CHAPTER 6 NOTES RECEIVABLE TECHNICAL KNOWLEDGE To understand the concept and nature of not receivable. To know the initial and subsequent measuremey of notes receivable. To know the accounting for interest-bearing not: receivable, To know the accounting for noninterest-bearing note receivable, 154 NOTES RECEIVABLE re claims supported by formal promises to 1¢ form of notes, ‘ e x nagoliable 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 isa written contract in which ‘one person, known as the maker, promises to pay another porson, 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. Dishonored notes When a promissory note matures and is not paid, itis said to be dishonored. Theoretically, dishonored notes receivable should be removed from the notes receivable account and transferred to accounts receivable. ‘The amount debited to accounts receivable should include the face amount, interest and other charges. 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. 155Initial measurement of notes receivable Conesptually, notes receivable shall be measured initia present value. ba The present value is the sum of all future cas] tied wn the pevsng market rate or Sagi similar notes. ‘The prevailing market rate of interest is actually the effect interest rate nl However, short-term notes receivable shall be measur 4 > Cash flows relating to short-term notes receivable are ne discounted because the ef nt i discounted because the effet of discounting is usualy at The ial measurement of long-term notes will depend ot Tengigt (He motes are interest-bearing or nonintered Interest-bear e t face jaring long-term notes are measured at f ing re measured ai ‘amount which is actually the present value upon issuanc _Nonineres-heating notes receivable Noninterest-b aring long-term not. dat Present value which jo rh jes are measure’ is the discounted value o ur ash flows using the effective Tea oa Actually, the term * because all ™ “noninterest-bearing" is a misnomé ites implicitly contain interest. Its simply a case of Omount athe than hang eet eng included in the 0% 'ne stated as a separate rate. 156 Subsequent measurement Subsequent to initial recognition, long-term notes receivable shall be measured at amortized cost using the effective interest method. ‘The amortized cost measurement is in accordance with PFRS 9, paragraph 5.2.1 ‘The amortized cost is the amount at which the note receivable is measured initially: a, Minus principal repayment b. Plus or minus cumulative amortization of any difference between the initial carrying amount and the principal maturity amount cc. Minus reduction for impairment or uncollectibility. In other words, for long-term noninterest-bearing notes receivable, the amortized cost is the present value plus ‘amortization of the discount, or the face amount minus the unamortized unearned interest income ‘Accordingly, only long term interest bearing and noninterest bearing notes receivable will be discussed in conjunction with the present value concept. Illustration ~ Interest bearing note An entity owned a tract of land costing P800,000 and sold the land for P1,000,000. ‘The entity received a 3-year note for P1,000,000 plus interest of 12% compounded annually. When interest in the mathematical parlance ree minre ae Gagtacraed intrest recevable ako sare interest. ‘The selling price of P1,000,000 is reasonably a the present value of the note because the no bearing, sumed to be is interest 187Journal entries First year Note receivable 1,000,000 Land Gain onsale ofland ‘Accrued interest receivable 120,000 Interest income (12% x 1,000,000), Second year Accrued interest receivable 131,400 Interest income Face amount Interest accrued for first year Total Interest for second year (12% x 1,120,000) Third year Cash 1,404,928 ‘Note receivable ‘Accrued interest receivable Interest income Faceamount Interest accrued: Firstyear ian Second year 134,400 Total Interest for thitd year (12% x 1,254,400) Cash received iilustration ~ Noninterest bearing note An entity manufactures and sells machinery. On January 1 2022, the entity sold machinery costing P280,000 for P400,000. ‘the buyer signed a noninterest bearing note for '100,000, payable in four equal installments every December 31 ‘The cash sale price of the machinery is P350,000, Face amount of note ; ae Present value - cash sale price ea000 Unearned interestincome aan ‘cash sale price Sam Costof machinery soa Grossincome Journal entries for 2022 ‘To record the sale: Note receivable 400,000 s 350,000 Unearned interest income 50,000 To record the first installment collection ash 10,000 ‘Note receivable 100,000 ‘To recognize the unearned interest as income over the term of the note: Unearned interest income 20,000 Interest income @ OO) Note receivable Fraction 2022 400,000 410 2023 300,000 3/10 Boz 200,000 2/10 2025, 100,000 1/10 159Explanation + ‘The first installment is received on December 31, 2099. ‘Thus, for 2022 the note receivable outstanding is P99 99) and decreased by P100,000 each year. + The fractions are developed from the note receivahly balance every year. + ‘The fractions developed are multiplied by the total unearneg interest of P50,000 to get the yearly interest income, ‘Thus, for 2022, 4/10 x P50,000 equals P20,000 and s0 on, Statement presentation Ifa statement of financial position is prepared on December 31, 2022, the eurrent portion of the note receivable is classified as current asset. Note receivabe-current portion 100,000 Unearned interest income (25.000) Carrying amount or amortized cost ‘Total unearned interest income Realized in 2022 Balance-December 31, 2022 Realizable in 2023-current portion Realizable beyond 2022-noncurrent portion Total ‘The noncurrent portion of the note receivable is classified a8 noncurrent asset. Note receivable —noncurrent portion 200,000 ‘Unearned interest income 15,000) Carrying amountor amortized cost 155.08 160 Another illustration ~ Noninterest bearing note On January 1, 2022, an entity ‘of P250,000 for P400,000. ‘The buyer paid a down of P100,000 and signe bearing note for P300,000 payable wend noninterest installment of P100,000 every December 31 sold an equipment with a cost ‘The market interest rate for this note is 10%. The value of an ordinary annuity of | for three periods at reaent 2.4869. Periods at 10% is ‘The present value of the note is computed by multiplyin the annual installment of P100,000 by the pres ine facto of 2.4869 or P248,690, Face amount of note Present value of note (100,000 2.4869) Uneurned interest income Present value of note Cash received-down payment Sale rice Costof equipment Cain on ale of equipment Journal entries for 2022 1, To record the sale of equipment: Cash 100,000 Note receivable 800,000 Equipment 250,000 Gainon sale of equipment 98,690 Unearned interest income 51,310 2 To record the first installment collection: Cash 100,000 Notereceivable 100,000 3. To record the interest income for 2022: Unearned interest income 24.869 Interest ineome ae 161Computation ‘The computation of the interest income is made using effective interest method. Annual Interest Pr Date collection income Principal "yaya Jan. 1, 2022 243.00) ecat2o22 100.000 24,860 75,31 ITaegh Dee 31,2023 100,000 17,836 82,644 gdgtg Dee 31,2024 1000009085 90.915 uy + ‘The interest income is computed by multiplying the presont value by 10%. Thus, for 2022, 10% x P248,699 equals P24,869. ‘The principal payment is equal to annual collection minus interest income. Thus, for 2022, P100,000 minus P24,869 equals P75,131. ‘The present value is equal to the preceding balance minus the annual principal payment. Thus, on December 3], 2022, P248,690 minus P75,131 equals P173,559, Journal entries for 2023 1, To record the second annual collection: Cash, 100,000 ‘Note reesivable 100,000 2 To record the interest income for 2028: Unearned interest income 17,356 Interest inoome 17356 Journal entries for 2024 1. To record the third annual collection: Cath 100,000 ‘Note receivable 200,00 2 To record the interest income for 2024: Unerned interest income Interest income = 9,085 162 Another illustration ~ Noninterest bearing note On January 1, 2022, an entity sold an equipment "400,000 with accumulated dey on of Poe coeti Fo 0 areas! deprecation ot FES 000 an ‘The entity received as considera 100,000 noninterest bearing nate duc on Ngo ycahy and & due on January 1, 2025. ‘he prevailing rate of interest for note of this type i ‘The present value of 1 at 10% for 3 yearsis Osutg7Pe 3 10% Observe that the note is collectible on a lump sum basis after 3 years. Face amountof note tana Present value (400,000 x.7513) aan BED, Unearned interest income Aeodio ‘The unearned interest income is sometimes described discount on note receivable, Computation Present value of note 300,520 Cash received 100,000 Sale price 400,520 Carrying amount of equipment 350,000 Gain on sale of equipment 50,520 Journal entries 2022 Jan. 1 Cash 100,000 Note receivable 400,000 Accumulated depreciation 250,000 Equipment 600,000 Gain on eale of equipment 50.520 ‘Unearned interest income 99,480 ‘Dec.31 Unear interest income 30,052 ss se 163tation - effective interest method QUESTIONS Compu Interest — Unearned —Prasgy, Date tacome eee valuy 1, Define notes receivable, 99,480 ae ae sas coast 2, Define a negotiable promissory note 33057 36,371 Doe 38 atl ~ SEEM plan tho trnimont of Saban one Sof i 4, Explain the initial measurement of short-term notes ‘The interest income is computed by multiplying the receivable, present value by 10%. ‘Thus, for 2022, P300,520 x 10% equals P30,052. 5. Explain the initial measurement of long-term notes * The unearned interest income is arrived at by deducting receivable, the interest income from preceding balance. ‘Thus, on December 31, 2022, P99,480 minus P30,052 equals 69,428. * The presen! value is arrived at by adding the interest name to the proceding present value balance, 6.What is the meaning of noninterest bearing note receivable? 7. Bxplain the subsequent measurement of long-term notes receivable, 8. Explain compounding of interest in relation to interest ‘Thus, on December 31, 2022, P300,520 plus P30,052 equals bearing notes receivable. 330,572. Or face amount of note minus unearned interest income 9. What is the meaning of present value of notes receivable? equals present value. 10. Explain the computation of present value of long-term ‘Thus, on December 31, 2022, P400,000 minus P69,428 notes receivable, equals P330,57 mo Dee31. Unearned interest income 340057 Interest income 33051 20 Decl. Unearned interest 36,71 Interest income ss a6 at1 2s Jan. 1 Cash 400,000 Note recevable 00.00 164 165PROBLEMS Problem 6-1 (ACP) veasible Company sold to another entity a tract of land ena Fess ON for P7000000 on January 1, 2022 ng buyer paid P1,000,000 down and signed a two.ye ne ey notesfor the remainder of the purchase price plat Bint interest compounded annually. The note matures o¢ January 1, 2024. Required: Prepare journal entries for 2022, 2023 and 2024. Problem 6-2 (ACP) Byron Company manufactures and sells computers. On January 1, 2022, the entity sold a computer costing P400,00) for P600,000. ‘The buyer signed a noninterest bearing note for P600,000 payable in three equal installments every December 31, ‘The cash selling price of the computer is P540,000. Required: Prepare journal entries for the current year. Problem 6-3 (ACP) , Innova Company manufactures and sells electrical generators On January 1, 2022, the entity sold an electrical generator costing P700,000 for 1,000,000. The buyer paid P100,000 down and signed a P9000 noninterest bearing note payable in three equal installments every December 31 . 2 a a reming nent ato for a note of this type is 12%. The Proiat “alue of an ordinary annuity of 1 for three periods i Required: Prepare journal entries for the current year. 166 problem 6-4 (IAA) Gullible Company is a dealer in equipment, Or 31, 2022, the entity sold an equipment in ecnoes oe noninterest bearing note requiring five annual payments of 500,000. The first payment was made on December 31, 2023. ‘The market interest for similar notes was 8%, The relevant present value factors are PVof 1 at 8% for 5 periods . PVof anordinary annuity of 1 at 8% for 5 periods 399 Required: 1. Prepare journal entries for 2022 and 2023, 2 Determine the carrying amount of the note receivable on December 31, 2023, 3, Determine the interest income for 2024 Problem 6-5 (AICPA Adapted) On January 1, 2022, Enigma Company sold an equipment costing P500,000 which had a earrying amount of P350,000, receiving a P125,000 down payment and, as additional consideration, a P400,000 noninterest bearing note due on January 1, 2026. There was no established exchange price for the equipment, and the note had no ready market. ‘The prevailing rate of interest for a note of this type at January 1, 2022 was 12%, The present value of 1 at 12% for three periods is 0.7118. Required: Prepare journal entries for 2022, 2023, 2024 and 2026. 167Problem 66 (AICPA Adapted) ‘Om January 1, 2022, Denmark Company had the followigg account balances: Note receivable from sale of an idle building 7.500000 [ote receivable from an officer 2,000.00) -e P7,500,000 note receivable is dated May 1, 2021, ben Dahir ‘and represents the balance ofthe Consideratige interved from the sale of an idle building to Solid Company cipal payments of P2,500,000 plus interest are 4 Prinelfy eeqrming May 1, 2022. Solid Company made he first principal and interest payment on May 1, 2022, 1 2,000,000 note receivable is dated December 31, 2013, ‘ears interest at 8% and is due on December 81, 2024, ‘The note is due from the president of Denmark Company. Interest is payable annually on December 31 and all interest payments were made through December 31, 2022. On July 1, 2022, Denmark Company sold a parcel of land tp Boom Company for P4,000,000 under an installment sale contract. Boom Company made a P1,200,000 cash down payment on diy 1, 2022, and signed a 4-year 10% note for the P2,600.00 ‘The equal annual payments of principal and interest on the note totaled P880,000, payable on July 1 of each year from 2023 through 2026, ‘The fair value of the land at the date of sale was P4,000,00 and the cost of the land was P3,000,000. Required: 1. Prepare journal entries to record all indicated) ‘transactions for 2022 2 Determine the amount of notes receivable inclu crued interest that should be classified as curr asset on December 31, 2022, “Tassified & 3. Determine the amount of not Id be 3 amo tes receivable that shoul slassified as noneurrent asset on December 31, 2022 168 problem 6-7 (AICPA Adapted) On January 1, 2022, Ott Company sold goods to Fox Company. Fox Company signed a nonintorest-besring note 'Y annuity of 1 at 10% for 6 peri PY of an ordinat % for 6 periods 4.36 ty annuity of 1 at 10% for T periods. 4.87 Required: 1, Prepare all journal entries for 2022 4, Determine the carrying amount ef note receivable o December $1, 2022. Bom ee Problem 6-8 (TAA) Persia Company is a dealer in equipment. On January 1, 2022, the entity sold an equipment in exchange for a noninterest bearing note requiring five annual payments of P500,000, The first payment was made on December 31, 2022. The market interest rate for similar notes was 8% PY of Lat 8% for 5 periods Votan ordinry annsty of at for S periods a Required: 1, Prepare all journal entries for 2022, 2 Determine the carrying amount of note receivable on December 31, 2022. Problem 6-9 (AICPA Adapted) On January 1, 22, Emma Company sold equipment with a carrying amount of P4,800,000 in exchange for a P6,000,000 noninterest-bearing note due January 1, 2025, There was no established exchange price for the equipment. ‘The prevailing rate of interest for a similar note was 10% and the present value of 1 at 10% for three periods is 0.75. Required; 1, Prepare all journal entries for 2022. letermine the carrying amount of note receivable on December 31, 2022, 169Problem 6-10 (AICPA Adapted) June 1, 2022, Yola Company loaned Date P500,099 Sadat pavabie in five annual installments of PLoo.i, beginning January 1, 2023. In connection with this loan, Dale was re auired deposit P5,000 in a noninterest bearing escro w ¥ aceoun, 0 be returned to Dale ments have been made Interest on the note is payable on the first day of eas tater ooatag duly 5022, Dele mede timely yah through November 1, 202 ‘The amount held in escrow is all principal and interest p On January 1, 2023, Yola Company received payment the first principal installment plus all interest due. On December 31, 2022, what amount should be reportet as accrued interest receivable? a 0 b. 5,000 . 10,000 4. 15,000 Problem 6-11 (AICPA Adapted) Frame Company has an 8% note receivable dated June 3, 2022, in the original amount of P1,500,000. Payments P500,000 in principal plus accrued interest are due annually on July 1, 2023, 2024 and 2025. 1. What is the balance of note receivable on July 1, 2028! 1,500,000 1,000,000 500,000, 0 On June 30, 2024, what amount should be repartel 88 accrued interest receivable on the note receivable! a. 120,000 b. 40,000 © 80,000 49 170 problem 6-12 (AICPA Adapted) ear-ond, Jet Company received two P sented Ganeeny reed te (On both notes, interest is calculated on the outstanding falance at the ‘annual rate of 3% and payable at mameegyerenP el ‘The note frem Hart Company, made under customary trad jerms, 18 due in nine months and the note {raw fies Eimpany is due in Hive years, fhe note from Maxx 1,000,000 notes services rendered. ‘he market intoret rate for similar aates at oar-end was Fie Tis compound interest teees 008 st yearend was into present value at 8% are: Present value of I due in nine months hal iota cartyiag'amolal ot tatdh Satis Wicd og eae 1.624.000 Siro c, 1,680,000 & eooo Problem 6-13 (AICPA Adapted) At the beginning of current year, Jean Company purchased from Carmina Company a P2,000,000, 8%, five-year note that required five equal annual year-end payments of P500,900, ‘The note was discounted to yield 9% to Jean Company. At the date of purchase, Jean Company recorded the note at the present value of B1,948,500. 1. What amount of total.interest revenue should be recognized by Jean Company over the life of this note? 8. 504,500 . 556,000 ©. 800,000 4. 900,000 What amount should be recognized as interest revenue for the current year? 175,365 . 160,000 © 111,200 4. 180,000 amProblem 6-14 (IAA) December 31, 2022: Accounts receivable a Allowance for doubtful accounts = Interest receivable ae Notes receivable ame + ‘The notes receivable comprised: 1,000,000 note dated October 31, 2022, with p and interest payable on October 31, 2023, a 3,000,000 note dated March 31, 2022, with principal aa 8% interest payable on March 31, 2023, * During 2028, sales revenue totaled P21,000,00) 18,000,000 cash was collected from customers, anf accounts receivable of P60O,000 were written off All wi were made on a credit basis * Doubtful accounts expense was recorded at year-end by adjusting the allowance account to an amount equal 10% of year-end accounts receivable. 1. What amount should be reported as interest incon = PK nterest income fer a. 110,000 b. 240,000 ©. 60,000 4. 80,000 2% What amount should b expense for 20237 tes ma 750,000 850,000 00,000 100,000 172 a Company reported the following recaivayy, a Problem 6-15 (AICPA Adapted) On December 31, 2022, Park Company sold with eartying amount of P2.co0.da0 aca eeuoment noninterest-bearing note requiting payment of PS0G COG annually for ten years. The fist payment is due Desoto 31, 2028. ‘The prevailing rate of interest for this type of note issuance is 12% ‘ype of note at date of Present value of I at 12% for 10 periods sea Presentvalue of ordinary annuity of lat 12% fer 10periods 650 1. On December 81, 2022, what is the carrying amount of the note receivable? a. 5,000,000 b. 2,175,000 . 1,610,000 d. 2,825,000 2 What amount stould be recognized as gain oi sale of ‘equipment in 2022? 3,000,000 2,175,000 '825,000 0 3. What amount of interest income should be recognized for 20237 a. 600,000 b. 239,000 319,800 4. 300,000 4, What is the carrying amount of the note receivable on December 81, 2023? a. 2,325,000 b. 4,500,000 ©. 2,825,000 . 2,664,000 178Problem 6-16 (AICPA Adapted) (On December $1, 2022, Chang Company sold a machine jg the ordinary course of business to Door Company in exchange fora noninterest bearing note requiring ten annual payment, of P1,000,000. ‘The entity made the first payment on December 31, 2979 ‘The market interest rate for similar notes at date of isuane, was 8% PV of an ordinary annuity of 1 at 8% for 9 periods 695 PV of an ordinary annuity of 1 at 8% for 10 periods 671 1. What amount should be reported as sales revenue? a. 7,250,000 On December 31, 2022, what is the cart the note receivable? ‘a. 4,500,000 . 4,600,000 . 6,250,000 d. 6,710,000 ng amount of What amount shouldbe reported as interest income fr 2023? - me 2. 55000 & tanto &. canoo 4. exs000 What isthe cary carting amount of the not rcivaieo December 31, 20237 " ae 00000 0,00 5.280000 Sea09 14 problem 6-17 (IAA) yn January 1, 2022, Allure Company sold an equipment wi Ondeeying amount of P800,000, receiving f anmnnt bearing note due in three years with a face amount of P1,000,000. hore is no established market value for the equipment, ‘The interest rate on similar obligations is 12%. The present value of 1 at 12% for three periods is 712. i 1. What amount should be reported as gain or loss on the sale of equipment in 2022? a. 200,000 gain b. 200,000 loss cc. 88,000 gain d. 88,000 loss 2, What amount should be reported as interest income for 20227 288,000 120,000 ‘96,000 85,440 Vhat is the carrying amount of note receivable on jecember 31, 2022? gs pose 559,600 712,000 797,440 300,000 4. What amount should be reported as interest income for 2023? a. 95,693 b. 96,000, ©. 75,000 4. 60,000 115Problem 6-18 Multiple choice (AICPA Adapted) etober 1 of the current year, an entity received y Sneyear note receivable bearing interest at the market oar, The face amount of the note receivable and the entire ‘amount of the interest are due on September 30 of next, year. The interest receivable on December 31 of the {ierent year would consist of an amount representing 1. On O a. Three months of accrued interest income b. Nine months of accrued interest income c. Twelve months of accrued interest income The excess on October 1 of the present value of the note receivable over the face amount 2. On July 1 of the current year, an entity obtained a two-year 8% note receivable for services rendered, At ‘that time, the market rate of interest was 10%. The face amount of the note and the entire amount of interest are due on the date of maturity. Interest receivable on December 31 of the current year is a. 8% of the face amount of the note 1b. 4% of the face amount of the note ©. 5% of the present value of the note 4, 4% of the present value of the note 5. An entity uses the installment method to recognize revenue from installment sales. Customers pay the installment notes in 24 equal monthly amounts which include 12% interest. What is the carrying amount of the installment notes receivable six months after the sale? &. 75% of the original sales price b. Less than 75% of the original sales price. ©. The present value of the remaining monthly payments discounted at 12% 4. Less than the present value of the remaining monthly Payments discounted at 12%, 176 {, What is imputed interest? a, Interest based on the stated interest rate b, Interest based on the implicit intorest rate ¢. Interest based on the average interest ra 4. Interest based on the bank prime interest rate Accounting for the interest in a noninterest bearing note receivable is an example of what aspect of accountins theory? a. Relevance b. Verifiability e. Substance over form d. Form over substance 6. 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. The interest roocivable account would show a balance on a, July 1 but not December 31 b. December 31 but not July 1 ¢. duly Land December 31 4, Neither July 1 nor December 31 7. On duly 1 of the current year, an entity received one-year note receivable bearing intarost at the market rate, The fice amount of the note receivable and the entire amount of the taterest are due in one year. When the note receivable was eoorded on July 1, which of the following was debited? a. Interest receivable b. Learned discount on note receivable ©. Interest receivable and unearned discount on note receivable 4. Neither interest receivable nor unearned diseount on note raceivable 477