NOTE PAYABLE AND DEBT RESTRUCTURING

Note Payable:

•Written promises to pay a certain sum of money on a specified future date.

•Arise from purchases, financing, or other transactions.
•Classified as either “Short-term” or “Long-term” depending on the payment due date.
•Also classified as “Interest bearing” or “Zero-Interest bearing”.

Measurement of Notes Payable

 Initially, notes payable shall be measured at fair value which is equal to the present value or discounted value.
 Subsequently, the note payable shall be measured at amortized cost.

Note Issued Solely for Cash

 When a note is issued solely for cahs, the present value is equal to the cash proceeds. The entry to record the issuance of the note
is:
Cash xx
Discount on Note Payable xx
Notes Payable xx

Note: The discount debited, is the discount on notes payable for the whole year, the interest. So, if it is needed, the discount could be
amortized as interest expense.

Interest Expense xx
Discount on Notes Payable xx

Straight line method is used in amortizing the discount on note payable. The discount on notes payable is a direct deduction from the note
payable.
Note Payable xx
Less: Discount on Note payable (xx)
Book Value xx

Note: The book value is actually the amortized cost of the note payable.

Two Types of Notes Payable

Interest Bearing Note

Journal entries

•Issuance of an interest bearing note:

Cash xx
Notes Payable xx

•Payment of the note including interest:

Notes Payable xx
Interest Payable xx
Cash xx

Zero-Interest- Bearing Not

•Does not explicitly state an interest rate on the face of the note but Interest is still charged.
•At maturity the borrower must pay back an amount greater than the cash received.

Journal entries

•Issuance of a zero-interest-bearing note:

Cash xx
Discount on Notes Payable xx
Notes Payable xx

Interest Bearing Note Issued for Property

 When a property or noncash asset is acquired by issuing a note which is interest-bearing, the property or asset is recorded at
purchase price
  The purchase price is the present value of the and therefore the fair value of the property because the note issued is interest-
bearing.

Noninterest Bearing Note issued for Property

 When a noninterest bearing note is issued for property, the property is recorded at the cash price of the property. The cash price is
assumed to be the present value of the note issued.
 The difference between the cash price and the fce value of the note issued represents the imputed interest. The imputed interest is
based on the sound philosophy that no lender would part away with his money or property interest-free.

Dacion en pago Accounting: or can be considered as payment in kind. It arises when a mortgaged property is offered by the debtor in full
settlement of the debt.this transaction shall be accounted for as an “Asset Swap” for of debt restructuring.

This requires recognition of gain or loss based on the balance of the obligation including accrued interest and other charges.

If the balance of the obligation including accrued interest and other charges is more than the cost or book value of the property mortgaged,
there is a gain on extinguishment of debt. Otherwise, there is a loss on extinguishment.

Debt Restructuring: is a situation where the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants to the
debtor concession that would not be granted in a normal business relationship. The concession either stems from an agreement between the
credtor and debtor, or is imposed by law or a court.

Types of Debt Restructuring

1. Asset Swap: is a transfer by the debtor to the creditor of any asset such as real estate, inventory, receivables and investment, in full
payment of an obligation. Asset swap is recorded as follows:
Note payable xx
Accrued Interest Payable xx
Asset (transferred) xx
Gain on Extinguishment xx

2. Equity Swap: the issuance of share capital by the debtor to the creditor in full or partial payment of an obligation. Equity swap is
recorded as follows:
Bonds Payable xx
Accrued interest Payable xx
Share capital xx
Share Premium xx
Gain on extinguishment of debt xx

3. Modification of Terms: may involve either the interest, maturity value or both. PAS 39, that a substantial modification of terms of an
existing financial liability shall be accounted for as an extinguishment of the old financial liability and the recognition of a new
financial liability.

PROBLEMS

Problem 1
Samson Corporation issued a 4-year, $75,000, zero-interest-bearing note to Brown Company on January 1, 2011, and received a cash of
$47,664. The implicit interest rate is 12%. Prepare Samson’s journal entries for (a) the January 1 issuance and (b) the December 31
recognition of interest.

Problem 2

McCormick Corporation issued a 4-year, $40,000, 5% note to Greenbush Company on January 1, 2011m and received a computer that
normally sells for $31,495. The note requires annual interest payments each December 31. The market rate of interest for a note of similar risk
is 12%. Prepare McCormick’s journal entries for (a) the January 1 issuance and (b) the December 31 interest.

Problem 3

On January 1, 2010, East Company acquired an equipment for P850,000 payable in two annual equal instalments every December 31 of each
year. East Company signed an interest bearing note for P850,000. Interest of 14% is payable annually on the unpaid balance.
Prepare all indicated entries for 2010 and 2011.

Problem 4

On January 1, 2010, James Company borrowed P4,800,000 from a major customer evidenced by a noninterest bearing note due in three
years. James agreed to supply the customer’s inventory needs for the loan period at lower than market price. At the 11% imputed interest rate
for this type of loan, the present value of the note is P3,530,000 at January 1, 2010. What amount of interest expense should be included in
James’ 2010 income statement?

Problem 5
1.On December 31, 2010, CFord Company purchased a machine from Liss Company in exchange for a noninterest bearing note requiring 10
payments of P250,000. The first payment was made on December 31, 2010 and the others are due annually on December 31. At date of
issuance, the prevailing rate of interest for this type of note was 9%.
On December 31, 2010, the note payable should be reported at

Problem 6
On August 31, Jenks Co. partially refunded $180,000 of its outstanding 10% note payable made one year ago to Arma State Bank by paying
$180,000 plus $18,000 interest, having obtained the $198,000 by using $52,400 cash and signing a new one-year $160,000 note discounted
at 9% by the bank.

(1) Make the entry to record the partial refunding. Assume Jenks Co. makes reversing entries when appropriate.
(2) Prepare the adjusting entry at December 31, assuming straight-line amortization of the discount.

Problem 7

Hiroshima Corporation borrowed P60,000 on November 1, 2010, by signing a P61,350, 3-month, zero-interest bearing note. Prepare
Hiroshima’s November 1, 2010, entry; the December 31, 2010, annual adjusting entry and the February 1, 2011, entry.

Problem 8

Joshua Company bought a new machine on January 1, 2010 and agreed to pay in equal annual installments of 600,000 at the end of the next
five years. The prevailing interest rate for this type of transaction is 12%.

a.How much should Joshua report as note payable in the statement of financial position if financial statements were prepared on January 1,
2010.
b.What is the interest expense on the note payable?

Problem 9

On January 1, 2010, Pares Company borrowed P3,600,000 from a major customer evidenced by a non-interest bearing note due in three
years. Pares agreed to supply the customer’s inventory 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 January 1, 2010.

a.What interest expense should be reported in the 2010 income statement?

b.How much is the discount on the notes payable?

Problem 10
On December 31, 2010 , Boston Company purchased a machine from Helix Company in exchange for a non-interest bearing note requiring
eight payments of 200,000. The first payment was made on December 31, 2010 and the others are due annually on December 31. At the date
of issuance the prevailing rate of interest for this type of note was 11%.

On December 31, 2010, what should be reported as carrying amount of the note payable?

Problem 11
Coldwell, Inc. issued a $100, 000, 4-year, 10% note at face value to Flint Hills Bank on January 1, 2011, and received $100, 000 cash. The
note requires annual interest payments each December 31. Prepare Coldwell’s journal entries to record (a) the issuance of the note and (b)
the December 31 interest payment.

Problem 12
Samson Corporation issued a 4-year, $75, 000, zero-interest-bearing note to Brown Company on January 1, 2011, and received cash of $47,
664. The implicit interest rate is 12%. Prepare Samson’s journal entries for (a) the January 1 issuance and (b) the December 31 recognition of
interest.

Problem 13
McCormick Corporation issued a 4-year, $40, 000, 5% note to Greenbush Company on January 1, 2011, and received a computer that
normally sells for $31, 495. The note requires annual interest payments each December 31. The market rate of interest for a note of similar
risk is 12%. Prepare McCormick’s journal entries for (a) the January 1 issuance and (b) the December 31 interest.

Problem 14
Shlee Corporation issued a 4-year, $60, 000, zero-interest-bearing note to Garcia Company on January 1, 2011, and received cash of $60,
000. In addition, Shlee agreed to sell merchandise to Garcia at an amount less than regular selling price over the 4-year period. The market
rate of interest for similar notes is 12%. Prepare Shlee Corporation’s January 1 journal entry.

Problem 15

On December 31, 2009, Roth Company issued a P1,000,000 face value note payable to Wake Company is 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%. At what amount should the note payable be reported in Roth’s December 31, 2009 statement of financial position?

Problem 16
On January 1, 2009, Pares Company borrowed P3,600,000 from a major customer evidenced by a noninterest bearing note due in three
years. Pares agreed to supply the customer’s inventory needs for the load 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 January 1, 2009. What amount of interest expense should be included in
Pares’ 2009 income statement?

Problem 17
On July 1, 2009, Cody Company obtained a P2,000,000, 180-day bank loan at an annual rate of 12%. The loan agreement requires Cody to
maintain a P400,000 compensating balance in its checking account at the lending bank. Cody would otherwise maintain a balance of only
P200,000 in this account. The checking account earns interest at an annual rate of 6%. Based on a 360-day year, the effective interest rate on
the borrowing is:

Loan 2,000,000
Less: Compensating balance in excess of the
Normal checking account balance ( 200,000)
1,800,000

Effective amount (1,800,000 x 180/360) 900,000

Effective interest rate (114,000/900,000) 12.67%

Problem 18

On March 1, 2008, 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, 2009. What amount should Fine report as a liability for accrued interest at December 31,
2009?

Problem 19

Joshua Company bought a new machine on January 1, 2009 and agreed to pay in equal annual installment of P600,000 at the end of each of
the next five years. The prevailing interest rate for this type of transaction is 12%. How much should Joshua report as note payable in the
statement of financial position if financial statements were prepared on January 1, 2009?

Problem 20

On December 31, 2009, Largo Company had a P750,000 note payable outstanding, due July 31, 2010. Largo borrowed the money to finance
construction of a new plant. Largo planned to refinance the note by issuing long-term bonds. Because Largo temporarily had excess cash, it
prepaid P250,000 of the note on January 15, 2010. In February 2010, Largo completed a P1,500,000 bond offering. Largo will use the bond
offering proceeds to repay the note payable at its maturity and to pay construction cost during 2010. On March 31, 2010, Largo issued its 2009
Financial Statements. What amount of the note payable should Largo include in current liabilities on December 31, 2009?

Problem 21

Versatile Company after having experienced financial difficulties in 2010 negotiated with a major creditor and arrived at an agreement to
restructure its notes payable on December 31, 2010. The creditor was owed principal of 3,600,000 and interest of 400,000 but agree d to
accept equipment worth 700,000 and note receivable from a Versatile Company’s customer with carrying amount of 2,700,000. The equipment
had an original cost of 900,000 and depreciation of 300,000.

How much should be recognized as gain from debt extinguishment on December 31, 2010?

Problem 22

On December 31, 2008, Nolte Co. is in financial difficulty and cannot pay a note due that day. It is a $600,000 note with $60,000 accrued
interest payable to Piper, Inc. Piper agrees to accept from Nolte equipment that has a fair value of $290,000, an original cost of $480,000, and
accumulated depreciation of $230,000. Piper also forgives the accrued interest, extends the maturity date to December 31, 2011, reduces the
face amount of the note to $250,000, and reduces the interest rate to 6%, with interest payable at the end of each year.

a.Nolte should recognize a gain or loss on the transfer of the equipment of_____________
b.Nolte should recognize a gain on the partial settlement and restructure of the debt of__________
c.Nolte should record interest expense for 2011 of____________

SOLUTIONS TO PROBLEMS

Solution to Problem 1

(a) January 1, 2011 Cash 47,664

Discount on Notes 27,336
Notes Payable 75,000
 (b) December 31, 2011 Interest Expense 5719.68
Discount on Notes 5719.68

Solution to Problem 2

Schedule of Note Discount Amortization

Effective Interest Method

Date Interest Expense Discount Amortized

January 1,2011
December 31, 2011 5,719.68 5,719.68
December 31, 2012 6,406.04 6,406.04
December 31, 2013 7,174.77 7,174.77
December 31, 2014 8,035.74 8,035.74

(a) January 1, 2011 Equipment 31, 495

Discount on Notes 8, 505
Notes Payable 40,000

(b) December 31, 2011 Interest Expense 5,779.4

Cash 2,000
Discount on Notes 3,774.9

Solution to Problem 3

Schedule of Note Discount Amortization

Effective Interest Method

Date Interest Expense Interest Paid Discount Amortized

January 1,2011
December 31, 2011 3779.4 2000 1779.4
December 31, 2012 3,992.93 2000 1992.93
December 31, 2013 4,232.08 2000 2232.08
December 31, 2014 4,499.93 2000 2499.93

January 1, 2010 Equipment 699,831

Discount on Notes 150,169
Notes Payable 850,000

*Present Value 850,000/2 = 425,000 x 1.6467 = 699,831

December 31, 2010 Interest Expense (850,000 x .14) 119,000

Notes Payable 425,000
Cash 544,000

December 31, 2010 Interest Expense (425,000 x .14) 59,500

Notes Payable 425,000
Cash 484,500

Solution to Problem 4

P388,300

P3530,000 x 11% = 388,300

Solution to Problem 5
 P1498,800

P250,000 x 6.9952 = 1748,800

(250,000)
1498,800

Solution to Problem 6
(1) Notes Payable................................................................................................................... 180,000
Interest Expense............................................................................................................... 18,000
Discount on Notes Payable (9% × $160,000)................................................................... 14,400
Notes Payable................................................................................................... 160,000
Cash.................................................................................................................. 52,400

(2) Interest Expense (1/3 × $14,400)...................................................................................... 4,800

Discount on Notes Payable.............................................................................. 4,800

Solution to Problem 7

Nov 1. Cash ………………………………………………………….. 60,000

Discount on Note Payable ………………………………… 1,350
Notes Payable …………………………………………. 61,350

Dec 1. Interest Expense ………………………………………………. 900

Discount on Notes Payable ………………………….. 900
( 1, 350 x 2/3 )

Feb. 1 Interest Expense ……………………………………………….. 450

Discount on Notes Payable ………………………... 450
( 1,350 x 1/3 )

Notes Payable ………………………………………………… 61,350

Cash ………………………………………………….. 61,350

Solution to Problem 8

a.PV of note payable on 1/1/2010 (600,000 x 3.60*) 2,160,000

Note: PV of Ordinary annuity of 1 at 12%
for 5 periods is 3.60*

b.Interest expense for 2010 ( 2,160,000 x 12% ) 259, 200

Solution to Problem 9

a.Interest expense for 2010 ( 2,550,000 x 12% ) 306,000

b.Face value of Note 3,600,000

Present value 2,550,000
Discount on Note Payable 1,050,000

Solution to Problem 10

PV of Note payable ( 200,000 x 5.712 ) 1,142,400

Payment on December 31, 2010 ( 200, 000)
PV of note payable – December 31, 2010 942,400

Note: PV of annuity of 1 in advance, 5.712, is used because the date of purchase is December 31, 2010 and the first payment is made on the
same date, December 31, 2010.

Solution to Problem 11

(a) Cash.................................................................................... 100,000

Notes Payable....................................................... 100,000
(b) Interest Expense............................................................. 11,000
Cash ($100,000 X 11% = $11,000)................... 11,000

Solution to Problem 12

(a) Cash.................................................................................... 47,664

Discount on Notes Payable ........................................ 27,336
Notes Payable.......................................................75,000
(b) Interest Expense............................................................ 5,720
Discount on Notes Payable ............................. 5,720

Solution to Problem 13
(a) Computer.......................................................................... 31,495
Discount on Notes Payable........................................ 8,505
Notes Payable ...................................................... 40,000

(b) Interest Expense............................................................ 3,779

Cash ......................................................................2,000
Discount on Notes Payable ............................. 1,779

Solution to Problem 14

Cash ............................................................................................... 60,000

Discount on Notes Payable .................................................... 21,869
Notes Payable................................................................... 60,000
Unearned Revenue ......................................................... 21,869

Solution to Problem 15

Answer: P1,000,000

Solution:
The note payable is shown at face value because it is short-term and made in the usual terms.

Solution to Problem 16

Answer: P306,000

Solution:
Interest expense for 2009 (2,550,000 x 12%) 306,000

Interest expense is computed by multiplying the present value (PV) by the imputed interest rate (effective rate).

Solution to Problem 17

Answer: 12.67%

Solution:
Interest Expense (2,000,000 x 12% x 180/360) 120,000
Interest income on compensating balance
In excess of the normal checking account
Balance (200,000 x 6% x 180/360) ( 6,000)
114,000

Solution to Problem 18

Answer: 232,000

Solution:
Accrued interest from March 1, 2008 to
February 28, 2009 (1,000,000 x 12%) 120,000
Accrued interest from March 1 to December 31,2009
(1,000,000 + 120,000 x 12% x 10/12) 112,000
Accrued interest payable, December 31, 2009 232,000

Solution to Problem 19

Answer: 2,160,000

Solution
PV of Note payable on 1/1/2009 600,000 ((1-1/(1.12)^5 )/(.12)) 2,160,000

Solution to Problem 20

Answer: 750,000

Solution/Explanation:
The entire amount of 750,000 is shown as current liability because the note payable is due to be settled within one year regardless of the
issuance of bonds payable.

Solution to Problem 21

Note payable 3,600,000

Accrued interest payable 400,000
Total Liability 4,000,000
Asset transferred:
Note receivable 2,700,000
Equipment at CA 600,000 3,300,000
Gain on extinguishment 700,000

Solution to Problem 22

a. $290,000 – ($480,000 – $230,000) = $40,000.

B. ($600,000 + $60,000) – [$290,000 + $250,000 + ($250,000 × .06 × 3)]

= $75,000.

c 0. The effective-interest rate is 0%.