ee Chapter 2 Notes Payable Related standard: PFRS 9 Financial Instruments Learning Objectives : 1. State the initial and subsequent measurements of notes an . loans payable. 2. Apply present value factors and prepare amortization tables. 3. Account for origination fees. Notes payable Notes payable are obligations supported by. debtor promisson notes. The accounting for notes payable is similar to th accounting for notes receivable (as discussed in Intermediate Accounting Part 1A). Initial measurement Notes payable are initially recognized at fair value minus transaction costs. >. Fair value — is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” (PFRS 13, Appdx. A) For measurement purposes, notes payable are classified Short-term payable _ Long-term payable that bears a reasonable interest rate ~ Long-term payable that bears no interest (noninterest bearing) ide Long term payable that bears an unreasonable interest rate (‘below-market’ interest rate) “short-term” payable is one that matures within 1 year. A oe term” payable is one that matures beyond 1 ee Scanned with CamScannerNotes Payable 53 Short-term payable The fair value of a short- term payable may be e equal to it fae ts face ‘ ount. However, if the tran contaii ifica ! . eee the fair value of the short-term pa | present value. Long-term payables = e fair value interest r ce trate at the term noninterest bearing payable) 1e present value. oft the future cash flows on the instrument discounted using an an ted. interest rate. te ae } ing sae long-terr interest Is cash rR on. 1e in: "Interest rate, Other terms for imputed rate of interest include effective interest rate, market rate and yield rate. Effective interest rate is the — _rate that exactly discounts the future cash payments of a financial liability equal to its carrying amount. _ ; _ Cash price equivalent _ The fair value of a payable may be measured in relation to the _ cash price equivalent of the noncash asset (noncash consideration) | received in exchange for the payable. Cas opposed to installenent basis or ee deferred ccilement _ Example 1: An entity purchases a TV set on a 6-month installment basis. The _installment price is P120,000. However, if the TV set is purchased _ Outright [Link], the casi price would have been P100,000. Scanned with CamScannerod of } year. the seller normally sells tie gouus lur r22u,U() ha credit period of one month or with a ?5,000 discount f zh basis (i., outright payment in cash). The, initial measurement , Jof the payable is eee a follows: Yormal purchase price with a credit period of one month 220,00 Discount for outright payment (5,000 Cash price equivalent of the goods purchased 215,00 Both the purchase prices of 250,000 (special credit) an ?220,000 (normal credit) constitute a financing transaction, ie _they include consideration for the credit period. To compute fo the cash price equivalent of the goods, the P5,000 discount fo outright payment is deducted from the normal selling price 0 P220,000. Fe ‘Subsequent measurement Notes payal le that are initially measured at face amount ar emrectonentenas subsequently measured at t face_amount or “expected ayetemen amount. Notes payable that are initially med measured at present valu are subse juently measured at amortized co cost. > Amortized cost is the “amount at which the financial asset o: financi: liability is measured at initial recognition minu: principal - ‘repayments, plus or minus the cumulative Scanned with CamScannerte ee eee a, the face amount is initially recognized as a discount (or premium, in the case of bonds payable) and subsequently amortized as interest expense using the effective interest method. Effective interest_method i is a method’ of calculating the amortized cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant | period. ’ | Fv-TC ‘ £2 Summary of initial and subsequent measurements of notes payable follows: Initial measurement | Type of note Fair value minus Subsequent i bl transaction costs. The fair t | payabie value is determined as CA SHFETILEH 1. Short-term \av Face amount; or Expected: : \b/ Present value (if settlement f the transaction amount if the | oo a significant initial financing measurement is - face amount. : Amortized cost if the initial measurement is present value. Expected settlement component) reasonable interest rate amount. Scanned with CamScanner56 Chapter 3... Long-term | >. Present value > Amortized cost ~~ noninterest- bearin; Long-term with | > Present value > Amortized cost unreasonable interest rate “If the cash price equivalent is determinable, the note is initially measured at this amount. The subsequent measurement is amortized cost. _ Anote payable may be issued for cash, purchase of good: or services, or other noncash consideration. Regardless of the eoaailemton received, the accounting depends on the note’s classification for measurement purposes. » Mlustration 1: Short-term note gn 1 July 1, 20x1, ABC Co. bor d_P1,000,000 Aha issued a one year, note payable. The lender scounted the note at 1 %” @ _ © The term “discounted” as used in this context means the lénder deducted the 12% rest in advance. ABC Co.'s proceeds from the note are net of the advanced interest. sum. on June 30, 20x2. The effect o| | discounting (ie., time value of money) is immaterial. ” Z _ Analysis: Thetetire, the note is initially measured at face amount (net of th _ advanced interest). lournal entries: Cash (IM x 88%) l 880,000. Niscount on notes pavable (1M x 12%) 120,000 |- Scanned with CamScannerNotes Payable 83 Chapter 2: Summary e Notes payable are initially recognized at fair value minus transaction costs. The fair value may be measured as follows: (a) Short-term notes - face amount or present value; (b) Long-term notes with reasonable interest rate - face amount, (c) Long-term noninterest-bearing notes and Long-term notes with unreasonable interest rate - present value; or (d) If determinable, the cash price equivalent of the noncash consideration received. : © — Stated interest rate’ (nominal rate, coupon rate, or face rate) is the rate appearing on the face of an interest-bearing note. e — Effective interest rate (imputed rate of interest, current market rate or yield rate) is the rate used in present value computations. e A noninterest-bearing note has an unspecified principal and an unspecified interest. These elements are separated through present value computations. e Future cash flows x PV factor at x% = Present value e PVof #1is used when the future cash flow is due in lump sum or when the series of cash flows are non-uniform. e PV of an ordinary annuity of P1 is used when the future cash flows are due in installments and the first installment does not begin immediately; PV of an annuity due of P1 is used if the first installment begins immediately. Total interest expense recognized over the life of a noninterest- bearing note is equal to the discount on note payable on initial recognition. ‘ e Interest payable = Face amount x Nominal rate | © Interest expense = Present value x Effective interest rate Origination fees are deducted from the carrying amount of the loan are and subsequently amortized using the effective interest method. e] AREA a RT Scanned with CamScanner84 Chapter: PROBLEMS PROBLEM 1: TRUE OR FALSE + 1. Interest. payable is computed by multiplying the carrying amount of a note with the effective interest rate: { 2. OnJan. 1, 20x1, Crybaby Co. issued a noninterest-bearing note 424 643 with face amount of P2M and appropriately recognized it at xIV0 #0 P1,241,843. The note matures in lump sum on Dec. 31, 20x5. =1,502,08°The effective interest is 10%. The unamortized discount on TGs e4ok Dec. 31, 20x2 is P497,370,_ # 2M~ ¥ Sz s6O Raining Co. issues a 3-year, noninterest-bearing note of P1,000,000. Raining Co. determines that the effective interest rate on the transaction is 10%. The initial carrying amount of the note payable is computed as: P1,000,000 x PV of 1 @10%, n=3. Wet Co. issues a noninterest-bearing note of P3,000,000. The note is payable in three_ equal annual installments of P1,000,000, due at thefend of each year Wet Co, determines that the effective interest rate on thé transaction is 10%. The initial carrying-amount of the note payable is computed as P1,000,000 x PV of 1 1@10%)n=3, PV go 8 Fold Co. issues"a 2-year, noninterest-bearing hote of P1,200,000 in exchange for the purchase of a commodity. If Fold Co. had paid outright in cash, the purchase price would have been P800,000. At initial recognition, Fold Co. records discount on note payable of P400,000. J Bind Co. issues a 2-year, noninterest-bearing note of P500,000 “qooK-so/. for the purchase of equipment with a cash price of P400,000. The note requires lump sum payment at maturity date. Bind Co. determines that the effective interest rate on_ the transaction is 10%. The interest expense in Year 1 is P50,000. Cut Co. issues a long-term, noninterest-bearing note of P100,000. The note requires.a lump sum payment at maturity date. Cut Co. determines that the effective interest rate on the transaction is 10% and the appropriate present value factor is 0.90. The interest expense in Year 1 is P9,000. C1Ok x 107.) = AW X LO'/, TK Scanned with CamScannerNotes Payable 85 { 8. Use the information in the preceding problem (i.e., Cut Co.). The interest expense in Year 2 is P9,900. = 9. Bond Co. issues a P1,000,000, noninterest-bearing note that is payable in installments. On initial recognition, the carrying amount of the note was P900,000. If the amortization of the note during the period is 50,000, the carrying amount of the note at the end of the period must be ?950,000. E 10. Pawn Co. issues a P1,200,000, noninterest-bearing note that is payable in installments. On initial recognition, the carrying amount of the note was P900,000. At the end of Year 1, the carrying amount of the note was P800,000. The amortization of the note in Year 1 must be P100,000 PROBLEM 2: MULTIPLE CHOICE - THEORY—__ 1. Which of the following statements is incorrect?_~ a. Notes payable are initially recognized at fair value minus transaction costs. V b. Discount on notes payable is treated as a contra-liability account rather than an asset account. c. A short-term, non-trade note payable may nevertheless be discounted if it clearly contains a financing component.~ (@)an interest-bearing notes need not be discounted. 2.. The concept that best supports the discounting of notes to their present value is time value of money. c. accrual basis. b: matching. d. legal form over substance Which of the following rates is used to compute for the interest expense on a note payable? a. stated rate - effective interest rate b. nominal rate d. coupon rate Railing Co. issued a 4-year, P600,000, noninterest bearing note that requires payment in lump sum at maturity date. Railing Scanned with CamScanner86 Chapter 2 determined that the effective interest rate on the note is 12%. Which of the following statements is correct? a. \Railing Co. will most likely measure the note on initial \_/ recognition by multiplying the face amount of the note by PV of 1 @12%, n=4. b. Railing Co. will most likely measure the note on initial recognition by multiplying the face amount of the note by PV of ordinary annuity of 1 @12%, n=4. c. Railing Co. will most likely measure the note on initial recognition by multiplying the face amount of the note by PV of an annuity due of 1 @12%, n=4. d. Any of these as an accounting policy choice. On October 1 of this year, a company issued a one-year note payable that bears a market rate of interest. The face amount of the note and the entire amount of the interest are due on September 30 of next year. At December 31 of this year, the entity should report on its statement of financial position a. interest expense for the interest accruing this year. b. interest payable equal to one-year's interest on the note. c. no interest payable. d. interest payable for the interest accruing this year. Drops Co. issues a 3-year, P600,000, noninterest bearing note that requires three equal annual payments at the end of each year. The effective interest raté on the note is 14%. How should Drops Co, measure the note on initial recognition? a. 600,000 x PV of ordinary annuity of 1 @14%, n=3 b. P600,000 x PV of 1 @14%, n=3 c. 200,000 x PV i ordinary annuity of 1 @14%, n=3 d. 200,000 x PV of an annuity due of 1 @14%, n=3 An entity issues 4 three-year, P1M noninterest-bearing note that matures in lump sum payment. The effective interest rate is 12%. Which of tHe following is correct? Scanned with CamScannerNotes Payable 87 a. The measurement of the note on initial recognition is computed as P1M x PV of an ordinary annuity of 1 @12%, n=4, b. No interest expense shall be recognized on the note because it is noninterest-bearing. © The amortized cost of the note increases each year. d. The amortized cost of the note decreases each year. 8. An entity issues a three-year, P1M noninterest-bearing note that matures in three equal annual payments due at the end of each year. The effective interest rate is 12%. Which of the following is correct? a. The measurement of the note on initial recognition is computed as P1M x PV of an ordinary annuity of 1 @12%, n=4, b. No interest expense shall be recognized on the note because it is noninterest-bearing. The amortized cost of the note increases each year. C® The amortized cost of the note decreases each year. : 9. A company issued two one-year notes in exchange for merchandise. One note has a face amount of P6,000 and was interest-bearing at an annual rate of 18%. The other note has a face amount of P7,080 and was non-interest-bearing (its implied interest rate was 18%). a. The total amount of cash ultimately to be paid will be more for the interest-bearing note. )Both notes will cause the same total interest to be recognized, c. The amount of interest expense that should be recognized is higher for the interest-bearing note. d. The amount that should be debited to the inventory account is higher for the noninterest-bearing note Scanned with CamScanner88 Chapter 10. On March 1, 20x1, Nickelodeon Co. issued a P6,000, 12% not dated January 1, 20x1 in exchange for an outstanding accouri ‘payable of P6,000. The principal and the 6-month interest o1 the note are due on July 1, 20x1. On initial recognition, which of the following accounts increased? a. Prepaid interest c. Discount on note payable b. Interest payable d. Interest expense Hint: Recall the concept of “Pre-acquisition accrued interest” that is applied to notes receivable. PROBLEM 3: EXERCISES 1. On January 1, 20x1, Bark, Inc. issues a noninterest-bearing note of P2,000,000 in exchange for equipment. The note is due on December 31, 20x3. The effective interest rate is 16%. Requirement: Provide all the entries during the term of the note. 2. On January 1, 20x1, J&J Co. issues a noninterest-bearing note of P3,000,000 in exchange for equipment. The note is due in three equal annual installments every December 31. The effective interest rate is 18%. uirements: Compute for current and noncurrent portions of the note payable on December 31, 20x1. “Compute for the balance of discount on note payable on , ‘December 31, 20x1 and determine how this amount is allocated to the current and noncurrent portions of the note. Provide all the entries during the term of the note payable. Scanned with CamScanner