COLLEGE OF BUSINESS AND ACCOUNTANCY
Topic: Loans Payable
Learning Outcomes:
1. State the initial and subsequent measurements of loans receivable.
2. Explain the accounting for origination costs and fees.
3. Prepare amortization tables.
4. Compute for the effective interest rate.
Core Value/Biblical Principles:
Ecclesiastes 3: 1-8
1 There is a time for everything, and a season for every activity under the heavens: 2 a time to be born and a time
to die, a time to plant and a time to uproot, 3 a time to kill and a time to heal, a time to tear down and a time to
build, 4 a time to weep and a time to laugh, a time to mourn and a time to dance, 5 a time to scatter stones and a
time to gather them, a time to embrace and a time to refrain from embracing, 6 a time to search and a time to give
up, a time to keep and a time to throw away, 7 a time to tear and a time to mend, a time to be silent and a time to
speak, 8 a time to love and a time to hate, a time for war and a time for peace.
Learning Activities and Resources:
In today's world, credit is integrated into everyday life. From renting a car to reserving an airline ticket or hotel
room, credit cards have become a necessary convenience. However, using credit wisely is critical to building a
solid credit history and maintaining fiscal fitness. While most students have a general idea about the advantages
and disadvantages of credit, this lesson provides an opportunity to discuss these issues in more detail.
Introduction:
The term loan refers to a type of credit vehicle in which a sum of money is lent to another party in exchange for
future repayment of the value or principal amount. In many cases, the lender also adds interest and/or finance
charges to the principal value which the borrower must repay in addition to the principal balance.
Body:
LOANS PAYABLE
Loans payable are obligations supported by a formal promise to pay a certain amount of money at a
specific future date(s). It is similar to note payable, however, the term “loans payable” can be used to connote
bank loans and similar types of financing.
MEASUREMENT
Financial liabilities are initially recognized at fair value minus transaction costs that are directly
attributable to the issuance, except for financial liabilities at FVPL whose transaction costs are expensed
immediately.
Loans transactions usually involve transaction costs compare to notes.
Origination Fees
Origination fee is an upfront fee charged by a lender to cover the costs of processing the loan.
Origination fee comes normally in the form of “service fee” which is a percentage of the principal amount and is
directly deducted from the loan proceeds released to borrower.
Origination fees are deducted from the carrying amount of the loan and subsequently amortized using
the effective interest method.
Origination fees are included in the calculation of the effective interest rate over the expected term of
the loan payable, meaning, on transaction date, the origination fees are treated as adjustment to the effective
interest rate.
ILLUSTRATION 1: Origination Fees
On January 1, 20x1, ABC Co. borrowed P1,000,000 from a bank. The bank charged a 3% loan origination fee.
The principal is due on January 1, 20x4 but 10% interest is due annually starting on January 1, 20x2.
Initial Measurement:
Principal Amount 1,000,000
Origination Fee (1M x 3%) (30,000)
Carrying Amount of Loan, 01/01/20x1 970,000
01/01/20x1 Cash 970,000
Discount on loan payable 30,000
Loan Payable 1,000,000
TRIAL AND ERROR APPROACH
First Trial: (using random rate of 11%)
Future Cash flows PV Factors Present value
Principal 1,000,000 PV of 1 @11%, n=3 731,191
Interest 100,000 PVOA of 1 @11%, n=3 244,371
TOTAL 975,562
Second Trial: (using random rate of 12%)
Future Cash flows PV Factors Present value
Principal 1,000,000 PV of 1 @12%, n=3 711,780
Interest 100,000 PVOA of 1 @12%, n=3 240,183
TOTAL 951,963
To perform interpolation, we will use the following formula:
𝑥% − 11% 970,000 − 975,562 (5,562)
= = = 𝟎. 𝟐𝟑𝟓𝟕
12% − 11% 951,963 − 975,562 (23,599)
The effective interest rate is 11.2357%
Subsequent Measurement
Interest Interest
Date Amortization Present value
Payments Expense
01/01/x1 970,000
01/01/x2 100,000 108,986 8,986 978,986
01/01/x3 100,000 109,996 9,996 988,982
01/01/x4 100,000 111,018 11,018 1,000,000
Comparison between Discount and Premium
DISCOUNT PREMIUM
Carrying Amount < Face Amount Carrying Amount > Face Amount
Effective Interest Rate > Nominal Rate Effective Interest Rate < Nominal Rate
ILLUSTRATION 2: Amount of loan amortization
You want to acquire a car with a cash prize of P2,000,000 through a 12-month auto-loan that requires equal
month-end payments. The effective interest rate is 12%.
Requirements:
a. Amount of monthly payment
b. Total interest expense on the loan
a. Initial measurement:
Future Cash flows (monthly payments) 177,697.58
PV ordinary annuity of ₱1 @1%, n=12 11.255077
Present Value of Loan payable 2,000,000
b. Total interest expense on the loan
Monthly payment 177,697.58
Multiply by: No. of payments on the loan 12___
Total Cash Payments 2,132,370.96
PV of loan on initial recognition (2,000,000.00)
Total interest expense 132,370.96
Amortization Table
Date Monthly Payments Interest Expense Amortization Present value
2,000,000.00
1st Month 177,697.58 20,000.00 157,697.58 1,842,302.42
2nd Month 177,697.58 18,423.02 159,274.56 1,683,027.86
3rd Month 177,697.58 16,830.28 160,867.30 1,522,160.56
4th Month 177,697.58 15,221.61 162,475.97 1,359,684.59
5th Month 177,697.58 13,596.85 164,100.73 1,195,583.85
6th Month 177,697.58 11,955.84 165,741.74 1,029,842.11
7th Month 177,697.58 10,298.42 167,399.16 862,442.95
8th Month 177,697.58 8,624.43 169,073.15 693,369.80
9th Month 177,697.58 6,933.70 170,763.88 522,605.92
10th Month 177,697.58 5,226.06 172,471.52 350,134.40
11th Month 177,697.58 3,501.34 174,196.24 175,938.16
12th Month 177,698.58 1,759.38 175,938.16 -
Totals 2,132,371.96 132,370.93 2,000,000.00
Cost of Bank Loan
Cost of bank borrowing. May be determined in several ways:
Interest
1. Simple Interest Rate for a 1-year loan Borrowed Amount
Net Interest Expense
2. Discounted Interest Rate for a 1-year loan Net Loan Proceeds
Interest
3. Add-on Installment Interest Rate for a 1-year loan Average Borrowed Amount
ILLUSTRATION 3: Cost of Bank Loan
On January 1, 20x1, ABC Co. obtained a P1,000,000, 180-day bank loan at an annual rate of 10%. The loan
agreement requires ABC to maintain a P100,000 compensating balance in its bank account at the lending bank.
ABC would otherwise maintain a balance of only P50,000 in this account. The bank account earns interest at an
annual rate of 2%.
Requirement: Based on a 360-day year, compute for the effective rate of borrowing.
Net Interest Expense
Discounted Interest Rate for a 1-year loan Net Loan Proceeds
180 180
[(1,000,000 x 10% x360)−(50,000 𝑥 2% 𝑥360)
1,000,000−50,000
49,500
= 5.21% effective rate for 180 days
950,000
5.21% x 2 = 10.42% effective rate for 360 days
ILLUSTRATION 4: Loan Payable
On January 1, 20x1, Jaco Co. obtains a P3,000,000 bank loan which is maturing on December 31, 20x3. The
requires payment of 10% interest annually every December 31. The bank charges Jaco Co. a 4.8037%
nonrefundable loan origination fee.
Requirements:
a. Carrying amount of the loan on January 1, 20x1
b. Effective Interest rate on the loan
c. Carrying amount of the loan on December 31, 20x1
Requirement (a):
Loan payable 3,000,000
Transaction costs (3M x 4.8037%) (144,111)
Carrying amount - 1/1/x1 2,855,889
Requirement (b):
Trial and error:
Working formula:
(Principal: 3,000,000 x PV of 1 @ x%, n=3) + (Interest: 300,000 x PV ordinary annuity @ x%, n=3) =
2,855,889
First trial: @12%
Future Cash flows PV Factors Present value
Principal 3,000,000 PV of 1 @12%, n=3 2,135,340
Interest 300,000 PVOA of 1 @12%, n=3 720,549
TOTAL 2,855,889
❖ The effective interest rate is 12%.
Requirement (c):
Date Payments Interest expense Amortization Present value
1/1/x1 2,855,889
12/31/x1 300,000 342,707 42,707 2,898,596
12/31/x2 300,000 347,832 47,832 2,946,428
12/31/x3 300,000 353,572 53,572 3,000,000
Life Application:
Here's how the loan process works. When someone needs money, they apply for a loan from a bank,
corporation, government, or other entity. The borrower may be required to provide specific details such as the
reason for the loan, their financial history, Social Security Number (SSN), and other information. The lender
reviews the information including a person's debt-to-income (DTI) ratio to see if the loan can be paid back.
Based on the applicant's creditworthiness, the lender either denies or approves the application. The lender
must provide a reason should the loan application be denied. If the application is approved, both parties sign a
contract that outlines the details of the agreement. The lender advances the proceeds of the loan, after which
the borrower must repay the amount including any additional charges such as interest
Summary:
• A loan is when money is given to another party in exchange for repayment of the loan principal amount
plus interest.
• Loan terms are agreed to by each party before any money is advanced.
• Origination fees are deducted from the carrying amount of the loan and subsequently amortized using
the effective interest method.
• A loan may be secured by collateral such as a mortgage or it may be unsecured such as a credit card.
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References: INTERMEDIATE ACCTG 2 [by: Millan, Zeus Vernon B. (2021)]
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