CHAPTER 6 NOTE PAYABLE Refinancing and fair value option Problem 6-1 (AICPA Adapted) On September 1, 2019, Pine Company issued a note payable to National Bank in the amount of P1,800,000, bearing interest at 12%, and payable in three equal annual principal payments of P600,000. On this date, the bank’s prime rate was 11%. The first interest and principal payment was made on September 1, 2020. 1. On December 31, 2020, what amount should be reported as accrued interest payable? a. 44,000 b. 48,000 c. 66,000 d. 72,000 2. What amount should be reported as interest expense for 2020? a. 144,000 b. 216,000 c. 192,000 d. 132,000 76Solution 6-1 Question | Answer b Note payable — September 1, 2019 1,800,000 payment on September 1, 2020 (600,000) Note payable, September 1, 2020 1,200,000 Accrued interest payable from September 1 to December 31, 2020 (1 200,000 x 12% x 4/12) 48,000 Question 2 Answer c January 1 - August 31, 2020 (1,800,000 x 12% x g/12) 144,000 September | - December 31, 2020 48,000 192,000 Total interest expense for 2020 77Problem 6-2 (AICPA Adapted) Mann Company reported on June 30, 2020 a 10% note payable j, the amount of P3,600,000. The note is dated October 1, 2018 and is payable in three Saal annual payments of P1,200,000 plus interest. The first interest ang principal payment was made on October 1, 2019. On June 30, 2020, what amount should be reported as accrued interest payable? a. 270,000 b. 180,000 ce 90,000 d. 60,000 Solution 6-2 Answer b 3,600,000 Note payable — October 1, 2018 000, Payment on October 1, 2019 (1,200,000 Note payable, October 1, 2019 2,400,000 Accrued interest payable from October I, 2019 to June 30, 2020 (2,400,000 x 10% x 9/12) 180,000 Problem 6-3 (AICPA Adapted) At year-end, Roth Company issued a P1,000,000 face amount note payable to Wake Company in exchange for services rendered to Roth. The note, made at usual trade terms, is due in nine months and bears interest, payable at maturity, at the annual rate of 3%, ‘The market interest rate is 8%, The i The compound interest factor of 1 due innine months at 8% is .944, At what amount should the note payable be reported at year-end? a. 1,030,000 1,000,000 c. 965,200 944.000 Solution 6-3 Answer b Note payable at face amount 1,000,000 as 78problem 6-4 (AICPA Adapted) Loob Company had the following loans at 12% interest payable at maturity. The entity repaid each loan on scheduled maturity date Date Amount Maturity date Term 11/1/2018 500,000 10/31/2019 | year 2/1/2019 1,500,000 7/31/2019 6 months 5/1/2019 3,000,000 1/31/2020 9 months The entity recorded interest expense when the loans are repaid. As a result, interest expense of P150,000 was recorded in 2019. 1, What amount should be reported as interest expense for 2019? a. 150,000 b. 380,000 c. 390,000 d. 500,000 2, Ifno correction is made, by what amount would interest expense for 2019 be understated? 230,000 350,000 240,000 0 ao oP Solution 6-4 Question | Answer b Question 2 Answer a January | - October 31, 2019 ( 500,000 x 12% x 10/12) 50,000 February 1 - July 31,2019 (1,500,000 x 12% x 6/12) 90,000 May | - December 31, 2019 (3,000,000 x 12% x 8/12) 240,000 Total interest expense for 2019 i 350,000 Recorded interest expense in 2019 (150,000) Understatement of interest expense 230,000 719Os Problem 6-5 (AICPA Adapted) On December 31. 201 9, Boston Company purchased a machine from Helix Company in exchange for a noninterest bearing note requirin eight payments of P200,000. 8 The first payment was made on = aevittectsn due annually on December 31. December 31, 201 a Atdate of issuance, the prevailing rate of interest for this type of note was 11%. The PV of an ordinary annuity of 1 at 11% for 8 periods is 5.146, and the PV of an annuity of 1 in advance at 11% for 8 periods is 5.712. 1, On December 31, 2019, what is the carrying amount of the note payable? a. 1,142,400. b. 1,029,200 c. 1,046,200 d. 942,400 2. What amount should be reported as interest expense for 2020? a 125,664 b. 103,664 c. _ 176,000 d. 154,000 Solution 6-5 Question 1 Answer d PV of note payable (200,000 x 5.712) Payment on December 31, 2019 es PV of note payable — December 31, 2019 942,400 The PV of an annuity of | in advance is used because the date of urchase is December 31,2019 . Bate, December 31, 2019, and the fist payment is made on same Question 2 Answer b Interest expense for 2929, (11% x 942 400) : K 103,664 42,005problem 6-6 (AICPA Adapted) we W) Atthe beginning of current year, Pares Company borrowed P3,6t Oe from a major customer evidenced by anoninterest bearing note : in three years. The entity agreed to supply the customer s Inv entor needs for the loan period at lower than market price. At the 12% imputed interest rate for this type of loan, the present value of the note is P2,550,000 at the beginning of current year, What amount of interest expense should be reported for current year? a. 432,000 b. 350,000 c. 306,000 d. 0 Solution 6-6 Answer c Interest expense for current year (2,550,000 x 12%) 306,000 Discount on note payable (3,600,000 — 2,550,000) 1,050,000 Problem 6-7 (AICPA Adapted) On March 1, 2019, Fine Company borrowed P1,000,000 and signed a 2-year note bearing interest at 12% per annum compounded annually. Interest is payable in full at maturity on February 28, 2021. What amount should be reported as accrued interest payable on December 31, 2020? a. 100,000 b. 120,000 c. 232,000 d. 240.000 Solution 6-7 Answer c Accrued interest from March 1, 2019 to February 28, 2020 (1,000,000 x 12%) 120,000 Accrued interest from March 1 to December 31, 2020 (1,000,000 + 120,000 x 12% x 10/12) 112,000 Accrued interest payable — December 31, 2020 232,000 If the interest is compounded annually, it means that the accrued interest for one year will also earn interest.Problem 6-8 (AICPA Adapted) 1,000,000 On September 30, 2019, World Company borrows PI, on a 9% note payable. The entity paid the ne 3 payments of P264,200 when due on December ?*> hould be reported as interest expense fo! 1 2019? 1. What amounts 90,000 22,500 67,500 30,000 po oF >. On December 31, 2019, what is the carrying amount of the note payable? a. 758,300 b. 750,000 c. 825,800 d. 735,800 Solution 6-8 Question 1 Answer b Interest expense from October 1 to D (9% x 1,000,000 x 3/12) eember 31, 2010 22,500 Question 2 Answer a Note payable — Se; Principal paym oe 30, 2019 1,000 Quarterly payment — D a I ~ December 31 canyin est expense for 3 months eae ing amount ~ December 31,2019 22,500) (_241,700) 758,300 82problem 6-9 (IAA) onJanuary 1,2019, Solemn Company sold land to Glory Company: There Was NO established market price for the land. Glory gave Solemn a P2,400,000 noninterest bearing note payable in three equal annual installments of P800,000 with the first payment due December 31, 2019. The note has no ready market. The prevailing rate of interest for anote ofthis type is 10%. The present value ofa P2,400,000 note payable in three equal annual installments of P800,000 at a 10% rate of interest is P1,989,600. 1. What amount should be reported as interest expense fo 2019? a. 240,000 b. 198,960 c. 410,400 d. 205,200 i) . Whatis the carrying amount of the note payable on December 31, 2019? a. 1,989,600 b. 2,126,400 c. 1,388,560 d. 2,400,000 83Solution 6-9 Question 1 Answer b Interest expense for 2019 (10% x 1,989,600) 198.96 Journal entries for 2019 Land 1,989,600 Discount on note payable 410,400 Note payable 2,400,000 Interest expense 198,960 Discount on note payable 198,960 Note payable 800,000 Cash 800,000 Question 2 Answer c Note payable 2,400,000 Present value 1,989,600 Discount on note payable — January 1, 2019 410,400 Amortization of discount for 2019 (10% x 1,989.600) ( 198,960) Discount on note payable — December 31, 2019 211,440 Note payable — January 1, 2019 2,400,000 Annual payment on December 31, 2019 800,000) Note payable — December 31, 2019 1,600,000 Discount on note payable — December 31, 2019 (211,440) Carrying amount — December 31, 2019 88,560 8 eeeproblem 6-10 (AICPA Adapted) Jason Company offered a contest in which the winner would receive P1,000,000 payable over twenty years. onDecember 31,2019, Jason Company announced the winner of the contest and signed a note payable to the winner for P1,000,000 payable in P50,000 installments every January 31. On December 3°, 2019, Jason Company purchased an annuity for P418,250 to provide the P950,000 prize remaining after the first P50,000 installment which was paid on January 31, 2020. 1. OnDecember 31,2019, what amount should be reported as note payable-contest winner, net of current portion? 368,250 418,250 900,000 950,000 2. What amount should be reported as contest prize expense for 2019? a. 500,000 b. 418,250 c. 468,250 d. 0 Boop Solution 6-10 Question 1 Answer b Contest prize expense 418,250 Discount on note payable 531,750 Note payable — noncurrent - 950,000 Contest prize expense 50,000 ~ Note payable — current 50,000 The noncurrent note payable of P950,000 is presented minus the discount on note payable of P531,750 or P418,250. Question 2 Answer c Contest prize expense for 2019 (418,250 + 50,000) 468.250 85Problem 6-11 (AICPA Adapted) Eliot Company reported the following liabilities on December 3 i} 2019: Accounts payable and accrued interest 1,000,000 12% note payable issued November 1, 2018 maturing July 1, 2020 2,000,000 10% note payable issued October 1, 2018 maturing October 1, 2020 1,400,000 10% debentures payable, next annual principal installment of P500,000 due February 1, 2020 7,000,000 On December 31, 2019, the entity consummated a noncancelable agreement with the lender to refinance the 12% note payable on a long-term basis. The entity has the discretion to refinance the 10% note payable for at least twelve months after the end of reporting period. What total amount should be reported as current liabilities on December 31, 2019? a. 2,900,000 b. 3,000,000 c. 1,500,000 d. 2,500,000 Solution 6-11 Answer c Accounts payable and accrued interest 1,000,000 Debentures payable — current portion 500,000 Total current liabilities 1,500,000 An obligation that matures within one year shall be classified as current liability regardless of refinancing that was consummated after the aon reporting period and before issuance of financial However, if the refinancing occurs on or befo! e iod. th Senne : re the end of ting the 12% none nein is Gripen as noncurrent liability, ‘Accordingly, the note able shall be classified refinancing is made on December 31,2019. ent because the ue om ty has o discretion to refinance an obligation for at least obligation as noncurrent. ofreporting period, it shall Classify the Thus, the 10% note payable is Classified as noncurrent. 7 86problem 6-12 (AICPA Adapted) Dean Company had a P2,000,000 note payable due June 30, 2020 On December 31, 2019, the entity signed an agreement to borrow up to P2,000,000 to refinance the note payable on a long-term basis. The financing agreement called for borrowing not to exceed 80% of the value of the collateral the entity was providing. On December 31, 2019, the value of the collateral was P 1,500,000. On December 31, 2019, what amount of the note payable should be reported as current liability? a. 2,000,000 b. 1,500,000 c. 800,000 d. 500,000 Solution 6-12 Answer c Note payable 2,000,000 Refinanced on December 31, 2019 — noncurrent (80% x 1,500,000) 1,200,000 Note payable — not refinanced, current 800,000 Problem 6-13 (AICPA Adapted) On December 31, 2019, Largo Company had a P750,000 note payable due July 31, 2020. The entity planned to refinance the note by issuing long-term bonds. Because the entity temporarily had excess cash, it prepaid P250,000 of the note on January 15, 2020. In February 2020, the entity completed a P1,500,000 bond offering. On March 31, 2020, the entity issued the 2019 financial statements. What amount of the note payable should be included in current liabilities on December 31, 2019? a. 750,000 b. 500,000 ©. 250,000 qd. 0 Solution 6-13 Answer a The entire amount of P750,000 is reported as current liability ecause the note payable is due to be settled within one year Tegardless of the issuance of bonds payable. 87Problem 6-14 (AICPA Adapted) On July 1, 2019, Justine Company borrowed P1,000, five-year note payable. On December 31, 2019, the fair value of 000 ona 1 (4, the note is determined to b P975,000 based on market and interest factors. The entity has elected the fair vali lue option for reporting the financj, 1. What amount should be reported as interest expense for 2019? a. 100,000 b. 97,500 c. 50,000 d. 48,750 2. Whatis the carrying amount of the note payable on December 3}, 2019? a. 1,000,000 b. 975,000 ce, 500,000 d. 900,000 Le What amount should be reported as gain or loss in 2019 as a result of the fair value option? a. 25,000 gain b. 25,000 loss c. 12,500 gain d. 0 88solution 6-14 Question ] Answer c interest expense For 2019 (1,000,000 x 10% x 6/12) __ 50,000 Question 2 Answer b carrying amount equal to fair value 975,000 Question 3 Answera Note payable — July 1,2019 1,000,000 Fair value — December 31, 2019 975,000 Decrease in fair value of note payable— gain __ 25,000 Ifthe fair value option is elected for reporting a financial liability, the liability is reported at fair value at every year-end with resulting changes in fair value included in profit or loss. However, if the change in fair value is attributable to credit risk of the financial liability, the gain or loss is recognized in other comprehensive income. Journal entries I. Cash 1,000,000 Note payable 1,000,000 2. Note payable 25,000 Gain from change in fair value 25,000 (1,000,000 —975,000) 3. Interest expense (10% x 1,000,000 x 6/12) 50,000 cash - 50,000 Under the fair val ion, any discount o: i : lue optior di pret isnot r ved, ry t or premium on the note payable Therefore, any discount or premium does not affect the interest expense. 89Problem 6-15 (AICPA Adapted) On January 1, 2019, Jonathan Company borrowed P500,000 gy, interest-bearing note due in four years. The present value of the note o, January 1, 2019 was P367,500. The entity has efected the fair value option for reporting the financig liability. On December 31, 2019, the fair value of the note is P408, 159, 1. Whatisthe eve amount of the note payable on December 3 1, 2019? 500,000 367,500 408,150 460,000 nose 2. What amount should be reported as interest expense for 2019? 40,000 29,400 32,562 20,000 aorPp What amount should be reported as net gain from change in fair value in 2019? a. 132,500 b. 40,650 c. 91,850 d 0 At what amount should the discount on note payable be presented on December 3 1, 2019? a. 132,500 b. 103,100 c. 100,000 d. 0 90Solution 6-15 Question 1 Answer c Carrying amount equal to fair value on December 31, 2019 408,150 Question 2 Answera Interest expense for 2019 (500,000 x 8%) 40,000 Question 3 Answer c Face amount 500,000 Fair value — December 31, 2019 408,150 Net gain from change in fair value during 2019 91,850 Question 4 Answer d Ifthe fair value option is elected for reporting a financial liability, the accounting rules for reporting discount or premium no longer apply. Journal entries Jan. 1 Cash 500,000 Note payable 367,500 Gain from change in fair value 132,500 Dec. 31 Interest expense 40,000 Cash 40,000 31 Loss from change in fair value 40,650 Note payable 40,650 (408, 150 — 367,500) Gain from change in fair value « 132,500 Loss from change in fair value 40,650 Net gain from change in fair value 91,850 91Problem 6-16 (AICPA Adapted) On January 1, 2019, Lizelle Company signed a P1,000,009 noninterest-bearing note due in three years at a discount rate of 10% The entity elected the fair value option for reporting the note payable, On December 31, 2019, the credit rating and risk factors indicateg that the rate of interest applicable to its borrowings was 9%. Present value factors at 10% and 9% .751 PV factor 9%, 3 periods 72 PV factor 9%, 2 periods .842 917 PV factor 10%, 3 periods PV factor 10%, 2 periods .826 7 PV factor 10%, 1 period .909 PV factor 9%, | period 1. What is the carrying amount of the note payable on January 1, 2019? a. 751,000 b. 772,000 c. 826,000 d. 842;000 What is the carrying amount of the note payable on December 31, 2 2019? a. 842,00C b. 826,00 c. 917,000 d. 772,000 Solution 6-16 Question 1 Answera Fair value of note - January 1, 2019 (1,000,000 x .751) 751,000 The PV of | at 10% for one period is used. Question 2 Answer a Fair value of note— December 31, 2019 (1,000,000 x -842) 342,000 The PV of | at 9% for two periods is used. 92