CHAPTER 5 – NOTES RECEIVABLE CASH PRICE EQUIVALENT

 Is the amount that would have been paid if the

NOTES RECEIVABLE transaction was settled outright on a cash basis,
 A claim supported by a formal promise to pay a as opposed to installment basis.
certain sum of money a specific future date
usually in the form of a promissory note IMPUTED RATE OF INTEREST
 All notes contain an interest element because of  Effective interest rate, market rate, and yield
the time value of money rate
 Maker - The party making the promise  Prevailing rate for a similar instrument with
 Payee - the party to whom payment is made similar credit rating

CLASSIFICATION OF NOTES EFFECTIVE INTEREST METHOD

1. Interest bearing  Difference of present value and face amount of
 Have a stated interest rate AKA - nominal rate, receivables is:
coupon rate, or face rate a. Initially recognized as Unearned Interest Inc.
b. Subsequently recognized as interest
2. Non-interest bearing revenue
 Do not have a stated interest rate
 face amount represents an unspecified principal EFFECTIVE INTEREST RATE
and unspecified interest  The rate that exactly discounts estimated future
 Present Value Computation is needed to cash payments or receipts through the expected
separate the interest element from the principal life of the financial instrument
element
CH 5.2 – TIME VALUE OF MONEY
1. Trade Receivables
 Obtain from the sale of goods or services in the 1. Future Value of an Amount (FV of ₱1)
ordinary course of business  what will be the amount of the future
withdrawal?
2. Nontrade Notes Receivable
 Obtained from other sources such as such as 2. Future Value of an ordinary annuity of ₱1
loans to employees in affiliates, and sale of  If I make a series of equal deposits over several
property, plant, and equipment on credit. periods, how much will they accumulate in the
future?
CH 5.1 – MEASUREMENT CLASSIFICATION  Several deposits and one withdrawal
OF NOTES  Deposits are made at the end of each interest
period
Type of Receivable Initial Measurement
Fair value plus transaction costs 3. Future Value of annuity due of ₱1
a. Face Amount  Deposits are made at the beginning of each
b. Present Value interest period
- has a significant financing
component) 4. Present Value of an Amount (PV of ₱1)
1. Short-term
Receivable c. Transaction Price  What is the amount of the present deposit?
- for trade receivables that do
not have a significant
financing component. 5. Present Value of an ordinary annuity of ₱1
- It may not be discounted if it  How much do I have to deposit today to be able to
is due within 1 year make several equal withdrawals of ₱1 each over
2. Long-term Fair value plus transaction costs equal periods in the future?
receivables Fair value equals to face  one deposit and several withdrawals
bearing amount  first installment is made one period after the
reasonable deposit
interest rate
3. Long-term Fair value plus transaction costs 6. Present Value of annuity due of ₱1
noninterest Fair value is equal to the  First installment is made immediately or in
bearing present value of future cash advance
receivable flows from the receivable
4. Long-term Fair value plus transaction costs Time value of Money Application
receivables Fair value is equal to the FV of 1 FCF is in lump sum
bearing present value of future cash PV of 1 FCF is in lump sum
unreasonable flows from the receivable FV of ordinary annuity FCF installments, 1st
interest rate installment not made
(below market immediately
interest rate) PV of ordinary annuity FCF installments, 1st
5. When cash price equivalent of the non-cash asset installment not made
given up in exchange for the receivable is immediately
determinable, fair value of the receivable is equal to
FV of annuity due FCF installments, 1st
the cash price equivalent
installment made
 immediately NOTES WHEN USING CURRENT MARKET RATE
PV of annuity due FCF installments, 1st  Use current market rate of the date of recording
installment made the notes receivable. Therefore, change in
immediately current market rate after the date are ignored.
OTHER IMPORTANT NOTES WHEN USING
FV/PV COMPUTATION AMORTIZATION TABLE – LUMP SUM NOTES
 In solving for Value of Deposit (compound Dat a)Interest b) Unearned c) Present
interest), use FV of 1. e Income Interest Value
 Unearned Interest Income is a deduction to the c x effective
prev. bal – a Prev bal. + a
note receivable interest rate
 Revenue in the Journal entries is the present  Present Value increases, while Unearned
value of the NR interest decreases
 When using PV of Annuity Due  Periodic interests are added(amortized) to the
- Interest Income of 20x1 is the interest present value of the note in order to make the
income in 20x2 (following year in the table) present value of the note equal to the face
- Carrying Amount (Jan. 1, 20x2) xx amount at maturity date
Add back: Collections on Jan.1, 20x2 xx  Unearned interest income + present value =
Carrying Amount of NR (Dec.31,20x1)xx face amount
 Nominal Rate for FV, Effective Interest Rate for  Unearned interest income is decreased as
PV interests are earned. At maturity date its balance
is zero.
FORMULA IN COMPUTING PV OF FUTURE  For a noninterest bearing note, the initial
CASH FLOWS amount of unearned interest income represents
Future Cash Flows x PV factor = Present Value of the total interest income to be recognized over
NR the life of the note
 Carrying Amount = Present Value
TWO TYPES OF INTEREST  Loss on Sale Dr., Gain on Sale Cr.
1. Simple Interest  Unearned Interest Income Dr, Interest Income
 Interest earned only on the principle Cr.
2. Compound Interest Journal Entry Debit Credit
 Interest is earned on both the principal and the 1. 01/01/2021 - Initial Record of NR
interest (bali permi nimo i-add ang previous Cash 100K
interest sa principal para makuha ang next Notes Receivable 1M
interest) Accumulated Depreciation 700K
 In the journal entries, the life of the interest Loss on Sale of Equipment 488,220
element is always separately recognized as Transportation Equipment
interest receivable. Unearned Interest Income
2M
288,220
2 ELEMENTS OF A NOTES RECEIVABLE 2. 12/31/2021 - Record Accrued Interest for 2021
1. Principal Element Unearned Interest Income 85,414
 The measurement of the note receivable. It is Interest Income 85,414
the present value. 3. 12/31/2022-3 – Record Accrued Interest x2-x3
Unearned Interest Income 85,414
2. Interest Element Interest Income 85,414
 Initially recognized as unearned interest
4. 01/01/2024 – Record Settlement of Note
 Subsequently recognized as interest income Cash 1M
over a period of time Notes Receivable 1M

CH 5.3 – SUBSEQUENT MEASUREMENT AMORTIZATION TABLE – INSTALLMENT NOTES

1. Recoverable historical cost (net realizable b) Interest c) d) Present
Date a)
value) Income Amortizatio Value
Collection
 is the amount of cash expected to be recovered n
from the principal amount of the receivable Face dx
 Face Amount amount ÷ effective Prev. bal -
a-b
Less: Subsequent repayments of Principal # of interest c
Reduction for Impairment or payments rate
Uncollectability  Amortization is the portion of collection
applicable to the principal component
2. Amortized Cost  Divide carrying amount by number of
 Amount at which the financial assets or financial installments to get annual future cash flows to
liability is measured at initial recognition minus be used in computing the Present Value of the
principal repayments, plus or minus the Note Receivable.
cumulative amortization using the effective  Present value is reduced to zero at maturity
interest method date because the NR has been fully collected
 Present Value decreases, while Amortization  Compute Interest on outstanding balance
increases per year
CH 5.4 – CURRENT AND NONCURRENT
6. Note with Below
PORTIONS OF Amarket
NOTEinterest (compound
RECEIVABLE
interest) – Principal & interest due at
Current Portion is the Amortization in the maturity
immediately following year  Compute for Future Cash Flows, which
 Noncurrent Portion is the Present Value in the consists of both principal and interest
immediately following year Face Amount of NR xx
 The Sum of the current and non-current Multiplied by: FV of 1 0.xxx
portions = Carrying amount of current year Future Cash Flow xx
UNAMORTIZED BALANCE OF UNEARNED  Use computed FCF to get PV of Note
INTEREST INCOME (p.254) Receivable
Outstanding Face Amount (less 1st installment) xx  Use Modified Amortization Table
Carrying amount of NR – 12/31/21 (xx) Dat a) Interest b) Unearned c) Present
Unearned Interest Income – 12/31/21 xx e Income Interest Value
Current Portion of the Notes Receivable b x EIR IGNORE Prev bal. + a
Notes Receivable (20x2 collection) 250,000
Unearned Interest (20x2 interest income) (72,055)
NR, Net (presented in current assets) 177,945  To get Carrying Amount of NR
Noncurrent Portion of Notes Receivable b) Cumulative c) Carrying
Note receivable (20x3-20x4 collections) 500,000 Dat a) balance of amount
Unearned interest (20x3-20x4 interest inc.) (77,487) e Present Interest of Note
NR, Net (present in noncurrent assets) 422,513 Value Receivable a-b
TOTAL NR, NET – DEC.31,20X1 600,458 1/1/x1 777,781 - 777,781
12/31/
Alternative Solution to get Unearned Interest 871,115 (1M x 3%) = 30,000 841,115
x1
Note Receivable 250,000 12/31/ (1M + 30K) x 3%
Current Portion (Amortization) (177,945) x2 975,649 =30,900 +30,000 = 914,749
Unearned Interest (Current) 72,055 60,900
12/31/ (1M + 60.9K) x 3% =
Note Receivable 500,000 x3 1,092,727 31,827 + 60,900 = 1,000,000
92,727
Non-current Portion (Amortization) (422,513)
Unearned Interest (Current) 77,487
7. Total Interest Income over the life of a note
 Get Future Cash Flows
CH 5.5 – THINGS TO REMEMBER WHEN
FCF X PVF = PV
SOLVING:
FCF = PV ÷ PVF
1. Noninterest Bearing-Note with Semiannual FCF = 100,000 x 3.993
Cash Flow Equal Annual year-end payment = 25,044
 “n” = times 2
 Get Total Interect Income/ Revenue
 Interest rate = divided by 2
Total CFC (25,044 x 5 years) 125,220
PV of OA (25,044 x PV of OA) (97,412)
2. Noninterest Bearing Note - Non-uniform cash
Total Interest Revenue of NR 27,808
flows without impairment
 Use PV of 1
COMPUTING EFFECTIVE INTEREST RATE
 “n” = 1 – 3, etc.
 Inverse Relationship
- Higher effective interest rate, lower PV
3. Receivable with Cash Price Equivalent
- Lower effective interest rate, higher PV
 Present Value of NR = Cash Price
 Use Trial & Error
 Future Cash Flows = Carrying Amount of NR
 Interpolation (used after Trial and Error)
4. Note with Below market interest (simple x %−6 %
interest) – Principal due at maturity, interest 7 %−6 %
due periodically
 Interest Receivable = nominal rate x face
amount 1,000,000−1,007,543 (7,543)
= =0.2395
 Interest Income = effective interest rate x 979,559−1,007,543 (27,985)
present value - x% = Initial Carrying Amount of NR
 Use effective interest rate for PV factor - Substitute % with trial & error results
 Unearned Interest Income IR xx
Total Collection on Interest xx PREACQUISITION OF ACCRUED INTEREST
Total Interest Income xx  When interest has occurred before the
acquisition of an interest-bearing receivable, the
5. Note with Below market interest (simple subsequent receipt of interest is allocated
interest) – Principal & interest collectible in between the pre-acquisition and post-acquisition
installments periods.
 Interest in pre-acquisition is Gain
 Interest in post-acquisition is Interest Income

CH 5.6 – DEFERRED ANNUITIES

 An annuity in which periodic cash flows begin

only after two or more periods have passed

1. Future Value of Deferred Annuity

 The deferral period is ignored because there is
no accumulation of cash flows
 Do not include # of deferred periods in “n”

2. Present Value of Deferred Annuity

• It recognized interest that accrues during the
deferral period
a. Determine PV of ordinary annuity for the Full
Term ex. 5.650223 (n=10)
b. Determine the PV of ordinary annuity for the
Deferred Period ex. 3.037349 (n=4)
c. Get the difference between (a) and (b). The
amount obtained represents the PV factor for
the deferred annuity
PV of OA n=10 5.650223
PV of OA n =4 3.037349
PV factor for the 2.612874
payment period
d. The factor determined in (c ) is multiplies by the
annual cash flows to get the present value
Annual Cash flows 10,000
PV factor for PP 2.612874
Present Value of NR 26,129
3. Non-uniform payments
 Use of PV of 1

 During periods with NO collections, add

amortization to present value
 During periods WITH collections, deduct
amortization to present value
 At maturity date, present value is ZERO