this means that any
accrued interest receivable also earns interest.
The selling price of P1,000,000 is reasonably assumed to be the present value
of the note because the note is interest bearing.
Journal Entries
First year
Note receivable 1,000,000
Land 800,000
Gain on sale of land 200,000

Accrued interest receivable 120,000

Interest income(12% x 1,000,000) 120,000
Journal Entries
Second Year
Accrued interest receivable 134,400
Interest income 134,400

Face amount 1,000,000

Interest accrued for first year 120,000
Total 1,120,000
Interest for second year (12% x 1,120,000) 134,400
Journal Entries
Third Year
Cash 1,404,928
Note receivable 1,000,000
Accrued interest receivable 254,400
Interest income 150,528

Face amount 1,000,000

Interest accrued:
First year 120,000
Second year 134,400 254,400
Total 1,254,400
Interest for third year (12% x 1,254,400) 150,528
Cash received 1,404,928
Illustration - Noninterest Bearing Note

An entity manufactures and sells machinery. On January 1, 2022, the entity sold
machinery costing P280,000 for P400,000. The buyer signed a noninterest bearing note
for F 400,000, payable in four equal installments every December 31.
The cash sale price of the machinery is P350,000.
Face amount of note 400,000
Present value cash sale price 350,000
Unearned interest income 50,000
Cash sale price 350,000
Cost of machinery 280,000
Gross income 70,000
Journal Entries
To record the sale:
Notes Receivable 400,000
Sales 350,000
Unearned interest Income 50,000
To record the first installment collection:
Cash 100,000
Note Receivable 100,000
To recognize the unearned interest as income over the term of the note:
Unearned interest income 20,000
Interest income 20,000
 (a) Notes (b) Fraction (c) Interest Income
Receivable
2022 400,000 4/10 20,000
2023 300,000 3/10 15,000
2024 200,000 2/10 10,000
2025 100,000 1/10 5,000
1,000,000 50,000

The first installment is received on December 31, 2022.

Thus, for 2022 the note receivable outstanding is P400,000 and decreased by P100,000 each
year.
The fractions are developed from the note receivable balance every year.
The fractions developed are multiplied by the total unearned interest of P50,000 to get the yearly
interest income.
Thus, for 2022, 4/10 x P50,000 equals P20,000 and so on.
 Statement Presentation
If a statement of financial position is prepared on December 31, 2022, the current portion of the note receivable is classified as
current asset.
Note receivable-current portion 100,000
Unearned interest income (15,000)
Carrying amount or amortized cost 85,000
Total unearned interest income 50,000
Realized in 2022 (20,000)
Balance-December 31, 2022 30,000
Realizable in 2023-current portion 15,000
Realizable beyond 2022-noncurrent portion 15,000
Total 30,000

The noncurrent portion of the note receivable is classified as noncurrent asset.

Note receivable - noncurrent portion 200,000
Unearned interest income (15,000)
Carrying amount or amortized cost 185,000
Illustration - Noninterest Bearing Note
On January 1, 2022, an entity sold an equipment with a cost of P250,000 for P400,000.
The buyer paid a down of P100,000 and signed a noninterest bearing note for P300,000 payable in equal
annual installment of P100,000 every December 31.
The market interest rate for this note is 10%. The present value of an ordinary annuity of 1 for three periods at
10% is 2.4869.
The present value of the note is computed by multiplying the annual installment of P100,000 by the present
value factor of 2.4869 or P248,690.
Face amount of note 300,000
Present value of note (100,000 x 2.4869) 248,690
Unearned interest income 51,310
Present value of note 248,690
Cash received-down payment 100,000
Sale price 348,690
Cost of equipment 250,000
Gain on sale of equipment 98,690
Journal entries for 2022
1. To record the sale of equipment:
Cash 100,000
Note receivable 300,000
Equipment 250,000
Gain on sale of equipment 98,690
Unearned interest income 51,310
2. To record the first installment collection:
Cash 100,000
Note receivable 100,000
3. To record the interest income for 2022:
Unearned interest income 24,869
Interest income 24,869
Computation
The computation of the interest income is made using the effective interest
method.

Annual
Date Interest Income Principal Present Value
Collection
Jan. 1, 2022 248,690
December 31, 2022 100,000 24,869 75,131 173,559
December 31, 2023 100,000 17,356 82,644 90,915
December 31, 2024 100,000 9,085 90,915 -
The interest income is computed by multiplying the present value by 10%. Thus,
for 2022, 10% x P248,690 equals P24,869.
The principal payment is equal to annual collection minus interest income. Thus,
for 2022, P100,000 minus P24,869 equals P75,131.
The present value is equal to the preceding balance minus the annual principal
payment. Thus, on December 31, 2022, P248,690 minus P75, 131 equals
P173,559.
Journal entries for 2023
1. To record the second annual collection:
Cash 100,000
Note receivable 100,000
2. To record the interest income for 2023:
Unearned interest income 17,356
Interest income 17,356

Journal entries for 2024

1. To record the third annual collection:
Cash 100,000
Note receivable 100,000
2. To record the interest income for 2024:
Unearned interest income 9,085
Interest income 9,085
Illustration - Noninterest Bearing Note
On January 1, 2022, an entity sold an equipment costing P600,000 with accumulated
depreciation of P250,000 and carrying amount of P350,000.
The entity received as consideration P100,000 cash and a P400,000 noninterest
bearing note due on January 1, 2025.
The prevailing rate of interest for a note of this type is 10%. The present value of 1 at
10% for 3 years is 0.7513.
Observe that the note is collectible on a lump sum basis after 3 years.
Face amount of note 400,000
Present value (400,000 x .7513) 300,520
Unearned interest income 99,480
The unearned interest income is sometimes described as discount on note receivable.
 Computation
Journal entries
2022
Jan.1 Cash 100,000
Present value of note 300,520
Note receivable 400,000
Cash received 100,000 Accumulated depreciation 250,000
Sale price 400,520 Equipment 600,000
Carrying amount of equipment 350,000
Gain on sale of equipment 50,520 Gain on sale of equipment 50,520
Unearned interest income 99,480

Dec.31
Unearned interest income 30,052
Interest income 30,052
 Date Interest Income Unearned Interest Present Value
Jan.1, 2022 99,480 300,520
Dec. 31, 2022 30,052 69,428 330,572
Dec. 31, 2023 33,057 36,371 363,629
Dec. 31, 2024 36,371 - 400,000

• The interest income is computed by multiplying the present value by 10%.

• Thus, for 2022, P300,520 x 10% equals P30,052.
• The unearned interest income is arrived at by deducting the interest income from preceding
balance.
• Thus, on December 31, 2022, P99,480 minus P30,052 equals P69,428.
• The present value is arrived at by adding the interest income to the preceding present value
balance.
• Thus, on December 31, 2022, P300,520 plus P30,052 equals P330,572.
• Or face amount of note minus unearned interest income equals present value.
• Thus, on December 31, 2022, P400,000 minus P69,428 equals P330,572.
2023
Dec.31 Unearned interest income 33,057
Interest income 33,057

2024
Dec.31 Unearned interest income 36,371
Interest income 36,371

2025
Jan. 1 Cash 400,000
Note receivable 400,000
Thank You!