ee Chapter 2 ~s Notes Payable Related standard: PERS 9 Financial Instruments Thegogeter \ 1. State the initial and subsequent measurements of notes loans payable. j n 2. Apply present value factors and prepare amortization tables 3, Account for origination fees. 7 = on Notes payable Notes payable are obligations supported by debtor promis notes. The accounting for notes payable is similar to the accounting for notes receivable (as noose in Intermediate Accounting Part 14, 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 [Link]. A) For measurement purposes, notes payable are classified into the following: a. Short-term payable b. Long-term payable that bears a reasonable interest rate ¢. Long-term payable that bears no interest (noninterest bearing) 4. Long term payable that bears an unreasonable interest Ta (‘below-market’ interest rate) A “short-term” payable is one that matures within 7 yeat A “long-term” payable is one that matures beyond 1 year.Notes Payable 53 Short-term payable The fair value of a short-term payable may be equal to its face amount. However, if the transaction contains a significant financing component, the fair value of the short-term payable is equal to its present value. Long-term payable: The fair value of a long-term payable that bears @ reasonable interest rate is equal to the face amount. An interest rate is deemed ‘reasonable’ if it approximates the market rate at the transaction date. % The fair value of a long-term payable that bears no interest (long- term noninterest bearing payable) is equal to the present value of the future cash flows on the instrument discounted using an imputed interest rate. The fair value of a long-term payable that bears an unreasonable interest rate is also equal to the present value of the future cash flows on the instrument discounted using an imputed 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. Cash price equivalent is the amount that would have been Paid if the transaction was settled outright on cash basis, as opposed to installment basis or other deferred settlement. Example 1: An entity purchases a TV set on a 6-month installment basis. The installment price is 120,000. However, if the TV set is purchased Outright in cash, the cash price would have been P100,000.>» > The payable is initially recognized at P100,000, the cash p equivalent of the TV set, The P20,000 difference P1250 installment price less P100,000 cash price) is amortized oye, the credit term as interest expense using the effective interes, method. Example 2: An entity purchases goods for P250,000 under a special credit period of 1 year. The seller normally sells the goods for P220,009 with a credit period of one month or with a P5,000 discount for cash basis (j.e., outright payment in cash). > The initial measurement of the payable is computed as follows: Normal purchase price with a credit period of one month 220,000 Discount for outright payment (5,000) Cash price equivalent of the goods purchased 215,000 Both the purchase prices of P250,000 (special credit) and 220,000 (normal credit) constitute a financing, transaction, ic, they include consideration for the credit period. To compute for the cash price equivalent of the goods, the P5,000 discount for outright payment is deducted from the normal selling price of P220,000. Subsequent measurement Notes payable that are initially measured at face amount are subsequently measured at face amount or expected settlement amount. Notes payable that are initially measured at present value are subsequently measured at amortized cost > Amortized cost is the “amount at which the financial asset or financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative55 ation using the effective interest method of any difference between that initial amount and the maturity amount and, for financial assets adjusted for any loss allowance.” (PFRS 9. Appendix A) The amortized cost is determined using the effective interest method. When a note payable is initially measured at present value or cash price equivalent, the difference between that amount and the face amount is initially recognized punt (or premium, in the case of bonds payable) and subsequently amortized as interest expense using the effective interest m Effective interest method 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. QQ Summary of initial and subsequent measurements of notes payable Initial measurement Type of note ee ee t Subsequent payable Waid mace measurement follows: 1. Short-term a. Face amount; or | a. Expected b. Present value (¢ settlement the transaction amount if the contanes sigriiant ‘al eater measurement is face amount. b. Amortized cost if the initial measurement is present value. 2. Long-term with | > Face amount » Expected reasonable settlement interest rate amount, 56 i TR > Present value > Amortized comp Long-term noninterest- bearing, Long-term with unreasonable interest rate ‘ @ If the cash price equivalent is Geterminable, the note is initiayy measured at this amount, The subsequent measurement y |___ amortized cost. be issued for cash, purchase of goods sh consideration. Regardless of the g depends on the note's > Present value > Amortized cosp is A note payable may or services, Or other nonca: consideration received, the accountin classification for measurement purposes illustration 1: Short-term note On July 1, 20x1, ABC Co. borrowed P1,000,000 and issued a one. year, note payable. The lender “discounted the note at 12%”, ‘as used in this context means the lender di s proceeds from the note are nef of the advanced interes, (The term “discounted” leducted the 12% interest in advance. ABC Co.’ Case 1: Lump sum The note is due in lump sum on June 30, 20x2. The effect of value of money) is immaterial. Analysis: The note is shi Therefore, the note is initially measured at face amount ( advanced interest). ort-term and the effect of discounting is immaterial. net of the Journal entries: nly 1 T Cash (iM x 88%) 880,000 *1 | Discount on notes payable (1M x 12%) 120,000 Notes payable 1,000,000 to record the note payable : ‘Des. Interest expense (1M x 12% x 6/12) 60,000 oa Discount on notes payable 60,000 to record interest expenseNotes Pay a 57 = | "om expense (1M 12% x 0/12) “| 60,000 30, Discount on notes payable 60,000 2002 | __ tw record interest expense _ / june | Notes payable - 1,000,000 pos Cash 1,000,000 a record the. of note payable ‘The carrying amor rmined as follow: 7, 20x1 Dec. 31, 20x1 Notes payable 1,000,000 1,000,000 Discount on notes payable (120,000) (60,000) Carrying amounts 880,000, 940,000 * Note ‘” ABC Co, the borrower, is referred to as the “maker” ‘or “issuer” of the note. The lender is the “payee.” ‘” “Discount on notes payable” is a contra-liability account (i.e, a valuation account). It is deducted when determining the carrying amount of the note. “” Theoretically, all liabilities should be measured at present value except when: a. the effect of discounting is deemed immaterial; b. discounting, is prohibited by a Standard (e.g, PAS 12 Income Taxes prohibits the discounting of tax liabilities); or ¢. the transaction is made in the usual or customary terms. If the effect of discounting is not deemed immaterial, a short- term note is nonetheless measured at present value, Judgment on materiality rests with the entity’s management. The Standards do not require short-term notes to be measured at face amount nor prohibit their discounting,| Case 2: Installment F Teno a diel equal quarterly installments starting September 30, 20x1. The effect of discounting is fnmaterial. Analysis: The note is also measured at face amount. However, because the note is due in installments, the P120,000 advanced interest is allocated over the installment periods based on, for example, the outstanding principal balance of the note or some other arbitrary apportionment. Journal entries: July 1, | Cash am x 86%) 880,000 20x | Discount on notes payable (1M x 12%) | 120,000 . Notes payable 1,000,000 Sept. | Notes payable 250,000 30, | Interest expense 48,000 ait Cash 250,000 Discount on notes payable ™ 48,000 Dec. | Notes payable 250,000 31, | Interest expense 36,000 2Oe Cash 250,000 Discount on notes payable ™ 36,000 vsuthe entries in 20x2 follow the same pattern, Outstanding balance Date of note Allocation _ Interest expenst 9.30.21 1,000,000 120K x 12.5 48,000 12.31.81 750,000 120K x 7572.5 36,000 331x2 500,000 120K x 5/25 24,000 6.30.2 250,000 120K x 25/2.5 12,000 2,500,000 120,000 outstan The fractions u: ding balance of the note. ed in the allocation are derived from theNotes Payable es The carrying amounts of the note are determined as follows: July 1, 20x1_ Sept. 30, 201 Dec. 31, 2001 Notes payable 1,000,000, 750,000 500,000 Discount on notes payable (120,000) (72,000) (36,000) Carrying amounts 880,000 678,000 464,000 llustration 2: Long-term note with reasonable interest — Simple interest Pel On October 1, 20x1, ABC Co. issued a two-year, 12%, P1,000,000 note payable in exchange for a piece of land. Principal is due on October 1, 20x3 but interest is due annually. ‘Analysis: ¥ Type of payable: Long-term with reasonable interest rate — the 12% nominal rate is assumed to be equal to the current rate on initial recognition because no additional information is given. Y Initial measurement: Face amount ¥ Subsequent measurement: Face amount or expected settlement amount ¥ Type of interest: Simple interest — interest is computed only on the outstanding principal balance Journal entries: Oc, T Land 1,000,000 = Notes payable 1,000,000 to record the note payable ‘Dec. 31, | Interest expense (1M x 12 30,000 aid Interest payable 30,000 to record the accrued inter Oct-1. | Interest expense (1M x 12° 90,000 702 | Interest payable 30,000 | Cash 120,000 [to record the payment of accrued interest Dec. 31. | Interest expense (1M x 12% x 3/12) 30,000 702 | Interest payable 30,000 _L _1o record the acerued interest _2 Oa-7, | Interest expense (IM x 12% x 9/12) 90,000 20x3 | Interest payable 30,000 Cash 120, | terecora the payment of accrued interest ao ‘Oct.1, | Notes payable 1,000,000 em Cash 1,000,009 to record the settlement of note payable Illustration 3: Long-term note Compounded interest On January 1, 20x1, ABC Co. issued a three-year, 12%, P 1,000,000 note payable in exchange for a piece of land. Principal and interest are due on December 31, 20x3 ith reasonable interest _ Analysis: ¥ Type of payable and Measurement ~ same as Illustration 2 above Y Type of interest: Compounded interest — interest is computed on both the outstanding balances of principal and accrued interest. Journal entries: Jan. 1, | Land 1,000,000 aes Notes payable 1,000,000 to record the note payable Des" | Interest expense (1M x 12%) 120,000 ane | ecard i ered otra | [770.08 Des [ Interest expense [(1M + 120K) x 12%] 134,400 | h Interest payable 400 aos is record ihe ecru inter “ Dec. | Interest expense [(1M + 120K + 134.4K) x 12%] | 150,528 | an Interest payable (120,000 + 134,400) 254,400 Cash | 404,928 to-record the payment of accrued interest Dec. | Notes payable 7,000,000 3, | Cash 1,000,000 _ to record the settlement of note payable lNola Payee Sa eS ee ilustration 4: Noninterest-bearing note — Lump sum On January 1, 20x1, ABC Co. acquired a piece of equipment in exchange for P100,000 cash and a noninterest-bearing note of 1,000,000 due on January 1, 20x4. The prevailing rate of interest for this type of note is 12%, “Analysis: v_ Type of payable: Long-term noninterest-bearing (Lump sum) ¥ Initial measurement: Present value (using PV of P1) ¥_Subsequent measurement: Amortized cost Initial measurement: Future cash flow (face amount) 1,000,000 Multiply by: PV of P1 @12%, n=3 0.711780 Present value of note payable — Jan. 1, 20x1 711,780 Journal entry: Jan. | Equipment (100K + 711,780) 811,780 2d | Discount on notes payable (1M~711,780) | 288,220 Cash 100,000 Notes payable 1,000,000 ¥ Notes: = The difference between the present value and the face amount represents the discount on note payable. The unamortized balance of the discount is deducted from the face amount when determining the carrying amount of the note. * The ‘discount on note payable’ on initial recognition of a noninterest-bearing note represents the total interest expense to be recognized over the term of the note. © The equipment is measured at the amount of cash paid plus the present value of the note issued.62 | Discount on Pr it ] Date Interest expense | note payable resent value | | Tan. 1, 20x1_| __| 288,220 Dec. 31, 20x1 ‘Dec. 31, 20x2 | Dee. 31, 20x3 Total ‘The total interest expense is equal to the discount on note payable on initial recognition, Other pertinent entries: Dec. 31, T Interest expense 85,414 ae Discount on notes payable 85,414 ‘Dec. 31, | Tnterest expense 95,663 j see Discount on notes payable 95,663 | Dec 31, | Interest expense 107,143 | bi Discount on notes payable 107,143 | Jan. 1. | Notes payable 1,000,000 | sae Cash 1,000,000 | “Alternative solution; Determine the car tying amounts of the note on December 31, 20x] and December 31, 20x2, respectively. > Press 711,780, the PV of note on Jan. 1, 20x1. Multiply the } amount by 1.12 (100% + | 12%). You should get 797,194, the carrying amount on Dec. 31, 2041 Multiply again by 1.12, You should get 892,857, the carrying amount on Dec. 31, 2012. (Amounts are rounded-off) > Mlustration 5: Noninterest-bearing note On January 1, 20x1, ABC Co. ac exchange for P100,000 cash and note that is due in 4 equal annual December 31, 20x1. The prevailing intere: ~ Instaliment ‘quired a piece of equipment in @ P1,000,000 noninterest-bearing, installments starting on st rate is 12%, Analysis: ¥ Type of payable: Long-term noninte ¥ Initial me bearing (Installment) urement: Present value (using PV of ordinary annuity of PT) Subsequent measurement: Amortized costa —_—_=__ ap Initial measurement: Future ca: sh flows, annual installments (P1M +4) 2 Notes Payable Multiply by: PV ofan ordinary annuity of PI 012%, nod Present value of note payable - Jan. 1, 20x1 63 250,000 3.037349 759,337 Tan. 7, 201 Equipment (100K + 759,337) Discount on notes payable (1M ~ 759,337) ‘Cash Notes payable 859,337 240,663 100,000 1,000,000 Subsequent measurement: Amortization table (Installment) r | Interest | Present Date Payments | expense | Amortization value jan, 2001 | 1 1 [759,337 ‘Dec. 31, 20x1_| 250,000 | 91,120 ___ 158,880 600,457 | “Dec. 31, 20x2 | 2 72,055 177,945 422,512 Dec. 31, 20:3 | 250,000 | 50,701 199,299 223,213 Dec. 31, 20%4 | 26,787" 223,213 0 Tso 208215) teats tera Ta to owdina Other pertinent entries: Dec. 31, | Notes payable 250,000 701 | Interest expense 91,120 Cash 250,000 Discount on notes payable 91,120 Dec 3%, | Notes payable 250,000 22 | Interest expense 72,055 Cash 250,000 Discount on notes payable —- 72,055 — 1, | Notes payable 250,000 Interest expense 50,701 Cash 250,000 __Discount on notes payable 50,701 _ bad Notes payable 250,000 = Interest expense 26,787 | Cash 250,000 = ount on notes payable 26,787Chapter 2 A Current and noncurrent portions of a note payable When the principal amount is due in installments, the carrying amount of the note includes both current and noncurrent portions, ‘These portions are presented separately in the financial statements. To determine the current and noncurrent portions, we simply refer to the amortization table. The current portion is the amortization in the immediately following year. This is the portion of the next year’s payment applicable to the principai. The noncurrent portion is the present value in the immediately following year. For example, the carrying amount of the note on December 31, 20x1 600,457. The current and noncurrent tions of this amount are «eiermined as follows: 7 | Titerest Prosent |Payments expense __ Amortization. value i =I 759,337 _| | Dec. 31, 20x71, 250,000 91,120 158,880 600,457 | Dec. 31, 20x2 250,000 72,085 S77 955 > 992,512 | Sr eee payable on Dec. 31, 20x1 | [payable on Dee. 31, 2081 When disclosing in the financial statements, the discount on notes payable is allocated to both the current and noncurrent portions of the note by deducting the present value of the po: from the related future cash payment. ‘Current portion: Notes payable (250,000 duc in 20x2) 250,000 Discount on notes payable (250K - 177,915 current portion) (72,055) Notes payable, net (presented in current liabilities) 177,995. ‘Noncurrent portion: a Notes payable (250,000 due in 20.3 + 250,000 due in 20«4) 500,000 | Discount on notes payable (300K ~ 422.512 noncurrent portion) (77,488) | Notes payable — net (presented in nencurrent Habits, 422,512, Total notes payable, net - Dec. 31 = P 600,457,