DR. FILEMON C.

AGUILAR MEMORIAL COLLEGE

OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Course Code and Title : Intermediate Accounting 1

Lesson 3 : Notes and Loans Receivable and Receivable

Financing

Topics : Notes receivable, loans receivable, amortization and

impairment

This lesson identifies the recognition and measurement of notes and loans receivable in
accordance with Philippine Financial Reporting Standards 9 (PFRS 9). It demonstrates
the methods of preparing an amortization table as well as the computation of
impairment loss. Lastly, it discusses the methods of accelerating cash collections
through receivable financing.

Learning Objectives

At the end of this module, the learners are expected to:

COGNITIVE

1. Identify the recognition principle, classification and presentation of the notes and
loans receivables.

PSYCHOMOTOR

2. Compute for the initial and subsequent measurement, as well as the impairment loss
of notes and loans and prepare an amortization table that shows the value of the
notes and loans throughout its term.

AFFECTIVE

3. Appreciate the importance of receivable financing in a firms cash position.

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 1 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Pre-Assessment

Exercise #1: Preparation of amortization table

On January 1, 2014, Mill Company sold a building and received as consideration P1,000,000 cash
and a P4,000,000 noninterest bearing note due on January 1, 2017. There was no established
exchange price for the building, and the note had no ready market. The prevailing rate of interest
for a note of this type on January 1, 2014 was 10%. The present value of 1 at 10% for three periods
is 0.75.

Required:
Prepare the amortization table of the notes receivable.

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 2 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

LESSON PRESENTATION

INTRODUCTION
The notes receivable is an account on the balance sheet usually under the current
assets section if its life is less than a year. Specifically, a note receivable is a written
promise to receive money at a future date. The money is usually made up of interest
and principal.1

Loans receivable is an account in the general ledger of a lender, containing the current
balance of all loans owed to it by borrowers. This is the primary asset account of a
lender.2

Notes Receivable
Notes receivable are claims supported by formal promises to pay usually in the form
of notes.

A negotiable promissory note is an unconditional promise in writing made by one

person to another, signed by the maker, engaging to pay on demand or at a fixed
determinable future time a sum certain in money to order or to bearer.

Simply stated, a promissory note is a written contract in which one person, known as
the maker, promises to pay another person, known as the payee, a definite sum of
money. The note may be payable on demand or at a definite future date. Standing
alone, the term "notes receivable" represents only claims arising from sale of
merchandise or service in the ordinary course of business. Thus, notes received from
officers, employees, shareholders and affiliates shall be designated separately.

1
https://bit.ly/3anLhdO

2
https://bit.ly/3rWT5Js

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 3 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Dishonored Notes
When a promissory note matures and is not paid, it is said to be dishonored.

Theoretically, dishonored notes shall be removed from the notes receivable account
and transferred to accounts receivable at an amount to include, if any, interest and other
charges.

The journal entry to record dishonored notes is:

Accounts receivable xx
Notes receivable xx
Interest income xx

Such approach is defended on the ground that the overdue note has lost part of its
status as a negotiable instrument and really represents only an ordinary claim against
the maker.

Initial Measurement
Conceptually, notes receivable shall be measured initially at present value. The present
value is the sum of all future cash flows discounted using the prevailing market rate of
interest for similar notes. The prevailing market rate of interest is actually the effective
interest rate.

However, short-term notes receivable are measured at face value. Cash flows relating
to short-term notes receivable are not discounted because the effect of discounting is
usually not material.

The initial measurement of long-term notes depends on whether the notes are interest-
bearing or non-interest bearing.

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 4 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Interest bearing long-term notes are measured at face value which is actually the
present value upon issuance. Noninterest-bearing long-term notes are measured at
present value which is the discounted value of the future cash flows using the effective
interest rate. Actually, the term "noninterest-bearing" is a misnomer because all notes
implicitly contain interest. It is simply a case of the "interest being included in the face
amount" rather than being stated as a separate rate.

Subsequent Measurement
Subsequent to initial recognition, long-term notes receivable shall be measured at
amortized cost using the effective interest method.

The "amortized cost" is the amount at which the note receivable is measured initially
minus principal repayment, plus or minus the cumulative amortization of any difference
between the initial carrying amount and the principal maturity amount minus reduction
for impairment or uncollectibility.

For long-term noninterest-bearing notes receivable, the amortized cost is the present
value plus amortization of the discount, or the face value minus the unamortized
unearned interest income.

ILLUSTRATIVE EXAMPLE: Annuity Due

On January 1, 2014, Ott Company sold goods to Fox Company. Fox signed a noninterest-
bearing note requiring payment of P600,000 annually for seven years. The first payment was
made on January 1, 2014. The prevailing rate of interest for this type of note at date of
issuance was 10%. Information on present value factors is as follows:
Present value Present value of
Period of 1 at 10% ordinary annuity of 1 at 10%
6 .56 4.36
7 .51 4.87

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 5 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Solutions:
Initial measurement
The present value of the notes will be equal to:
First payment on January 1,2014 600,000
Present value of remaining six payments(600,000 x 4.36) 2,616,000
Correct sales revenue 3,216,000
Note receivable (600,000 x 6) 3,600,000
Less: Present value of remaining six payments 2,616,000
Unearned interest income 984,000

Since the note is long-term and noninterest-bearing, the sales revenue is equal to the
present value of the seven annual payments of P600,000.

Journal entry
Cash 600,000
Note receivable 3,600,000
Sales 3,216,000
Unearned interest income 984,000

Subsequent measurement
We will prepare an amortization table
Year Payments Interest income Amortization Amortized cost
201
4 600,000 600,000 2,616,000
201
5 600,000 261,600 338,400 2,277,600
201
6 600,000 227,760 372,240 1,905,360
201
7 600,000 190,536 409,464 1,495,896

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 6 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

201
8 600,000 149,590 450,410 1,045,486
201
9 600,000 104,549 495,451 550,034
202
0 600,000 49,966 550,034 -

Observations:
 The first payment was made on January 1, 2014, that is, the date of the notes.
 Interest income is equal to the amortized cost multiplied by the interest rate of 10%.
 The amortization is equal to the payments less interest income.
 The amortized cost is equal to the previous amount less the amortization.
 At the end of the term, the notes is fully paid for.
 At the year 2020, the interest income was rounded-off to balance the notes to zero.

Journal entry on December 31, 2014:

Interest receivable 261,600
Interest income 261,600
To accrue the interest earned for 2014

Journal entry on January 1, 2015:

Cash 600,000
Notes receivable 600,000

Unearned interest income 261,600

Interest receivable 261,600

On December 31, 2015, the following shall be presented on balance sheet with regards to the
notes:

Notes receivable 3,000,000

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 7 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Less: Unearned interest income 722,400

Carrying amount 2,277,600

ILLUSTRATIVE EXAMPLE: Ordinary annuity

On December 31, 2014, Park Company sold merchandise and received a noninterest-bearing
note requiring payment of P500,000 annually for ten years. The first payment is due
December 31, 2015 and the prevailing rate of interest for this type of note at date of issuance
is 12%. The present value of an ordinary annuity of 1 at 12% for 10 periods is 5.65.

Solutions:
Initial measurement
The note receivable is shown at present value on December 31, 2014.
Present value of note (500,000 x 5.65) 2,825,000

Journal entry
Note receivable 5,000,000
Sales 2,825,000
Unearned interest income 2,175,000

Subsequent measurements
Year Payments Interest income Amortization Amortized cost
201
4 2,825,000
201
5 500,000 339,000 161,000 2,664,000
201
6 500,000 319,680 180,320 2,483,680
201
7 500,000 298,042 201,958 2,281,722
201 500,000 273,807 226,193 2,055,528

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 8 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

8
201
9 500,000 246,663 253,337 1,802,192
202
0 500,000 216,263 283,737 1,518,455
202
1 500,000 182,215 317,785 1,200,669
202
2 500,000 144,080 355,920 844,749
202
3 500,000 101,370 398,630 446,119
202
4 500,000 53,881 446,119 -

Observations:
 The first payment was made on December 31, 2015, that is, one year after the date of
the notes.
 Interest income is equal to the amortized cost multiplied by the interest rate of 12%.
 The amortization is equal to the payments less interest income.
 The amortized cost is equal to the previous amount less the amortization.
 At the end of the term, the notes is fully paid for.
 At the year 2024, the interest income was rounded-off to balance the notes to zero.

Loans Receivable
A loan receivable is a financial asset arising from a loan granted by a bank or other
financial institution to a borrower or client. The term of the loan may be short-term but
in most cases, the repayment periods cover several years.

Initial Measurement

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 9 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

At initial recognition, an entity shall measure a loan receivable at fair value plus
transaction costs that are directly attributable to the acquisition of the financial asset.
The fair value of the loan receivable at initial recognition is normally the transaction
price, meaning, the amount of the loan granted.
 Transaction costs that are directly attributable to the loan receivable include
origination fees.
 Direct origination costs should be included in the initial measurement of the loan
receivable.

Origination fees
Lending activities usually precede the actual disbursement of funds and generally
include efforts to identify and attract potential borrowers and to originate a loan.
The fees charged by the bank against the borrower for the creation of the loan are
known as "origination fees".
Origination fees include compensation for activities such as evaluating the borrower's
financial condition, evaluating guarantees, collateral and other security, negotiating the
terms of the loan, preparing and processing documents and closing the loan
transaction.
 The origination fees received from borrower are recognized as unearned interest
income and amortized over the term of the loan.
 If the origination fees are not chargeable against the borrower, the fees are
known as "direct origination costs".
 The direct origination costs are deferred and also amortized over the term of the
loan.
 Preferably, the direct origination costs are offset directly against any origination
fees received.
 If the origination fees received exceed the direct origination costs, the difference
is unearned interest income and the amortization will increase interest income.

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 10 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

 If the direct origination costs exceed the origination fees received, the difference
is charged to "direct origination costs" and the amortization will decrease interest
income.
 Accordingly, the origination fees received and the direct origination Costs are
included in the measurement of the loan receivable.

Subsequent Measurement
PFRS 9, paragraph 4.1.2, provides that if the business model in managing financial
asset is to collect contractual cash flows on specified dates and the contractual cash
flows are solely payments of principal and interest, the financial asset shall be
measured at amortized cost.

Accordingly, a loan receivable is subsequently measured at amortized cost using the

effective interest method.

The "amortized cost" is the amount at which the receivable is measured initially minus
principal repayment, plus or minus the cumulative amortization of any difference
between the initial amount recognized and the principal maturity amount, minus
reduction for impairment or uncollectibility.

ILLUSTRATIVE EXAMPLE
Appari Bank granted a loan to a borrower on January 1, 2014. The interest rate on the loan is
10% payable annually starting December 31, 2014. The loan matures in five years on
December 31, 2018. The data related to the loan are:

Principal amount 4,000,000

Origination fee received from borrower 350,000
Direct origination cost incurred 61,500

The effective rate on the loan after considering the direct origination cost incurred and

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 11 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

origination fee received is 12%.

Solutions:
Initial recognition
Origination fee received 350,000
Direct origination cost (61,500)
Unearned interest income 288,500

Note receivable 4,000,000

Unearned interest income (288,500)
Carrying amount - January 1, 2014 3,711,500

Journal entries
Loans receivable 4,000,000
Cash 4,000,000
To record the loan

Cash 350,000
Unearned interest income 350,000
To record the origination fee received

Unearned interest income 61,500

Cash 61,500
To record the direct origination cost

The origination fee may be charged against the borrower. If not, the origination fee is
known as "direct origination cost". The origination fee received from the borrower is
recognized as unearned interest income to be amortized over the term of the loan. The
direct origination cost is a deferred charge and also amortized over the term of the loan.
Preferably, the two are offset against the other.

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 12 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Subsequent measurement
Year Interest received Interest income Amortization Amortized cost
2014 3,711,500
2014 400,000 445,380 45,380 3,756,880
2015 400,000 450,826 50,826 3,807,706
2016 400,000 456,925 56,925 3,864,630
2017 400,000 463,756 63,756 3,928,386
2018 400,000 471,614 71,614 4,000,000

Observations:
 The loan is payable after 5 years.
 Interest received is equal to the face amount of 4,000,000 multiplied by 10% nominal
rate.
 Interest income is equal to the amortized cost multiplied by the effective rate of 12%
 The difference between the interest income and interest received is the amortization of
the loan.
 The amortization of the loan is added to the amortized cost/carrying amount to bring
the loan to its face value at the end of the term
 In 2018, the amortization is rounded-off to bring the amount of loan to its face value.

Journal entries on December 31, 2014

Cash (10% x 4,000,000) 400,000
Interest income 400,000

Unearned interest income 45,380

Interest income 45,380

Loan receivable 4,000,000

Unearned interest income - 12/31/2014(288,500-45,380) ( 243,120)
Carrying amount -12/31/2014 3,756,800

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 13 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Impairment of Loans
PFRS 9, paragraph 5.2.2, in conjunction with PAS 39, paragraph 58, provides that an
entity shall assess at every end of reporting period whether there is objective evidence
that a financial asset or group of financial assets is impaired.

If such evidence exists, the entity shall determine and recognize the amount of any
impairment loss.
Objective evidence of impairment may result from the following "loss events" occurring
after the initial recognition of the financial asset:

1. Significant financial difficulty of the issuer or obligor.

2. Breach of contract, such as default or delinquency in interest or principal payment.
3. Debt restructuring
The lender, for economic or legal reason relating to the borrower's financial difficulty,
grants to the borrower a concession that the lender would not otherwise consider.
4. Probability that the borrower will enter bankruptcy or other financial reorganization.
5. The disappearance of an active market for the financial asset because of financial
difficulty.
6. Measurable decrease in the estimated future cash flows from a group of financial
assets since the initial recognition, although the decrease cannot yet be identified
with the individual financial assets in the group.

Measurement of Impairment
PFRS 9, paragraph 5.2.2, provides that if there is evidence that an impairment loss on
loan receivable carried at amortized cost has been incurred, the amount of the loss is
measured as the "difference between the carrying amount of the loan receivable and
the present value of estimated future cash flows discounted at the original effective rate
of the loan."

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 14 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

The carrying amount of the loan receivable shall be reduced either directly or through
the use of an allowance account.

The amount of the impairment loss shall be recognized in profit or loss.

ILLUSTRATIVE EXAMPLE
Beach Bank loaned Boracay Company P7,500,000 on January 1, 2012. The terms of the loan
were payment in full on January 1, 2016 plus annual interest payment at 11%. The interest
payment was made as scheduled on January 1, 2013. However, due to financial setbacks,
Boracay Company was unable to make the 2014 interest payment. Beach Bank considered
the loan impaired and projected the cash flows from the loan on December 31, 2014. The
bank accrued the interest on December 31, 2013, but did not continue to accrue interest for
2014 due to the impairment of the loan. The projected cash flows are:

Date of cash flow Amount projected on December 31, 2014

December 31, 2015 500,000
December 31, 2016 1,000,000
December 31, 2017 2,000,000
December 31, 2018 4,000,000

The PV of 1 at 11% is 0.90 for one period, 0.81 for two periods, 0.73 for three periods, and
0.66 for four periods.

Solutions:
December 31, 2015 (500,000 x .90) 450,000
December 31, 2016 (1,000,000 x .81) 810,000
December 31, 2017 (2,000,000 x .73) 1,460,000
December 31, 2018 (4,000,000 x .66) 2,640,000
Total present value of loan 5,360,000
Loan receivable 7,500,000
Accrued interest receivable (7,500,000 x 11 %) 825,000

Prepared by: Josart B. Tubay, CPA, MBA (for DFCAMCLP use only)
Page 15 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Carrying amount 8,325,000

Present value of loan 5,360,000
Impairment loss 2,965,000

PFRS 9, paragraph 5.2.2, in conjunction with PAS 39, paragraph 63, provides that the
impairment loss on loan receivable is measured as the difference between the carrying
amount of loan receivable and the present value of the loan using the original effective
rate.

Journal entry on December 31, 2014

Impairment Loss 2,965,000
Allowance for loans impairment 2,140,000
Interest receivable 825,000

Subsequent measurement after the impairment

Year Payments Interest income Amortization Balance
201
4 5,360,000
201
5 500,000 589,600 89,600 5,449,600
201
6 1,000,000 599,456 (400,544) 5,049,056
201
7 2,000,000 555,396 (1,444,604) 3,604,452
201
8 4,000,000 395,548 (3,604,452) -

Observations:
 The principal payments is based on the projected cash flows.

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Page 16 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

 The interest income is equal to the balance of the loan multiply by 11%.
 Amortization is the difference between the interest income and the payments.
 The loan balance is equal to the previous balance plus the amortization.

Journal entries on December 31, 2015

Cash 500,000
Loans receivable 500,000

Allowance for loan impairment 589,600

Interest income 589,600

Receivable Financing
Receivable financing is the financial flexibility or capability of an entity to raise money
out of the receivables.

The common forms of receivable financing are pledge, assignment, factoring of

accounts receivable and discounting of notes receivable.

Pledge of Accounts Receivable

When loans are obtained from the bank or any lending institution, the accounts
receivable may be pledged as collateral security for the payment of the loan.

Normally, the borrowing entity makes the collections of the pledged accounts but may
be required to turn over the collections to the bank in satisfaction for the loan.

No complex problems are involved in this form of financing except the accounting for
the loan. The loan is recorded by debiting cash and discount on note payable if loan is
discounted, and crediting note payable.

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Page 17 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

The subsequent payment of the loan is recorded by debiting note payable and crediting
cash.
With respect to the pledged accounts, no' entry would be necessary. It is sufficient that
disclosure is made in a note to financial statement.

Treatment of Pledge
Accounts receivable pledged or hypothecated against borrowing should still be included
in total accounts receivable but the amount of accounts receivable involved should be
properly disclosed.

Assignment of Accounts Receivable

In substance, assignment of accounts receivable means that a borrower called the
assignor transfers its rights in some of its accounts receivable to a lender called the
assignee in consideration for a loan.

Actually, assignment is a more formal type of pledging of accounts receivable. It is

evidenced by a financing agreement and a promissory note both of which the assignor
signs.

However, pledging is general because all accounts receivable serve as collateral

security for the loan.

On the other hand, assignment is specific because specific accounts receivable serve
as collateral security for the loan.

Treatment of Assignment
 Accounts receivable assigned should also be included in total accounts
receivable but disclosure is necessary.

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Page 18 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

 The reason is that assignment of accounts receivable is a secured borrowing and

not a sale of accounts receivable.
 The assignor should disclose its "equity in the assigned accounts" which is equal
to the accounts receivable assigned minus note payable to the bank.

Journal entry to reclassify the assigned accounts receivable:

Accounts receivable – assigned XX
Accounts receivable XX

Disclosure in the notes to financial statements:

Accounts receivable – assigned XX
Less: Notes payable to bank XX
Equity in the assigned accounts XX

ILLUSTRATIVE EXAMPLE
On December 1, 2014, Bamboo Company assigned specific accounts receivable totaling
P2,000,000 as collateral on a P1,500,000,12% note from a certain bank. The entity will
continue to collect the assigned accounts receivable. In addition to the interest on the note,
the bank also charged a 5% finance fee deducted in advance on the P1,500,000 value of the
note. The December collections of assigned accounts receivable amounted to P1,000,000
less cash discounts of P50,000. On December 31, 2014, the entity remitted the collections to
the bank in payment for the interest accrued on December 31, 2014 and the note payable.

Solutions:
Journal entry
December 1, 2014
Cash 1,425,000
Finance cost (5% x 1,500,000) (75,000)
Note payable 1,500,000

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Page 19 of 37
DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Accounts receivable – assigned 2,000,000

Accounts receivable 2,000,000

December 31, 2014

Cash 950,000
Sales discount 50,000
Accounts receivable – assigned 1,000,000
To record the collection on assigned AR

Notes payable 935,000

Interest expense (1,500k x 12% x 1/12) 15,000
Cash 95,000
To record the remittance of collection

Disclosure on notes in December 31, 2014

Accounts receivable - assigned (2,000,000 - 1,000,000)1,000,000
Note payable (565,000)
Equity of Bamboo Company in assigned accounts 435,000

Factoring of Accounts Receivable

Factoring is a sale of accounts receivable on a without recourse, notification basis. In a
factoring arrangement, an entity sells its accounts receivable to a bank or finance entity
called a factor.

Accordingly, a gain or loss is recognized for the difference between the proceeds
received and the carrying amount of the accounts receivable factored.

Factoring differs from an assignment in that an entity actually transfers ownership of the
accounts receivable to the factor. Thus, the factor assumes responsibility for
uncollectible factored accounts. In assignment, the assignor retains ownership of the

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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

accounts assigned. Because of the nature of the transaction, the customers whose
accounts are factored are notified and required to pay directly to the factor. The factor
has then the responsibility of keeping the receivable records and collecting the
accounts.

Treatments in Factoring
 Accounts receivable factored should be excluded from total accounts receivable.
 The reason is that factoring is an absolute sale of accounts receivable and
therefore the accounts receivable factored should be derecognized.
 If the factor withholds a certain portion or percentage of the accounts receivable
purchased, the portion retained by the purchaser should be included in
receivables by the seller.
 The amount withheld by the factor is known as "factor's holdback" which is
actually an amount due from the factor.

ILLUSTRATIVE EXAMPLE
Daisy Company sold accounts receivable without recourse with face amount of P6,000,000.
The factor charged 15% commission on all accounts receivable factored and withheld 10% of
the accounts factored as protection against customer returns and other adjustments. The
entity had previously established an allowance for doubtful accounts of P200,000 for these
accounts. By year-end, the entity had collected the factor's holdback there being no customer
returns and other adjustments.

Solutions:
Accounts receivable 6,000,000
Factor's holdback (10% x 6,000,000) (600,000)
Commission (15% x 6,000,000) (900,000)
Cash received 4,500,000

Journal entry

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Cash 4,500,000
Factor’s holdback 600,000
Allowance for bad debts 200,000
Loss on factoring 700,000
Accounts receivable 6,000,000

Discounting of Notes Receivable

Legally, discounting is a transfer or endorsement of a promissory note by the payee in
favor of another party, usually a bank.
Thus, to discount the note, the payee must endorse it. The payee legally becomes an
endorser and the bank becomes an endorsee.
 Endorsement may be with recourse which means that the endorser shall pay the
endorsee if the maker dishonors the note. This is the contingent liability of the
endorser.
 Endorsement may be without recourse which means that the endorser avoids
future liability even if the maker refuses to pay the endorsee on the date of
maturity.

In the absence of contrary statement, endorsement is assumed to be with recourse.

Definition of Terms
1. Net proceeds refer to the discounted value of the note received by the endorser from
the endorsee.
The formula is as follows:
Net proceeds = Maturity value minus Discount
2. Maturity value is the amount due on the note at the date of maturity.
Principal plus interest equals the maturity value.
3. Discount is the amount of interest deducted by the bank in advance.
Discount is equal to maturity value times discount rate times discount period.
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Discount rate is the rate used by the bank in computing the discount.
Discount period is the period of time from date of discounting to maturity date. It is
the unexpired term of the note.

Notes Receivable Discounted

Notes receivable discounted without recourse shall be excluded from total notes
receivable without separate disclosure.

Notes receivable discounted with recourse shall be excluded from total notes receivable
but the contingent liability shall be appropriately disclosed.

Some believe that if a note receivable is discounted with recourse, the transaction shall
be accounted for as a secured borrowing.

Accordingly, an entity shall not derecognize the note receivable discounted but instead
shall record an accounting liability for an amount equal to the face amount of the note
discounted.

A simple journal entry for each of the situations:

Discounting without Discounting with recourse
recourse
Conditional sale Secured borrowings
Cash X Cash XX Cash X
X X
Loss on X Loss on discounting XX Interest expense X
discounting X X
Notes XX Noted receivable – XX Liability on note XX
receivable discounted discounted
Interest XX Interest income XX Interest income XX
income

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

ILLUSTRATIVE EXAMPLE: Without recourse

On July 1, 2014, Kay Company sold equipment to Mando Company for P1,000,000. Kay
accepted a 10% note receivable for the entire sales price. This note is payable in two equal
installments of P500,000 plus accrued. interest on December 31, 2014 and December 31,
2015. On July 1, 2015, the entity discounted the note at a bank at an interest rate of 12%.
What is the amount received from the discounting of note receivable?

Answer:
Principal 500,000
Add: Interest (500,000 x 10%) 50,000
Maturity value 550,000
Less: Discount (550,000 x 12% x 6/12) 33,000
Net proceeds 517,000

Only the balance of P500,000 on December 31, 2014 was discounted because the first
installment of P500,000 was paid on said date. This balance of P500,000 matures on
December 31, 2015 and therefore the corresponding interest is for one year from
December 31,2014 to December 31, 2015. However, the discount period is only 6
months because the note was discounted on July 1, 2015.

Journal entries
July 1, 2014
Notes receivable 1,000,000
Sales 1,000,000

December 31, 2014

Cash 600,000
Notes receivable 500,000
Interest income (1,000,000 x 10%) 100,000

July 1, 2015

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OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Cash 517,000
Loss on discounting 8,000
Notes receivable 500,000
Interest income (500,000 x 10% x 6/12) 25,000

ILLUSTRATIVE EXAMPLE: Secured borrowings

On August 31, 2014, Sunflower Company discounted with recourse a note at the bank at
discount rate of 15%. The note was received from the customer on August 1, 2014, is for 90
days, has a face value of P5,000,000, and carries an interest rate of 12%. The customer paid
the note to the bank on October 30, 2013, the date of maturity.

If the discounting is accounted for as a secured borrowing, what is the interest expense to be
recognized on August 31, 2014?

Answer:
Principal 5,000,000
Interest (5,000,000 x 12% x 90/360) 150,000
Maturity value 5,150,000
Discount (5,150,000 x 15% x 60/360) 128,750
Net proceeds 5,021,250

Principal 5,000,000
Accrued interest receivable (5,000,000 x 12% x 30/360) 50,000
Carrying amount of note receivable 5,050,000

Net proceeds 5,021,250

Carrying amount of note receivable (5,050,000)
Interest expense ( 28,750)

Journal entry

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Cash 5,021,250
Interest expense 28,750
Liability for note discounted 5,000,000
Interest income 50,000

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

ACTIVITY EVALUATION

Student Name: Date Taken:

Course, Year and Section: Time Frame:

Multiple Choice
Choose the correct answer from the choices provided. Write your answer beside the
number. USE CAPITAL LETTERS. ERASURES ARE NOT ALLOWED.

1
. On July 1 of the current year, an entity received a one-year note receivable bearing interest
at the market rate. The face amount of the note receivable and the entire amount of the
interest are due in one year. When the note receivable was recorded on July 1, which of
the following was debited?
A. Interest receivable
B. Unearned discount on note receivable
C. Both interest receivable and unearned discount on note receivable
D. Neither interest receivable nor unearned discount on note receivable

2
. On August 15 of the current year, an entity sold goods for which it received a note bearing
the market rate of interest on that date. The four-month note was dated July 15 of the
current year. Note principal, together with all interest, is due November 15 of the current
year. When the note was recorded on August 15, which of the following accounts
increased?
A. Interest receivable C. Prepaid interest
B. Interest revenue D. Unearned discount

3
. In calculating the carrying amount of loan receivable, the lender adds to the principal:
I. Direct origination cost.
II. Indirect origination cost.
III. Origination fee charged to borrower
A. I only C. I and III only
B. I and II only D. I, II and III

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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

4
. In calculating the carrying amount of loan receivable, the lender adds to the principal
A. Interest incurred by the borrower
B. Loan origination fee charged to the borrower
C. Direct loan origination cost incurred by the lender
D. Indirect loan origination cost incurred by the lender

5
. Which of the following is not an objective evidence of impairment of a financial asset?
A. Significant financial difficulty of the issuer.
B. A decline in the fair value of the financial asset below the previous carrying amount.
C. A breach of contract, such as a default or delinquency in interest or principal payment.
D. The lender, for economic or legal reason relating to the borrower's financial difficulty,
grants to the borrower a concession that the lender would not otherwise consider.

6
. If accounts receivable are pledged against borrowing, the amount of accounts receivable
pledged shall be
A. Included in total receivables with disclosure
B. Excluded from total receivables with disclosure
C. Included in total receivables without disclosure
D. Excluded from total receivables without disclosure

7
. It is a financing arrangement whereby one party formally transfers its rights to accounts
receivable to another party in consideration for a loan.
A. Assignment C. Factoring
B. Discounting D. Pledge

8
. Which of the following is used to account for probable sales discounts, sales returns and
sales allowances?
A. Due from factor
B. Recourse liability
C. Both due from factor and recourse liability
D. Neither due from factor nor recourse liability

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

9
. A note receivable bearing a reasonable interest rate is sold to a bank with recourse. The
note receivable discounted account was appropriately credited. The note receivable
discounted account should be reported as
A. Liability account for the face amount of the note
B. Contra asset account for the face amount of the note
C. Liability account for the proceeds from the discounting transaction
D. Contra asset account for the proceeds from the discounting transaction

10
. If a note receivable is discounted without recourse
A. Note receivable shall be credited
B. Liability for note receivable discounted shall be credited
C. The transaction shall be accounted for as a secured borrowing as opposed to a sale
D. The contingent liability may be disclosed in either a contra account to note receivable or
in a note to the financial statements

11
. Jeah Company purchased from Carmina Company a P2,000,000,8%, five-year note that
required five equal annual year-end payments of P500,000. The note was discounted to
yield a 9% rate to Jean Company. At the date of purchase, Jean Company recorded the
note at the present value of P1,948,500. What is the total interest revenue earned by Jean
Company over the life of this note?
A. 504,500 C. 800,000
B. 556,000 D. 900,000

12
. On December 31, 2014, Chang Company sold a machine in the ordinary course of
business to Door Company in exchange for a noninterest bearing note requiring ten annual
payments of P100,000. Door made the first payment on December 31, 2014. The market
interest rate for similar notes at date of issuance was 8%. Information on present value
factors is:

Period 9 10
Present value of 1 at 8% .50 .46

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

Present value of ordinary annuity of 1 at 8% 6.25 6.71

On December 31, 2014, what is the carrying amount of the note receivable?
A. 450,000 C. 625,000
B. 460,000 D. 671,000

THE NEXT ITEMS ARE BASED ON THE FOLLOWING

National Bank granted a loan to a borrower on January 1,2014. The interest on the loan is 10%
payable annually starting December 31, 2014. The loan matures in three years on December
31, 2016. The data related to the loan are:
Principal amount - P4,000,000;
Origination fee charged against the borrower - P342,100; and
Direct origination cost incurred - P150,000.

After considering the origination fee charged against the borrower and the direct origination cost
incurred, the effective rate on the loan is 12%.

13
. What is the carrying amount of the loan receivable on January 1, 2014?
A. 3,657,900 C. 4,000,000
B. 3,807,900 D. 4,150,000

14
. What is the interest income for 2014?
A. 380,900 C. 456,948
B. 400,000 D. 480,000

THE NEXT ITEMS ARE BASED ON THE FOLLOWING

On January 1,2014, Oceanic Bank made a PI,000,000, 8% loan. The P80,000 interest is
receivable at the end of each year, with the principal amount to be received at the end of five
years. At the end of 2014, the first year's interest of P80,000 has not yet been received because
the borrower is experiencing financial difficulties. The borrower negotiated a restructuring of the
loan. The payment of all of the interest for 5 years will be delayed until the end of the 5-year
loan term. In addition, the amount of principal repayment will be dropped from PI,000,000 to

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

P500,000. The PV of 1 at 8% for 4 periods is .735. No interest revenue has been recognized in
2014 in connection with the loan.

15
. What is the loan impairment loss on December 31, 2014?
A. 238,500 C. 338,500
B. 288,000 D. 388,000

16
. What is the interest income for 2015?
A. 0 C. 52,920
B. 48,960 D. 80,000

THE NEXT ITEMS ARE BASED ON THE FOLLOWING

Apex Company accepted from a customer P1,000,000 face amount, 6-rp.dhth, 8% note dated
April 15,2014. On the same date, the entity discounted the note without recourse at a 10%
discount rate.

17
. What amount of cash was received from the discounting?
A. 972,000 C. 990,000
B. 988,000 D. 1,040,000

18
. What is the loss on note receivable discounting?
A. 12,000 C. 50,000
B. 40,000 D. 52,000

THE NEXT ITEMS ARE BASED ON THE FOLLOWING

Freeway Company provides financing to other entities by purchasing their accounts receivable
on a nonrecourse basis. Freeway charges clients a commission of 15% on all receivables
factored.
In addition, Freeway withholds 10% of receivables factored as protection against sales returns
and other adjustments.

Freeway credits the 10% withheld to Clients Retainer account and makes payments to clients at

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

the end of each month so that the balance in the retainer is equal to 10% of unpaid receivables
at the end of the month.
Experience has led Freeway to establish an allowance for doubtful accounts of 4% of all unpaid
receivables purchased.

On December 1, 2014, Freeway purchased receivables from Motorway Company totaling

P3,000,000. Motorway had previously established an allowance for doubtful accounts for these
receivables at P100,000.
By December 31, 2014, Freeway had collected P2,500,000 on these receivables.

19
. What is the amount of cash initially received by Motorway Company from Freeway
Company?
A. 2,250,000 C. 2,700,000
B. 2,550,000 D. 3,000,000

20
What is the loss on factoring to be recognized by Motorway
Company?
A. 350,000 C. 650,000
B. 450,000 D. 750,000

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

REINFORCEMENT
ASSIGNMENT
DIRECTION: Prepare an amortization table

Kalibo Bank loaned P5,000,000 to Caticlan Company on January 1, 2012. The terms of the loan require
principal payments of P1,000,000 each year for 5 years plus interest at 8%. The first principal and interest
payment is due on January 1,2013. Caticlan Company made the required payments during 2013 and 2014.

However, during 2014 Caticlan Company began to experience financial difficulties, requiring Kalibo Bank to
reassess the collectibility of the loan.

On December 31,2014, Kalibo Bank has determined that the remaining principal payment will be collected
but the collection of the interest is unlikely. Kalibo Bank did not accrue the interest on December 31, 2014.

The present value of 1 at 8% is as follows:

For one period 0.926

For two periods 0.857

For three periods 0.794

Required: Prepare the amortization table of the loan after impairment.

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Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

REFERENCES
Suggested Textbooks:
Intermediate Accounting 1 (2019), Millan, Zeus Vernon B., Bandolin Enterprise, Baguio
City
Intermediate Accounting 1 (2020), Valix, Conrad, et.al., GIC Enterprise and Co., Inc.,
Manila

Additional Learning Materials:

Intermediate Accounting 4th Edition, Spiceland, Nelson and Thomas, McGraw Hill

Journals
Automate Accounting Journals, www.blackline.com
Partnership Accounting,www.Clifsnotes.com>Accounting Principles II
Warren, Carl S., Accounting 25th ed., (2015)

Suggested Websites:
www.iasplus.com
www.deloitte.com

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DR. FILEMON C. AGUILAR MEMORIAL COLLEGE
OF LAS PINAS
Golden Gate Subdivision, Talon III, Las Piñas City
Tel Nos. 519-1960/4788671/4031985

ANSWERS

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Page 35 of 37
1
. D

2
. A

3
. A

4
. C

5
. B

6
. A

7
. A

8
. A

9
. B

10
. A

11
.Answer is (B).
Total payments (500,900x5) 2,504,500
Present value of the note (1,948,500)
Total interest revenue 556,000
12
.Answer is (C).
The note receivable is shown at present value on December 31, 2014.
Face value - remaining nine payments (100,000 x 9) 900,000
Present value (100,000 x 6.25) 625,000
Unearned interest income 275,000

Journal entry
Cash 100,000
Note receivable 900,000
Sales 725,000
Unearned interest income 275,000

First payment on December 31,2014 100,000

Present value of remaining payments 625,000
Total sales revenue 725,000
13
.Answer is (B).
Origination fee received 342,100
Direct origination cost incurred (150,000)
Unearned interest income 192,100

Loan receivable 4,000,000

Unearned interest income ( 192,100)
Carrying amount - January 1, 2014 3,807,900
14
.Answer is (C).
Interest income for 2014 (12% x 3,807,900) 456,948
Interest received for 2014 (10% x 4,000,000) 400,000
Amortization of unearned interest income 56,948
15
.Answer is (C).
Present value of principal (500,000 x .735) 367,500
Present value of interest (80,000 x 5 = 400,000 x .735) 294,000
Total present value of loan 661,500

Loan receivable 1,000,000

Present value of loan 661,500
Loan impairment loss 338,500
16
.Answer is (C).
Interest income for 2015 (8% x 661,500) 52,920
17
.Answer is (B).
Principal 1,000,000
Add: Interest (1,000,000 x 8% x 6/12) 40,000
Maturity value 1,040,000
Less: Discount (1,040,000 x 10% x 6/12) 52,000
Net proceeds 988,000
18
.Answer is (A).
Net proceeds 988,000
Carrying amount of note receivable - equal to principal (1,000,000)
Loss on note receivable discounting (12,000)

Journal entry
Cash 988,000
Loss on note receivable discounting 12,000
Note receivable 1,000,000
19
.Answer is (A).
Accounts receivable 3,000,000
Commission (15% x 3,000,000) ( 450,000)
Holdback (10% x 3,000,000) ( 300,000)
Cash initially received 2,250,000
20
.Answer is (A).
Accounts receivable 3,000,000
Commission ( 450,000)
Net sale price 2,550,000
Carrying amount of accounts receivable (3,000,000 - 100,000) 2,900,000
Loss on factoring ( 350,000)

Entry on the books of Motorway Company

Cash 2,250,000
Allowance for doubtful accounts 100,000
Loss on factoring 350,000
Due from factor 300,000
Accounts receivable 3,000,000

Entry on the books of the factor, Freeway Company

Accounts receivable 3,000,000
Cash 2,250,000
Commission income 450,000
Clients retainer 300,000