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COLLEGE OF BUSINESS AND ACCOUNTANCY
Topic: Notes Receivable
Learning Outcomes:
- State the initial and subsequent measurements of notes receivable.
- Compute for present value factors and apply them properly.
- Prepare amortization tables.
- Compute for the effective interest rate.
Core Value/Biblical Principles:
Leviticus 25:35-37 ESV
“If your brother becomes poor and cannot maintain himself with you, you shall support him as though he were a
stranger and a sojourner, and he shall live with you. Take no interest from him or profit, but fear your God, that
your brother may live beside you. You shall not lend him your money at interest, nor give him your food for profit.
Learning Activities and Resources:
So far, our discussion of receivables has focused solely on accounts receivable. Companies, however, can
expand their business models to include more than one type of receivable. This receivable expansion allows a
company to attract a more diverse clientele and increase asset potential to further grow the business.
Introduction:
Notes receivable are a balance sheet item that records the value of promissory notes that a business is owed
and should receive payment for. A written promissory note gives the holder, or bearer, the right to receive the
amount outlined in the legal agreement.
Body:
NOTES RECEIVABLE
Notes 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.
A note can be a negotiable instrument that a maker signs in favor of a designated payee who may
legally and readily sell or otherwise transfer the note to others.
MEASUREMENT
Financial assets are initially recognized at fair value plus transaction costs.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.
Transaction costs are incremental costs that are directly attributable to the issue of a financial liability. An
incremental cost is one that would not have been incurred if the entity had not issued the instrument.
CLASSIFICATION OF NOTES RECEIVABLE
TYPES OF RECEIVABLES Initial Measurement Subsequent Measurement
Short Term
Face Amount
Present Value (w/ significant financing)
Transaction Price (Trade Rec. w/
practical expedient)
Recoverable Historical Cost
Amortized Cost
Transaction Price (PFRS 15)
Long-term bearing
reasonable interest rate
Face Amount Recoverable Historical Cost
Long-term noninterest-
bearing receivables
Present Value Amortized Cost
Long-term bearing
unreasonable interest rate
Present Value Amortized Cost
If the initial measurement is cash price equivalent of the non-cash asset given up, the subsequent measurement is
amortized costs.
PFRS 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 1 year.
Cash price equivalent is the amount that would have been paid if the transaction was settled outright on
cash basis , as opposed to installment basis or other deferred settlements.
Recoverable Historical Cost (Net Realizable Value)
Represents the amount of cash expected to be recovered from the principal amount of the receivable.
It is computed as the face amount of the receivable minus subsequent repayments of principal and minus any
reduction (directly or through the use of allowance account) for impairment or uncollectability.
Amortized Cost
the amount at which the financial asset or financial liability is measured at initial recognition minus
the principal repayments, plus or minus the cumulative amortization using the effective interest method of
any difference between that initial amount and the maturity amount and, for financial assets, adjusted for any
loss allowance.
Effective interest rate (imputed rate of interest, current market rate or yield rate) more determinable of
either:
a. The prevailing interest rate for a similar instrument of an issuer with a similar credit rating; or
b. A rate of interest that discounts the face (nominal) amount of the receivable to the current cash
sales price of the goods or services.
Stated interest rate (nominal rate, coupon rate, or face rate)
the rate appearing on the face of an interest-bearing note.
The difference between the present value and the face amount of the receivable is initially recognized as
unearned interest and subsequently amortized as interest income under the effective interest method.
Effective Interest Method is a method of calculating the amortized cost of financial asset or financial liability
and of allocating the interest income or interest expense over the relevant period.
TIME VALUE OF MONEY
1. Future Value of an Amount vs. (FV of ₱1) - The FV of ₱1 and PV of ₱1 are opposites. - The FV of ₱1 answers the question “If I invest ₱100,000 today at 10% interest, how much money
do I have in three-years’ time ?”
- FV of ₱1 = (1 + i ) n = (1 + 10%) 3 = 1.
Answer: (₱100,000 x 1.331) = ₱133,100 or (₱100,000 x 110% x 110% x 110%) = ₱133,
2. Present Value of Future Amount (PV of ₱1) - The PV of ₱1 answers the question “If I want to have ₱133,100 in three-years’ time, how much
money do I have to invest today (at 10% interest)?
- PV of ₱1 = (1 + i ) - n = (1 + 10%) - 3 = 0.
Answer: (₱133,100 x 0.751315) = ₱100,
ILLUSTRATION 1: Initial measurement at face amount
ABC Co. received the following notes receivable on Jan. 1, 20x
9 - month, 10% note from Alpha Company 5,
6 - month, noninterest bearing note from Beta Inc. (the effect of discounting is
immaterial)
14%, 3-year note from Charlie Corp. 20,
Market rate of interest on Jan. 1, 20x1 10%
Requirement: At what amount will be the notes be initially recognized?
Solution: (5,000 + 10,000 + 20,000) = 35,
ILLUSTRATION 2: Simple Interest
On April 1, 20x1, ABC Co. received a P1,500,000, 10%, 3-year note receivable in exchange for land with
carrying amount of P850,000. Principal, in three equal installments, plus interest rate are due annually
starting April 1, 20x2. Current market rates as of April 1, 20x1, December 31, 20x1, and December 31, 20x
are 10%, 12% and 13%, respectively.
04/01/20x1 Notes Receivable 1,500,
Land 850,
Gain on Sale 650,
12/31/20x1 Interest Receivable (1.5M x 10% x 9/12) 112,
Interest Income 112,
04/01/20x2 Cash 650,
Notes Receivable (1.5M/3) 500,
Interest Income (1.5M x 10% x 3/12) 37,
Interest Receivable 112,
12/31/20x2 Interest Receivable (1M x 10% x 9/12) 75,
Interest Income 75,
04/01/20x3 Cash 600,
Notes Receivable (1.5M/3) 500,
Interest Income (1M x 10% x 3/12) 25,
Interest Receivable 75,
12/31/20x3 Interest Receivable (500k x 10% x 9/12) 37,
Interest Income 37,
04/01/20x4 Cash 550,
Notes Receivable (1.5M/3) 500,
Interest Income (500k x 10% x 3/12) 12,
Interest Receivable 37,
ILLUSTRATION 2: Compounded Interest
On January 1, 20x1, ABC Co. extended a P1,000,000 loan to one of its officers. The note received is due on
January 1, 20x4 and bears 10% interest compounded annually.
01/01/20x1 Notes Receivables 1,000,
Cash 1,000,
12/31/20x1 Interest Receivable (1M x 10%) 100,
Interest Income 100,
12/31/20x2 Interest Receivable (1.1M x 10%) 110,
Interest Income 110,
12/31/20x3 Interest Receivable (1.21M x 10%) 121,
Interest Income 121,
01/01/20x4 Cash 1,331,
Notes Receivable 1,000,
Interest Receivable (100k +110k + 121k) 331,
ILLUSTRATION 3 : Noninterest-bearing note – lump sum
On January 1, 20x1, Candle Co. received a 3-year noninterest-bearing note of P133,100 in exchange for land
with carrying amount of P 1 00,000. The note is due on December 31, 20x3. The effective interest rate is 10%.
Requirements:
a. Prepare the amortization table
b. Provide all necessary journal entries
Initial measurement:
Future Cash flows 133,
PV of ₱1 @10%, n= 3 = .7513 15
Present Value of Notes Receivable 100,
Requirement (a):
Date Interest income Unearned interest Present value
1/1/x1 33,100 100,
12/31/x1 10,000 23,100 110,
12/31/x2 11,000 12,100 121,
12/31/x3 12,100 - 133,
Requirement (b):
1/1/x1 Note receivable 133,
Unearned interest 33,
Land 100,
12/31/x1 Unearned interest 10,
Interest income 10,
12/31/x2 Unearned interest 11,
Interest income 11,
12/31/x1 Unearned interest 24,
Interest income 24,
Cash 100,
Note receivable 100,00 0
12/31/x2 Unearned interest 17,
Interest income 17,
Cash 100,
Note receivable 100,
12/31/x3 Unearned interest 9,
Interest income 9,
Cash 100,
Note receivable 100,
Requirement (e):
Interest income 24,
Loss on sale of equipment (51,315)
Net effect on P/L - decrease (26,446)
ILLUSTRATION 5 : Noninterest-bearing note – installment in advance
On January 1, 20x1, Otters Co. received a 3-year noninterest-bearing note of P1,200,000 in exchange for
equipment with historical cost of P 2 ,000,000 and accumulated depreciation of P700,000. The note is due in
three equal annual instalments beginning on January 1, 20x1 and every January thereafter. The effective
interest rate is 10%.
Requirements:
a. Prepare the amortization table
b. How much is the interest income in 20x1?
c. How much is the carrying amount of the receivable on Dec. 31, 20x1?
Initial Measurement
Future Cash flows (1.2M ÷ 3) = 400,000;
PV of an annuity due of ₱1 @10%, n=3 = 2.
Present Value of Notes Receivable 1,094,
Requirement (a):
Date Collections Interest income Amortization Present value
1/1/x1 1,094,
1/1/x1 400,000 - 400,000^ 694,
1/1/x2 400,000 69,422^ 330,578^ 363,
1/1/x3 400,000 36,363^ 363,637^ (0)
Requirement (b):
69,422 – see table above.
Requirement (c):
Carrying amt. on 1/1/x2 363,
Add back: Collection on 1/1/x2 400,
Carrying amt. on 12/31/x1 763,
ILLUSTRATION 6 : Noninterest-bearing note – semi-annual cash flows
On January 1, 20x1, ABC Co. sold machinery with historical cost od P2,000,000 and accumulated depreciation
of P1,100,000 in exchange for a 3-year P1,200,000 noninterest-bearing note receivable due in equal semi-
annual installments every July 1 and December 31 starting on July 1, 20x1. The prevailing rate of interest for
this type of note is 10%.
Initial Measurement
Future Cash flows (1.2M ÷ 6 ) = 2 00,000;
PV of ordinary annuity of ₱1 @ 5 %, n= 6 5.
Present Value of Notes Receivable 1,015,
Subsequent Measurement
Date Collections Interest income Amortization Present value
0 1/ 0 1/x1 1,015,
07 / 0 1/x1 2 00,000 50,757 149,243 865,
12/31/x1 2 00,000 43,295 156,705 709,
07 / 0 1/x 2 2 00,000 35,460 164,540 544,
12/31/x2 2 00,000 27,233 172,767 371,
07 / 0 1/x 3 2 00,000 18,594 181,406 190,
12/31/x3 2 00,000 9,523 190,477 0
01/01/20x1 Note Receivable 1,200,
Accumulated Depreciation 1,100,
Machinery 2,000,
Unearned Interest Income 184,
Gain on sale of machinery 115,
ILLUSTRATION 7: Noninterest-bearing note – non-uniform cash flows
On January 1,20x1, ABC Co. sold machinery costing P2,000,000 with accumulated depreciation of P1,100,
in exchange for a 3-year, P1,200,000 noninterest-bearing note payable due as follows:
DATE AMOUNT OF INSTALLMENT
December 31, 20x1 600,
December 31, 20x2 400,
December 31, 20x3 200,
TOTAL 1,200,
The prevailing rate of interest is 10%
Initial Measurement
Date Cash flows PV of P1 at 10%, n=1 to 3 Present value
12/31/x1 600,000 0.90909 545,
12/31/x2 400,000 0.82645 330,
12/31/x3 200,000 0.75131 150,
TOTAL 1,200,000 1,026,
Discounting semiannual cash flows
When discounting cash flows that are due in semiannual installments, the “n” (period) used in the
present value factor is multiplies by 2 because there are two semiannual installments per year.
Furthermore, the effective interest rate is divided by 2 because interest rates are normally
expressed on a per annum basis.
The effective interest rate is 6.2695%
12/31/20x1 Unearned Interest Income 62,
Interest Income 62,
Initial Measurement
Date Interest income
Unearned
Interest Income
Present value
1/1/ 20 x1 200,000 1,000,
12/31/x1 62,695 137,305 1,062,
12/31/x2 66,626 70,679 1,129,
12/31/x3 70,679 0 1,200,
Subsequent Measurement
01/01/20x1 12/31/20x1 12/31/20x 2 12/31/20x 3
Notes Receivable 1,200,000 1,200,000 1,200,000 1,200,
Unearned Interest
Income
Carrying Amount 1,000,000 1,062,695 1,129,321 1,200,
ILLUSTRATION 9: Note with below-market rate of interest – simple interest
(Principal due at maturity, interests due periodically)
On January 1, 20x1, ABC Co. sold a machinery with historical cost of P2,000,000 and accumulated
depreciation of P950,000 in exchange for a 3-year, P1,000,000, 3% note receivable. Principal is due on
January 1, 20x4 but interest is due annually every January 1. The prevailing interest rate for this type of note
is 12%.
Initial Measurement
Future Cash flows PV Factors Present value
Principal 1,000,000 PV of 1 @ 12 %, n=3 711,
Interest 30,000 PVOA of 1 @ 12 %, n=3 72,
TOTAL 783,
Subsequent Measurement
Date
Collections on
interests
Interest
income
Amortization Present value
0 1/ 0 1/x1 783,
01/01/x 2 30,000 94,060 64,060 847,
01/01/x 3 30,000 101,747 71,747 919,
01/01/x 4 30,000 110,358 80,358 1,000,
01/01/20x1 Notes Receivable 1,000,
Accumulated Depreciation 950,
Loss on sale of machinery 266,
Machinery 2,000,
Unearned interest income 216,
12/31/20x1 Interest Receivable 30,
Unearned Interest income 64,
Interest income 94,
01/01/20x2 Cash 30,
Interest Receivable 30,
ILLUSTRATION 10: Note with below-market rate of interest – simple interest
(Principal due at maturity, interests is due semi-installments)
Use the same information in Illustration 9 except that the interest is payable semi-annually.
Initial Measurement
Future Cash flows PV Factors Present value
Principal 1,000,000 PV of 1 @ 6 %, n= 6 704,
Interest 15,000 PVOA of 1 @ 6 %, n= 6 73,
TOTAL 778,
Subsequent Measurement
Date
Collections on
interests
Interest
income
Amortization Present value
0 1/ 0 1/x1 778,
07/01/x1 15,000 46,723 31,723 810,
01/01/x 2 15,000 48,627 33,627 844,
07/01/x2 15,000 50,644 35,644 879,
01/01/x 3 15,000 52,783 37,783 917,
07/01/x3 15,000 55,050 40,050 957,
01/01/x 4 15,000 57,453 42,453 1,000,
ILLUSTRATION 1 1 : Note with below-market rate of interest – simple interest
(Principal and interests collectible in installments)
On January 1, 20x1, ABC Co. sold a machinery with historical cost of P2,000,000 and accumulated
depreciation of P950,000 in exchange for a 3-year, P1,200,000, 3% note receivable. Principal is due in three
equal annual installments. Interests on the outstanding principal balance are also due annually and are to be
collected together with the principal. The prevailing interest rate for this type of note is 12%.
Initial Measurement
Date
Collections
on Principal
Interest on outstanding
Principal balance
Total cash flows
PV of 1 @12%,
n=
Present Value
12/31/x 400,000 (1.2 M x 3%) = 36,000 436,000 0.8928 57 389,
12/31/x 400,000 (800k x 3%) = 24 ,000 424,000 0.79719 4 338,
12/31/x 400,000 (400k x 3%) = 12 ,000 412,000 0.711780 293,
TOTAL 1,272,000 1,020,
Subsequent Measurement
Date Collections Interest income Amortization Present value
0 1/ 0 1/x1 1,020,
12/31/x1 436,000 122,466 313,534 707,
12/31/x2 424,000 84,842 339,158 367,
12/31/x3 412,000 44,143 367,857 0
12/31/20x1 Interest Receivable 30,
Unearned Interest 63,
Interest Income 93,
12/31/20x2 Interest Receivable 60,
Unearned Interest 73,
Interest Income 104,
12/31/20x3 Interest Receivable 92,
Unearned Interest 85,
Interest Income 117,
01/01/20x4 Cash 1,092,
Interest Receivable 92,
Notes Receivable 1,000,
ILLUSTRATION 13: Total Interest Income over the life of note
ABC Co. received a P100,000, 8%, 5-year note that requires five equal annual year-end payments. The
effective interest rate on the note is 9%.
Requirement: Compute for the total interest revenue to be earned over the term of the note?
Solution:
Cash Flows x PVF = Present Value
CF x PVOA = PV
CF x 3.992710 = 100,
CF = 100,000 / 3.
CF = 25,046 (equal annual year-end payments)
Total Cash Flows (25,046 x 5 years) 125,
LESS: (PVOA @ 9 %, n=5)(25,046) 97,
Total Interest revenue over the life of the note 27,
DEFERRED ANNUITIES
A deferred annuity is an annuity in which periodic cash flows begin only after two or more periods
have passed.
Future Value of Deferred Annuity – the deferral period is simply ignored because there is no accumulation
of cash flows on which interest may accrue.
Present Value of Deferred Annuity – recognizes interest that accrues during the deferral period.
ILLUSTRATION 14: Present value of a Deferred annuity
An entity has developed a patent. On January 1, 20x1, the patent was sold in exchange for a P60,
noninterest-bearing note collectible in six annual installments of P10,000 each beginning on January 1, 20x
and every January 1 thereafter. The last installment is due on January 1, 20x11. The appropriate discount rate
is12%.
Requirement: What is the present value of the note received by ABC Co.?
Solution: The full term is 10 years and the deferred period is 4 years
PV of OA of P1@12%, n = 10 5.
PV of OA of P1@12%, n = 4 (3.037349)
PV factor for the payment period 2.
Initial measurement:
Annual Cash flows 10,
PV factor for the payment period 2.
Present Value of Notes Receivable 26,
Date Collections
PV of P
@12%, n = 5 to 10
Present value
0 1/ 0 1/x 6 10,000 0.56743 5,
01/01/x 7 10,000 0.50663 5,
01/01/x 8 10,000 0.45235 4,
01/01/x 9 10,000 0.40388 4,
01/01/x10 10,000 0.36061 3,
01/01/x 11 10,000 0.32197 3,
TOTAL 26,
ILLUSTRATION 15: Present value of a Deferred annuity
On January 1, 20x1, ABC Co. sold a used equipment in exchange for a P3,000,000 noninterest bearing note due
in three annual installments as follows:
Jan. 1, 20x4 1,500,
Jan. 1, 20x5 1,000,
Jan. 1, 20x6 500,
TOTAL 3,000,
The current market rate of interest on January 1, 20x1 is 12%.
Requirement: Compute for the present value of the note on January 1, 20x1.
Initial Measurement
Date Cash flows PV of P1 PV Factors Present value
01/01/x4 1,500,000 PV of P1 @ 12%, n=3 0.711780 1,067,
01/01/x5 1,000,000 PV of P1 @ 12%, n=4 0.635518 635,
01/01/x6 500,000 PV of P1 @ 12%, n=5 0.567427 283,
Subsequent Measurement
Date Collections Interest income Amortization Present value
01/01/x1 1,986,
01/01/x2 238,428 238,428 2,225,
01/01/x3 267,040 267,040 2,492,
01/01/x4 (^) 1,500,000 299,084 1,200,916 1,291,
01/01/x5 1,000,000 154,974 845,026 446,
01/01/x6 500,000 53,571 446,429 0
