HAND-OUT NO. 4: NOTES RECEIVABLE FINANCIAL ACCOUNTING AND ...

FINANCIAL ACCOUNTING AND REPORTING HAND-OUT NO. 4: Notes Receivable

HAND-OUT NO. 4: NOTES RECEIVABLE Brian Christian S. Villaluz, CPA

INTRODUCTION A note receivable is a claim supported by a formal promise to pay a certain sum of money at a specific future date usually in the form of a promissory note.

CLASSIFICATION OF NOTES RECEIVABLE Entities classify notes as either:

1. Interest-bearing notes ? they have a stated interest rate i.e., the contracted interest rate stated on the promissory note. Other terms for stated interest rate include nominal rate, coupon rate, and face rate.

2. Noninterest-bearing notes ? they do not have a stated interest rate because they include the interest element as part of the face amount.

Trade vs. Nontrade classification 1. Trade notes receivable ? these are promissory notes received from sale of goods or services in the ordinary course of business. 2. Nontrade notes receivable ? these are promissory notes received from sources other than sale of goods or services in the ordinary course of business.

INITIAL MEASUREMENT Receivables are initially measured at fair value plus transaction costs. For measurement purposes, receivables are classified into the following:

1. Short-term receivable 2. Long-term receivable that bears no interest (noninterest bearing note) 3. Long-term receivable that bears a reasonable interest rate. 4. Long-term receivable that bears an unreasonable interest rate.

Short-term receivable The fair value of a short-term receivable may be equal to its face amount. However, if the transaction contains a significant financing component, the fair value of the short-term receivable is equal to its present value.

IFRS 15 exceptions on trade receivables Trade receivables that do not have a significant financing component shall be measured at their transaction price. As a practical expedient, a trade receivable may not be discounted if it is due within one year.

Other terms for imputed rate of interest include effective interest rate, market rate, and yield rate. The difference between the present value and the face amount is initially recognized as unearned interest and subsequently recognized as interest income under the effective interest method.

Problem 1: (Long-term note that bears a reasonable interest rate) Faith Company has an 8% note receivable dated July 1, 2018, in the original amount of P1,500,000. Payments of P500,000 in principal plus accrued interest are due annually on July 1, 2019, 2020, and 2021. The market rate of interest of this kind of note is 8%.

1. How much is the interest income on the note for the year ended December 31, 2019? 2. How much is the carrying value of the note as of December 31, 2019? 3. What amount should be reported as current assets in relation to the note on December 31, 2019?

Problem 2: (Long-term note that bears a reasonable interest rate) Tusk Company sold an equipment on January 1, 2018 for P7,000,000. The company received a cash down payment of P1,000,000 and a 4-year, 12% note for the balance.

The note is payable in equal annual installments of principal and interest of P1,975,400 payable on December 31 of each year until 2021.

1. What is the interest income for 2018? 2. What is the carrying amount of the note receivable on December 31, 2018?

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HAND-OUT NO. 4: NOTES RECEIVABLE Brian Christian S. Villaluz, CPA

3. What is the interest income for 2019? 4. What is the carrying amount of the note receivable on December 31, 2019?

Problem 3: (Noninterest-bearing note; Lump Sum Payment) On January 1, 2019, DEXTER Company sold equipment with a carrying amount of P4,800,000 in exchange for a P6,000,000 non-interest bearing note due January 1, 2022. There was no established exchange price for the equipment.

The prevailing rate of interest for a note of this type on January 1, 2019 was 10%. The present value of 1 at 10% for three periods is 0.75.

1. What amount should be reported as gain or loss on sale of equipment? 2. What amount should be reported as interest income for 2019? 3. How much shall be presented as current assets in relation to the note on December 31, 2019? 4. How much shall be presented as non-current assets in relation to the note on December 31, 2019?

Problem 4: (Noninterest-bearing note with installment payments; Ordinary annuity) On January 1, 2019, DEXTER Company sold equipment with a carrying amount of P4,800,000 in exchange for a P6,000,000 non-interest bearing note due in annual installments of P2,000,000 every December 31 starting December 31, 2019. There was no established exchange price for the equipment.

The prevailing rate of interest for a note of this type on January 1, 2019 was 10%. The present value of 1 at 10% for three periods is 0.75 and the present value of an ordinary annuity of 1 at 10% is 2.49.

1. What amount should be reported as gain or loss on sale of equipment? 2. How much shall be presented as current assets in relation to the note on December 31, 2019? 3. How much shall be presented as non-current assets in relation to the note on December 31, 2019? 4. What amount should be reported as interest income for 2020?

Problem 5: (Noninterest-bearing note with installment payments; Annuity Due) On January 1, 2018, AA Company sold goods to BB Company. BB Company signed a non-interest bearing note requiring payment of P600,000 annually for seven years. The first payment was made on January 1, 2018. The prevailing rate of interest for this type of note at date of issuance was 10%.

PV of an ordinary annuity of 1 at 10% for 6 periods 4.36 PV of an ordinary annuity of 1 at 10% for 7 periods 4.87

1. What amount should be recorded as sales revenue in January 2018? 2. What is the interest income for 2018? 3. What is the carrying amount of the note receivable on December 31, 2018?

Problem 6: (Long-term note that bears an unreasonable interest rate; One-time principal collection with periodic interest collection; Discount on notes) [WITH ANSWERS] On January 1, 2018, Solid Co. sold an equipment to Liquid Co. Liquid Co. issued a 4-year, P100,000, 10% note to Solid Co. The note requires interest to be paid annually every December 31 starting December 31, 2018. The equipment has a cost of P500,000 and accumulated depreciation as of January 1, 2018 of P350,000. The prevailing interest rate for a note of this type is 16%. (Round off PV factors to four decimal places)

1. Compute for the following as of December 31, 2018: a. Gain or loss on sale of equipment. b. Interest income c. Current portion of the notes receivable d. Noncurrent portion of the notes receivable

2. Prepare all the necessary entries in 2018.

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PV of principal (100K x 0.5523) PV of interest (100K x 10% x 2.7982) PV of NR CV (500K - 350K) LOS

55,230.00 27,982.00 83,212.00 150,000.00 (66,788.00)

Face of NR PV of NR Discount on NR

100,000.00 83,212.00 16,788.00

2

1/1/2018 NR

100,000.00

A/D

350,000.00

Loss on sale

66,788.00

Equipment

Discount on NR

HAND-OUT NO. 4: NOTES RECEIVABLE

Brian Christian S. Villaluz, CPA

Date Collections Interest Income Amortization CV

1/1/2018

83,212

12/31/2018 10,000.00

13,314

3,314 86,526

12/31/2019 10,000.00

13,844

3,844 90,370

12/31/2020 10,000.00

14,459

4,459 94,829

12/31/2021 10,000.00

15,171

5,171 100,000

100,000.00

0

ANSWERS: a. 66,788 loss b. 13,314 c. 0 d. 86,526

500,000.00 16,788.00

12/31/2018 Cash Int. Inc.

10,000.00 10,000.00

Discount on NR Int. Inc.

3,314

3,314

Problem 7: (Long-term note that bears an unreasonable interest rate; installment principal collection with periodic interest collection; Discount on notes) On January 1, 2018, Solid Co. sold an equipment to Liquid Co. Liquid Co. issued a 4-year, P100,000, 10% note to Solid Co. The note requires the principal amount to be paid in four equal annual installments and interest on the unpaid balance to be paid annually every December 31 starting December 31, 2018. The equipment has a cost of P500,000 and accumulated depreciation as of January 1, 2018 of P350,000. The prevailing interest rate for a note of this type is 16% (Round off PV factors to four decimal places).

1. Compute for the following as of December 31, 2018: a. Gain or loss on sale of equipment. b. Interest income. c. Current portion of the notes receivable. d. Noncurrent portion of the notes receivable

2. Prepare all the necessary entries in 2018.

Problem 8: (Long-term note that bears an unreasonable interest rate; installment principal collection with periodic interest collection; Premium on notes) On January 1, 2018, Solid Co. sold an equipment to Liquid Co. Liquid Co. issued a 4-year, P100,000, 16% note to Solid Co. The note requires the principal amount to be paid in four equal annual installments and interest on the unpaid balance to be paid annually every December 31 starting December 31, 2018. The equipment has a cost of P500,000 and accumulated depreciation as of January 1, 2018 of P350,000. The prevailing interest rate for a note of this type is 10% (Round off PV factors to four decimal places).

1. Compute for the following as of December 31, 2018: a. Gain or loss on sale of equipment. b. Interest income. c. Current portion of the notes receivable. d. Noncurrent portion of the notes receivable

2. Prepare all the necessary entries in 2018.

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HAND-OUT NO. 4: NOTES RECEIVABLE Brian Christian S. Villaluz, CPA

FINANCIAL ACCOUNTING THEORIES 1. Which of the following rates may be used to compute for the interest income on a receivable? A. Stated rate B. Effective rate C. Either A or B D. Neither A nor B

2. Which of the following rates may be used to compute for the interest receivable on a note receivable? A. Stated rate B. Effective rate C. Either A or B D. Neither A nor B

3. Total interest income recognized over the life of a noninterest bearing note is A. Zero B. Greater than the total interest received on the note C. Less than the total interest received on the note D. Equal to the unearned interest income on initial recognition

4. Which of the following items are true about discount on notes receivable?

I.

The face value of the note is higher than its present value

II.

The present value of the note is higher than its face value

III. The nominal rate is higher than the effective rate

IV. The effective rate is higher than the effective rate

A. I and III C. II and III

B. I and IV D. II and IV

5. On July 1 of the current year, a company obtained a two-year 8% note receivable for services rendered. At that

time, the market rate of interest was 10%. The face amount of the note and the entire amount of interest are due

on the date of maturity. Interest receivable on December 31 of the current year was

A. 5% of the face amount of the note.

B. 4% of the face amount of the note.

C. 5% of the present value of the note.

D. 4% of the present value of the note.

END OF HANDOUT

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