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Understanding Notes Receivable Basics

Notes receivable are formal claims evidenced by written promises to pay, such as promissory notes and time drafts. They are initially recognized at transaction price and subsequently measured at amortized cost under IFRS 9, provided they meet certain conditions. The document also discusses types of notes, impairment measurement, and borrowing arrangements involving pledging and discounting of notes.

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8 views3 pages

Understanding Notes Receivable Basics

Notes receivable are formal claims evidenced by written promises to pay, such as promissory notes and time drafts. They are initially recognized at transaction price and subsequently measured at amortized cost under IFRS 9, provided they meet certain conditions. The document also discusses types of notes, impairment measurement, and borrowing arrangements involving pledging and discounting of notes.

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wwaw4280
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Notes Receivable

● • A formal claim against another that is evidenced by a written promise, a promissory


note, or a written order to pay later, called a time draft.
● A promissory note is an unconditional written agreement to pay the bearer or the
order of the payee a certain sum of money on a specific or determinable date.
● A time draft is a written order (made by the drawer), addressed to the drawee to pay
a certain sum of money on a specific or determinable date.

Initial recognition
Following IFRS 9, a note receivable is initially recognized when the entity becomes a party to
the contractual provision of the instrument, that is when the entity becomes the payee of the
note issued by the maker.

● A note is initially recognized at the transaction price based on the circumstances that
give to the receipt of the note, which are as follows: a. The amount of cash given up
in exchange for the note;
● The fair value of the non-cash consideration given up in exchange for the note, or if
such fair value cannot be practically determined, the fair value of the note received,
which is the discounted cash flow of future collections, is based on the implicit
interest rate.

Subsequent Measurement
• Notes and accounts receivable meet the IFRS 9 Financial Instruments requirements for the
financial assets to be classified as subsequently measured at amortized cost. The two
conditions are:

● The financial asset is held within the enterprise’s business model whose objective is
to hold assets in order to collect contractual cash flows
● The contractual terms of the financial asset give rise on specified dates to cash flows
that are solely payments of principal and interest.

Types of Notes Receivables


• Interest bearing -
● With Realistic interest rates – When a note has a stated rate that approximates the
prevailing market rate for similar notes
● Unrealistic interest rates – When a note bears an interest rate that is significantly
different from the prevailing interest rate for similar notes, or when the face value of
the note is significantly different from the market value of the consideration given up
in exchange for the note.
• Non-interest bearing or zero-interest bearing
Measuring Impairment loss
• IFRS 9 requires an entity to measure its expected credit losses not necessarily based on a
loss event but based on reasonable and supportable information available without undue
cost and effort and which includes past experiences, present condition,s and future
expectations. The IFRS 9 model requires three stages in impairment measurement and
recognition:
Pledging/Hypothecating/General Assignment
• Refers to borrowing money from the bank or any financial institution where receivables are
generally used as collateral or security of loan. • The pledge of accounts receivable involves
no special accounting problems. The only entry required in the books would record the loan
obtained from the finance company or bank.

• The accounts receivable balance is not, in any manner affected by the pledging.

Assignment / Specific Assignment


Is a more formal borrowing arrangement in which the specific receivables are identified and
used as security.

● • Non-notification basis – buyer is not informed of the assignment arrangement and


will continue to remit its payment to the seller (assignor)

● Notification basis – buyer is informed of the assignment arrangement and will remit
payment directly to the assignee (e.g. bank)

Discounting
• It is a sale of notes to a third party, usually a bank. The sale is usually on a recourse basis
which means that upon the default of the debtor, the seller of the note becomes liable for its
maturity value.

● Without recourse – the endorser avoids future liability even if the maker refuses to
pay the endorsee on the date of maturity.
● With recourse – the endorser shall pay the endorsee if the maker dishonors the note.
This is the contingent or secondary liability of the endorsee

Common questions

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Pledging of accounts receivable involves using the receivables as collateral without affecting the accounts receivable balance, with the only necessary accounting entry being to record the loan obtained. In contrast, assignment is more formal, involving specific receivables as security. Depending on whether it is a notification or non-notification basis, the buyer may need to remit payments directly to the assignee or continue their usual payee relationship .

Under IFRS 9, an entity measures the impairment loss based on expected credit losses, which do not rely solely on a loss event. Measurement involves evaluating information that is reasonable, supportable, and available without undue cost or effort, including past experiences, present conditions, and future expectations. The IFRS 9 model includes three stages for impairment measurement and recognition .

If the fair value of non-cash consideration for a note receivable is impractical to determine, the note’s initial recognition reverts to the fair value of the note received. Here, the fair value is calculated using the discounted cash flows of future collections based on the implicit interest rate, ensuring a practical and defendable valuation process when determining initial recognition .

Under IFRS 9, notes receivable are classified as financial assets measured subsequently at amortized cost if they meet two conditions: the asset is held within a business model whose objective is to collect contractual cash flows, and the contractual terms result in cash flows that are solely payments of principal and interest on specified dates .

Interest-bearing notes with realistic interest rates have a stated rate that approximates the prevailing market rate for similar notes. In contrast, notes with unrealistic interest rates either have a rate significantly different from the prevailing market rates or an interest-free face value significantly differing from the market value of the consideration given in exchange .

In discounting with recourse, the endorser remains liable if the maker dishonors the note, as they are obligated to pay the endorsee. Conversely, in discounting without recourse, the endorser avoids future liability, even if the maker refuses to pay the endorsee at maturity .

A time draft is a written order by the drawer to the drawee to pay a sum on a specific date. It serves more as a payment order, making it suitable in business transactions involving parties like suppliers and customers. A promissory note, however, is an unconditional written promise where one party commits to paying a sum to the bearer or payee on a specific date. It is generally used for clearer loan-type agreements with precisely defined terms between less intermediated parties .

To classify a financial asset under a business model that aims to collect contractual cash flows, it must align with IFRS 9 conditions: the enterprise should hold the asset within a business model focused on collecting these cash flows, and the asset’s contractual terms should result in cash flows that are solely payments of principal and interest on defined dates .

For non-interest bearing or zero-interest notes, the measurement often requires discounting the future funds using the implicit interest rate to assess the fair value. In contrast, interest-bearing notes are usually straightforward as they have stated interest rates, although the recognition may vary if these rates differ significantly from the market rate .

A note receivable is initially recognized under IFRS 9 when an entity becomes a party to the contractual provisions of the instrument, specifically when it becomes the payee of the note issued by the maker. The note is initially recognized at the transaction price, which is determined by either the amount of cash given up in exchange for the note, or the fair value of the non-cash consideration given up. If the fair value cannot be practically determined, it defaults to the fair value of the note received, calculated as the discounted cash flow of future collections based on the implicit interest rate .

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