CHAPTER 2

LOANS AND RECEIVABLES

TOPIC OVERVIEW:
This chapter discusses loans and receivables, their characteristics and classifications, initial and
subsequent measurement of each type of receivable and provision for bad debts.

LEARNING OBJECTIVES:
After studying this chapter, the students should be able to:
1. Define and identify the different classification of receivables.
2. Explain the initial recognition, initial measurement, subsequent measurement, financial
statement presentation and derecognition of receivables.
3. Explain the accounting of discounts and freight and how will it affect receivables account.
4. Apply the different methods of accounting for bad debts.
5. Explain and identify the different methods of receivable financing.
6. Calculate the correct balances of receivables and related accounts.

RECEIVABLES
Receivable is a financial asset that represents a contractual right to receive cash or another financial
asset from another entity. It represents the amount collectible from customers and others, most
frequently arising from sale of merchandise, claims for money lent, or the performance of services.
Under PFRS 15 paragraph 108, a receivable is an entity’s right to consideration that is
unconditional. A right to consideration is unconditional if only the passage of time is required
before payment of that consideration is due.

CLASSIFICATION OF RECEIVABLES

A. As to source
1. Trade receivables – refer to claims arising from sale of merchandise or services in the
ordinary course of the business operations. This includes:

a) Accounts Receivable / Customers’ accounts / trade debtors – these are open

accounts not supported by promissory note arising from sale of merchandise or
services in the ordinary course of business

b) Notes Receivable – is a formal claim against another that is evidenced by a written

promise called promissory note, or a written order to pay at a later time called time
draft. Negotiable promissory note is an unconditional written agreement to pay a
certain sum of money on a specific or determinable date to order of the payee or to
bearer.
NOTE: Only negotiable promissory note is included as part of notes receivable.
Dishonored notes receivable do not qualify as note receivable in the statement of
financial position as well as overdue notes. They are reclassified as accounts
receivable together with the accrued interest.

2. Nontrade receivables – these are receivables that arise from sources other than from sale
of goods or services in the normal course of business.
 Examples of Nontrade Receivables

1 Loans to officers, shareholders, directors, and Noncurrent if due more than

employees 12 months from the
reporting date
2 Advances to affiliates Long term investment unless
collectible within one year
(short term investment)
3 Advances to supplier for acquisition of merchandise Current Asset
4 Accrued income receivables such as dividends Current Asset
receivable, accrued rent income, accrued royalties
income and accrued interest on bonds investments
5 Deposits to guarantee performance or payment or to Current Asset
cover possible damages or losses
6 Deposit with creditors, claims for losses and Current Asset
damages
7 Claims receivables from common carriers for Current Asset
damaged or lost goods; claims against creditors for
returned, damaged, or lost goods
8 Claims for tax refunds or rebates Current Asset
9 Special deposit on contract bids Normally classified as other
noncurrent assets unless
collectible within one year
(current asset)
10 Debit balance of creditors account that may arise Current asset if material,
from overpayments or returns and allowance otherwise it may be netted
against account payable with
credit balance.

Issue on Subscription Receivable

Under the Securities and Exchange Commission of the United States of America (USA)
and Section 22.7.c of the PFRS for SME, subscriptions receivable must be netted against
the Subscribed Share Capital. However, under the old Statement of Financial Standards of
the Philippines (SFAS), it is presented as current asset if collectible currently, otherwise it
is deducted from subscribed share capital.
The authors still believe the latter treatment under SFAS will be used until the Financial
Reporting Standards Council addresses this matter.

B. As to Statement of Financial Position Classification

1. Current
a) Trade receivables – generally classified as current because of the concept of
normal operating cycle notwithstanding the period from the reporting date
b) Nontrade receivables – classified as current only if they are reasonably expected
to be realized in cash within 12 months after the reporting date

Normal operating cycle is the period between the acquisition of materials entering
into a process (or the purchase of goods for resale) and its realization in cash or an
instrument that is readily convertible to cash.

2. Noncurrent – nontrade receivables that are not reasonably expected to be realized in cash
within 12 months after the reporting date.
INITIAL RECOGNITION
Receivables are recognized simultaneously with the recognition of revenue under PFRS 15. An
entity shall recognize revenue to depict the transfer of promised goods or services to customers in
an amount that reflects the consideration to which the entity expects to be entitled in exchange for
those goods or services (PFRS 15.2)

OTHER REVENUE RECOGNITION ISSUES

Bill and hold sales

A bill-and-hold arrangement is a contract under which an entity bills a customer for a product but
the entity retains physical possession of the product until it is transferred to the customer at a point
in time in the future. For example, a customer may request an entity to enter into such a contract
because of the customer’s lack of available space for the product or because of delays in the
customer’s production schedule.

Revenue is recognized when the customer have obtained control of a product. A customer has
obtained control when all of the following criteria are met:
a) The reason for the bill-and-hold arrangement must be substantive (for example, the
customer has requested the arrangement)
b) The product must be identified separately as belonging to the customer
c) The product currently must be ready for physical transfer to the customer
d) The entity cannot have the ability to use the product or to direct it to another customer

Revenue is not recognized when there is simply an intention to acquire or manufacture the goods
in time for delivery.

Goods shipped subject to conditions

1. Installation and inspection conditions
Revenue is normally recognized when the buyer accepts delivery, and installation and
inspection are complete. However, revenue is recognized immediately upon the buyer’s
acceptance of delivery when:
i. The installation process is simple in nature, for example, the installation of a factory
tested television receiver which only requires unpacking and connection of power
and antennae, or
ii. The inspection is performed only for purposes of final determination of contract
prices, for example, shipments of iron ore, sugar or soya beans
2. On approval when the buyer has negotiated a limited right of return
If there is uncertainty about the possibility of return, revenue is recognized when the
shipment has been formally accepted by the buyer or the goods have been delivered and
the time period for rejection has elapsed.

Layaway sales
Layaway sales are sales where the goods are delivered only when the buyer has paid a final
installment in a series of payments.

Revenue from such sales is recognized when the goods are delivered. However, when experience
indicates that most of such sales are consummated, revenue may be recognized when a significant
deposit is received provided the goods are on hand, identified and ready for delivery to the buyer.

Sales to distributors or other intermediate parties

Revenue from such sales is generally recognized when the control has been transferred. However,
when the buyer is acting in substance as an agent, the sale is treated as a consignment sale.
Orders when payment (or partial payment) is received in advance
Orders when payment (or partial payment) is received in advance of delivery for goods not
presently held in inventory, for example, the goods are still to be manufactured or will be delivered
directly to the customer from a third party.
Revenue is recognized when the control of goods are transferred to the buyer. Normally, control
is transferred when delivery takes place.

Subscriptions to publications and similar items

When the items involved are of similar value in each time period, revenue is recognized on a
straight-line basis over the period in which the items are dispatched. When the items vary in value
from period to period, revenue is recognized on the basis of the sales value of the item dispatched
in relation to the total estimated sales value of all items covered by the subscription.

Installment Sales
Installment sales are sales under which the consideration is receivable in installments.
Revenue attributable to the sales price, exclusive of interest, is recognized at the date of sale. The
sale price is the present value of the consideration, determined by discounting the installments
receivable at the imputed rate of interest. The interest element is recognized as revenue as it is
earned using the effective interest method.

Credit card sales

Credit card is a plastic card which enables the holder to obtain credit up to a predetermined limit
from the issuer of the card for the purchase of goods and services. Service is usually charged
ranging from 1% to 5%.

SUBSEQUENT MEASUREMENT
Receivables are subsequently measured at amortized cost (net realizable value) using the effective
interest method.

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

SHORT-TERM RECEIVABLES
Initial Measurement
Short term receivables with no stated interest rates can be measured initially at transaction price
(ex. Invoice price) when the effect of discounting is immaterial.

Trade discount/volume discount/quantity discount

Trade discounts are given to encourage prospective customers to buy the goods in large quantities.
These discounts are deducted from the list price to arrive at the invoice price and are never
recognized in the accounting record since the journal entry is based on the amount on the sales
invoice.

NOTE: Sales and related receivables are always recorded net of trade discounts, which is the same
with the transaction price.

Cash discount/Settlement discount

Cash discounts are reductions from invoice price as an inducement for prompt payment of an
account within the discount period (e.g. 2/10, n/30). This is also called sales discount from the
point of view of the seller, while it is termed as purchase discount from the point of view of the
buyer.
 1. Gross price method – sales and receivables are recorded at the gross amount. Sales
discounts taken by customers are debited to the Sales Discount account which is reported
as a reduction of sales. This is considered to be more practical than the net method.
NOTE: Discount is computed based on invoice price, not including the freight paid by the
seller.

2. Net price method – sales and receivables are recorded at the net amount. Sales discount
not taken by customers are credited to the Sales Discount Forfeited account which is
reported in the Other Income line item of the Statement of Comprehensive Income. This
method is considered to be theoretically correct since the receivable and sales ae recorded
using the cash price equivalent.

3. Allowance method – accounts receivable and sales are recorded at gross amount and a
corresponding allowance for sales discount is recorded

ILLUSTRATION: Gross vs. Net Method

Si Cand Company entered into the following during the year:
Jan 2 Sold 10,000 units of merchandise to Rex Company at a selling price of P100 with
terms of 2/10, 1/20, n/30.
4 Sold 15,000 units of merchandise to Zeus Company at a selling price of P100 with
terms of 2/10, 1/20, n/30.
6 Rex returned 2,000 units of goods to the company.
10 Rex paid his account availing of the cash discount.
Feb 2 Zeus Company paid his account.

Required: Prepare all the necessary journal entries assuming the company used:
a. Gross Method b. Net Method

Solution:
GROSS METHOD NET METHOD
Date Account Title Debit Credit Account Title Debit Credit
Jan Accounts 1,000,000 Accounts 980,000
2 Receivable Receivable
Sales 1,000,000 Sales 980,000

4 Accounts 1,500,000 Accounts 1,470,000

Receivable Receivable
Sales 1,500,000 Sales 1,470,000

6 Sales Return 200,000 Sales Return 196,000

Accounts Receivable 200,000 Accounts Receivable 196,000

10 Cash 784,000 Cash 784,000

Sales Discount 16,000
Accounts Receivable 800,000 Accounts Receivable 784,000

Feb
2 Cash 1,500,000 Cash 1,500,000
Accounts Receivable 1,500,000 Sales Discount Forfeited 30,000
Accounts Receivable 1,470,000
FREIGHT CHARGE
Terms related to freight charge:
1. FOB – means either Free on Board or Freight on Board
2. FOB Destination – means ownership of the goods will be transferred to the buyer only
upon the receipt of goods at the point of destination
3. FOB Shipping Point - means ownership of the goods will be transferred to the buyer upon
shipment of the goods
4. Freight Collect – means that freight charge on the goods shipped is not yet paid by the
seller and the common carrier shall collect the same from the buyer
5. Freight Prepaid – means that the freight charge on the goods shipped was already paid by
the seller

SUMMARY TABLE FOR FREIGHT

Freight Terms Buyer Seller
Freight collect Reduction of A/P Reduction to A/R
FOB Destination
Freight prepaid No effect No effect
Freight collect No effect No effect
FOB Shipping Point
Freight prepaid Addition to A/P Addition to A/R

ILLUSTRATION: Freight Terms

Assume the following data for BNM Company:
List price of the merchandise sold P 200,000
Trade discount 10, 20
Sales discount 3/10, 2/15, n/30
Invoice price of the merchandise returned on January 8 P 10,000
Date of sale January 5, 2018
Date of collection January 20, 2018
Freight cost P 2,000

Assume the following freight terms:

Case 1: FOB Destination, freight prepaid
Case 2: FOB Destination, freight collect
Case 3: FOB Shipping Point, freight collect
Case 4: FOB Shipping Point, freight prepaid

Required: Using the above independent cases:

1. Prepare the journal entries for the freight both on the part of the buyer and seller.
2. Compute for the net cash collection on January 20, 2018.

Solution:
Case 1: FOB Destination, freight prepaid
SELLER BUYER
Freight out 2,000
No entry
Cash 2,000

Requirement 2:
Invoice price of the merchandise sold
(P 200,000 * 90% * 80%) P 144,000
Less: Invoice price of the merchandise returned 10,000
Net invoice price 134,000
Less: Sales discount (P134,000 * 2%) 2,680
Total cash collection P 131,320
Case 2: FOB Destination, freight collect

SELLER BUYER
Freight out 2,000 Accounts Payable 2,000
Accounts Receivable 2,000 Cash 2,000

Requirement 2:
Invoice price of the merchandise sold
(P 200,000 * 90% * 80%) P 144,000
Less: Invoice price of the merchandise returned 10,000
Net invoice price 134,000
Less: Sales discount (P134,000 * 2%) 2,680
Collection before freight P 131,320
Less: Freight paid by buyer 2,000
Total net cash collection P 129,320

Case 3: FOB Shipping Point, freight collect

SELLER BUYER
Freight in 2,000
No entry
Cash 2,000

Requirement 2:
Invoice price of the merchandise sold
(P 200,000 * 90% * 80%) P 144,000
Less: Invoice price of the merchandise returned 10,000
Net invoice price 134,000
Less: Sales discount (P134,000 * 2%) 2,680
Total cash collection P 131,320

Case 4: FOB Shipping Point, freight prepaid

SELLER BUYER
Accounts Receivable 2,000 Freight in 2,000
Cash 2,000 Accounts Payable 2,000

Requirement 2:
Invoice price of the merchandise sold
(P 200,000 * 90% * 80%) P 144,000
Less: Invoice price of the merchandise returned 10,000
Net invoice price 134,000
Less: Sales discount (P134,000 * 2%) 2,680
Collection before freight P 131,320
Add: Freight paid by buyer 2,000
Total net cash collection P 133,320

METHODS OF ACCOUNTING FOR BAD DEBTS

1. Direct write-off (tax): When a specific account is ascertained or proven to be uncollectible, Bad
Debt Expense is debited and Accounts Receivable is credited. This method is theoretically
undesirable because it makes no attempt to match revenues and expenses, and does not result in
receivables being stated at net realizable value in the statement of financial position.

2. Allowance Method (GAAP): At the end of each accounting period, an estimate is made of
expected losses from uncollectible accounts. This estimate is debited to Bad Debt Expense and
credited to Allowance for Doubtful Accounts. This method is justified because a company has
incurred a loss the moment customers receive goods or services that they will never pay for.

METHODS OF ESTIMATING BAD DEBT EXPENSE UNDER ALLOWANCE METHOD

1. Percentage of Sales (Income Statement Approach): Bad debt expense is estimated directly by
multiplying a percentage to sales account.
2. Percentage of A/R (Balance Sheet Approach)
a. First, the required ending balance in the Allowance for Doubtful Accounts is estimated by
multiplying a percentage to the ending outstanding receivables.
b. Then, bad debt expense is equal to the difference between the required ending balance and the
existing balance in the Allowance account.
3. Aging the A/R (Balance Sheet Approach)
This has the same procedure with the percentage of receivables; the only difference is the
percentage use for each term in the aging schedule.

Accounts Receivable
Beginning balance xx xx Sales Return and Allowances
Sales on account xx xx Sales Discounts
Recoveries xx xx Collections including recoveries
xx Accounts written off
xx Ending balance

Allowance for Doubtful Accounts

Accounts written off xx xx Beginning balance
Ending balance xx xx Doubtful accounts expense
xx Recoveries

The items in the T-accounts are derived from the following journal entries:
1. To record sales on account
Accounts Receivable xxx
Sales xxx

2. To record sales return by the customer

Sales return and allowances xxx
Accounts Receivable xxx

3. To record collection within the discount period

Cash xxx
Sales Discounts xxx
Accounts Receivable xxx

4. To record accounts written-off

Allowance for doubtful accounts xxx
Accounts Receivable xxx

5. To record re-establishment of accounts previously written-off

Accounts Receivable xxx
Allowance for doubtful accounts xxx

6. To record collection of accounts previously written off

Cash xxx
Accounts Receivable xxx
7. To record the provision for bad debts during the year
Bad debts expense/Doubtful accounts expense xxx
Allowance for doubtful accounts xxx

ILLUSTRATION: Different Methods of Accounting for Bad Debts

CC Company’s unadjusted trial balance at December 31 included the following accounts:
Debit Credit
Accounts Receivable P 1,500,000
Allowance for Doubtful Accounts P 40,000
Sales 10,000,000
Sales returns and allowances 700,000

The following analysis pertains to the accounts receivable reported in the trial balance:
Classification Balance of A/R Percentage
Collectible
0-1 month category P 500,000 98%
1-6 months category 800,000 95%
Over 6 months 200,000 80%
P 1,500,000

Required:
1. CC Company estimates its bad debt expense to be 2% of net sales. Determine its bad debt
expense for the year.
2. Assuming the same method of estimating bad debts in number 1, compute for the allowance for
doubtful account at the end of the year.
3. CC Company estimates its bad debt expense to be 5% of accounts receivable. Compute for the
allowance for doubtful account at the end of the year.
4. Assuming the same method of estimating bad debts in number 3, determine its bad debt expense
for the year.
5. Assuming the same method of estimating bad debts in number 3, compute for the net realizable
value of accounts receivable.
6. CC Company estimates its bad debt expense based on aging. Compute for the allowance for
doubtful account at the end of the year.
7. Assuming the same method of estimating bad debts in number 6, compute for the net realizable
value of accounts receivable.

Solution:
1.
Net Sales (P10,000,000-700,000) P 9,300,000
Multiply by: Percentage of uncollectible accounts 2%
Bad debts expense P 186,000

2.
Allowance for bad debt expense, beg P 40,000
Add: Bad debts expense 186,000
Allowance for bad debts expense, end P 226,000

3.
Accounts Receivable, end P 1,500,000
Multiply by: Percentage of uncollectible accounts 5%
Allowance for bad debts expense, end P 75,000
4.
Allowance for bad debt expense, beg P 40,000
Add: Bad debts expense (squeeze) 35,000
Allowance for bad debts expense, end P 75,000

5.
Accounts Receivable, end P 1,500,000
Less: Allowance for bad debts expense, end 75,000
Net realizable value P 1,425,000

6.
Classification Balance of A/R Percentage Required
Uncollectible Balance
0-1 month category P 500,000 2% P 10,000
1-6 months category 800,000 5% 40,000
Over 6 months 200,000 20% 40,000
Allowance for bad debts, end P 90,000

7.
Accounts Receivable, end P 1,500,000
Less: Allowance for bad debts expense, end 90,000
Net realizable value P 1,410,000

NOTES RECEIVABLES
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.

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.

Dishonored notes should be recorded as follows:

Accounts Receivable xx
Notes Receivable xx
Interest Income xx

LONG-TERM NOTES RECEIVABLES

Long term notes receivable may be classified as interest bearing and non-interest bearing. Interest
bearing note may be further classified into two, with realistic interest rates and unrealistic rates.

Initial Measurement: Long-term Notes Receivable

a. Interest bearing notes receivable – With realistic interest rate

Interest bearing notes with realistic or reasonable interest rate is initially measured at its fair value,
which is equal to its face value.

b. Interest bearing notes receivable – With unrealistic interest rate

Interest bearing notes with unrealistic rates are discounted using the imputed interest rate that
approximates the market rate of interest for the same note.

Unrealistic interest rates – interest bearing note with a nominal rate which is significantly different
from prevailing interest rate for similar notes or when the notes face value is significantly different
from market value of the consideration given on exchange for the note.

c. Non-interest bearing notes receivable/zero interest bearing

Non-interest bearing note is discounted to arrive at the fair value or the present value of future cash
flows using the prevailing market rate of interest for the similar receivables. In determining the
fair value of non-interest bearing notes, the following rules should be applied:
1. Periodic payment (with available cash price). The present value of the note is equal to the
cash price.
2. One-time collection of principal (no available cash price). The present value of the note is
equal to face value multiplied by present value of 1.
3. Uniform collection of principal annually (no available cash price). The present value of the
note is equal to periodic payment multiplied by present value of ordinary annuity of 1.

Subsequent Measurement: Long-Term Notes Receivable

Long-term notes receivable is subsequently measured at amortized cost using effective interest
method.

a. Interest bearing notes receivable – with realistic interest rate

Interest bearing notes with realistic or reasonable interest rate is subsequently measured at
amortized cost. Its amortized cost is its face value.

b. Interest bearing notes receivable – with unrealistic interest rate

Interest bearing notes with unrealistic rates are subsequently measured at amortized cost using the
imputed interest rate that approximates the market rate of interest for the same variables.

c. Non-interest bearing notes receivable/zero-interest bearing

Non-interest bearing notes are measured subsequently at amortized cost using the prevailing
market rate of interest for the similar receivables. The amortized cost for interest bearing note with
unrealistic interest rate or non-interest bearing note is computed as follows:

Face amount xx
Add: Premium on notes receivable xx
Or Less: Discount on notes receivable xx
Loss Allowance xx
Amortized cost xx

ILLUSTRATION: Interest-Bearing Note with Realistic Interest Rate

On January 1, 2018, VV Company sold a machine to BB Company. In lieu of cash payment, BB
gave VV a 4-year P100,000, 10% note. The note requires interest to be paid annually on December
31. The machinery has a cost of P500,000 and accumulated depreciation as of January 1, 2018 of
P350,000.
The 10% interest rate is a realistic rate of interest for a note of this type.

Required:
a. Compute for the following as of December 31, 2018:
1. Gain or loss on sale of machinery
2. Interest income
3. Current portion of the notes receivable
4. Noncurrent portion of the notes receivable

b. Prepare all the necessary entries in 2018.

Solution:
Requirement 1.
Net selling price P 100,000
Less: Carrying amount of machinery
Cost P 500,000
Accumulated Depreciation 350,000 150,000
Loss on sale (P 50,000)

Requirement 2
Interest income = 100,000 * 10% = P10,000

Requirement 3
Zero. No principal amount is collectible within one year from the reporting date.

Requirement 4
P100,000

b. Journal entries for 2018 are as follows:

Jan 1
Notes Receivable 100,000
Accumulated depreciation 350,000
Loss on sale 50,000
Machinery 500,000

Dec 31
Cash 10,000
Interest Income 10,000

ILLUSTRATION: Interest Bearing Note with Unrealistic Interest Rate, One-Time

Collection of Principal

On January 1, 2018, VV Company sold a machine to BB Company. In lieu of cash payment, BB

gave VV a 4-year P100,000, 10% note. The note requires interest to be paid annually on December
31. The machinery has a cost of P500,000 and accumulated depreciation as of January 1, 2018 of
P350,000. The prevailing interest rate for this type of note is 16%.

Required:
a. Compute for the following as of December 31, 2018:
1. Gain or loss on sale of machinery
2. Interest income
3. Current portion of the notes receivable
4. Noncurrent portion of the notes receivable

b. Prepare all the necessary entries in 2018.

Solution:
Requirement 1.
 Net selling price
Present value of principal (P100,000 * 0.5523) P 55,230
Add: Present value of interest (P10,000 * 2.7982) 27,982 P 83,212
Less: Carrying amount of machinery
Cost P 500,000
Accumulated Depreciation 350,000 150,000
Loss on sale (P 66,788)

Amortization Table
Interest Discount
Date Interest Income Present Value
Collection Amortization
01/01/18 P 83,212
12/31/18 P 10,000 P 13,314 P 3,314 86,526
12/31/19 10,000 13,844 3,844 90,370
12/31/20 10,000 14,459 4,459 94,829
12/31/21 10,000 15,173 5,171 100,000

Requirement 2.
P 13,314

Requirement 3
Zero. No principal amount is collectible within one year from the reporting date.

Requirement 4
Principal collectible beyond one year P 100,000
Less: Unearned interest income 13,474
Carrying amount of notes receivable P 86,526

b. Journal entries for 2018 are as follows:

Jan 1
Notes Receivable 100,000
Accumulated depreciation 350,000
Loss on sale 66,788
Machinery 500,000
Unearned interest income (100,000 – 83,212) 16,788

Dec 31
Cash 10,000
Interest Income 10,000

Unearned interest income 3,314

Interest income 3,314

ILLUSTRATION: Interest Bearing Note with Unrealistic Interest Rate, Interest is Payable
Semi-annually, One-Time Collection of Principal

On January 1, 2018, VV Company sold a machine to BB Company. In lieu of cash payment, BB

gave VV a 4-year P100,000, 10% note. The note requires interest to be paid semi-annually on June
30 and December 31. The machinery has a cost of P500,000 and accumulated depreciation as of
January 1, 2018 of P350,000. The prevailing interest rate for this type of note is 16%.

Required:
a. Compute for the following as of December 31, 2018:
1. Gain or loss on sale of machinery
2. Interest income
3. Current portion of the notes receivable
4. Noncurrent portion of the notes receivable

b. Prepare all the necessary entries in 2018.

Solution:
Requirement 1.
Net selling price
Present value of principal (P100,000 * 0.5403) P 54,030
Add: Present value of interest (P5,000 * 5.7466) 28,733 P 82,763
Less: Carrying amount of machinery
Cost P 500,000
Accumulated Depreciation 350,000 150,000
Loss on sale (P 67,237)

Amortization Table
Interest Discount
Date Interest Income Present Value
Collection Amortization
01/01/18 P 82,763
06/30/18 P 5,000 P 6,621 P 1,621 84,384
12/31/18 5,000 6,751 1,751 86,135
06/30/19 5,000 6,891 1,891 88,026
12/31/19 5,000 7,042 2,042 90,068
06/30/20 5,000 7,205 2,205 92,273
12/31/20 5,000 7,382 2,382 94,655
06/30/21 5,000 7,572 2,572 97,227
12/31/21 5,000 7,778 2,773 100,000

Requirement 2.
P 6,621 + 6,751 = P 13,372

Requirement 3
Zero. No principal amount is collectible within one year from the reporting date.

Requirement 4
Principal collectible beyond one year P 100,000
Less: Unearned interest income 13,865
Carrying amount of notes receivable P 86,135

b. Journal entries for 2018 are as follows:

Jan 1
Notes Receivable 100,000
Accumulated depreciation 350,000
Loss on sale 67,237
Machinery 500,000
Unearned interest income (100,000 – 82,763) 17,237

June 30
Cash 5,000
Interest Income 5,000
 Dec 31
Cash 5,000
Interest Income 5,000

Unearned interest income 3,372

Interest income 3,372

ILLUSTRATION: Interest Bearing Note with Unrealistic Interest Rate, Uniform Collection
of Principal

On January 1, 2018, VV Company sold a machine to BB Company. In lieu of cash payment, BB

gave VV a 4-year P100,000, 10% note. The note requires interest to be paid annually on December
31. The machinery has a cost of P500,000 and accumulated depreciation as of January 1, 2018 of
P350,000. The prevailing interest rate for this type of note is 16% and the principal amount of the
note is to be paid in four equal annual installments of P25,000 every December 31.

Required:
a. Compute for the following as of December 31, 2018:
1. Gain or loss on sale of machinery
2. Interest income
3. Current portion of the notes receivable
4. Noncurrent portion of the notes receivable

b. Prepare all the necessary entries in 2018.

Solution:
Requirement 1.
Net selling price P 88,733
Less: Carrying amount of machinery
Cost P 500,000
Accumulated Depreciation 350,000 150,000
Loss on sale (P 61,267)

Present value of notes receivable:

Interest Total Present
Principal PV of 1
Date Collection Collection Value
(A) (D)
(B) (A+B) C*D
12/31/18 P 25,000 P 10,000 P 35,000 0.8621 P 30,172
12/31/19 25,000 7,500 32,500 0.7432 24,153
12/31/20 25,000 5,000 30,000 0.6407 19,220
12/31/21 25,000 2,500 27,500 0.5523 15,188
Total P 88,733

Amortization Table
Interest Interest Principal Present
Date Amortization
Collection Income Collection Value
01/01/18 P 88,733
12/31/18 P 10,000 P 14,197 P 4,197 P 25,000 67,930
12/31/19 7,500 10,869 3,369 25,000 46,299
12/31/20 5,000 7,408 2,408 25,000 23,707
12/31/21 2,500 3,793 1,293 25,000 -

Requirement 2.
P 14,197. See amortization table above.
Requirement 3
P 21,631 (P 25,000 – 3,369)

Requirement 4
Principal collectible beyond one year P 50,000
Less: Discount Amortization (2,408+1,293) 3,701
Carrying amount of notes receivable P 46,499

b. Journal entries for 2018 are as follows:

Jan 1
Notes Receivable 100,000
Accumulated depreciation 350,000
Loss on sale 61,267
Machinery 500,000
Unearned interest income (100,000 – 88,733) 11,267

Dec 31
Cash 35,000
Notes Receivable 25,000
Interest Income 10,000

Unearned interest income 4,197

Interest income 4,197

ILLUSTRATION: Non-interest Bearing Note, One-Time Collection of Principal

On January 1, 2018, VV Company sold a machine to BB Company. In lieu of cash payment, BB
gave VV a 5-year, P500,000 note. The machinery has a cost of P500,000 and accumulated
depreciation as of January 1, 2018 of P150,000. The note is a non-interest bearing note and the
prevailing rate of interest for a note of this type is 10%.

Required:
a. Compute for the following as of December 31, 2018:
1. Gain or loss on sale of machinery
2. Interest income
3. Current portion of the notes receivable
4. Noncurrent portion of the notes receivable

b. Prepare all the necessary entries in 2018.

Solution:
Requirement 1.
Net selling price P 310,450
Less: Carrying amount of machinery
Cost P 500,000
Accumulated Depreciation 150,000 350,000
Loss on sale (P 39,550)

Date Interest Income Present value

01/01/18 P 310,450
12/31/18 P 31,045 341,495
12/31/19 34,150 375,645
Requirement 2
P31,045. See amortization table above.

Requirement 3
Zero. No principal amount is collectible within one year from the reporting date.

Requirement 4
Principal collectible beyond one year P 500,000
Less: Unearned interest income 158,505
Carrying amount of notes receivable P 341,495

b. Journal entries for 2018 are as follows:

Jan 1
Notes Receivable 500,000
Accumulated depreciation 150,000
Loss on sale 39,550
Machinery 500,000
Unearned interest income 189,550

Dec 31
Unearned interest income 31,045
Interest Income 31,045

ILLUSTRATION: Non-interest Bearing Note, Uniform Collection of Principal

On January 1, 2018, VV Company sold a machine to BB Company. In lieu of cash payment, BB
gave VV a 3-year, P600,000 note. The machinery has a cost of P500,000 and accumulated
depreciation as of January 1, 2018 of P150,000. The note is a non-interest bearing note and the
prevailing rate of interest for a note of this type is 14% and the principal amount of the note is to
be paid in three equal annual installments of P200,000 every December 31.

Required:
a. Compute for the following as of December 31, 2018:
1. Gain or loss on sale of machinery
2. Interest income
3. Current portion of the notes receivable
4. Noncurrent portion of the notes receivable

b. Prepare all the necessary entries in 2018.

Solution:
Requirement 1.
Net selling price P 464,320
Less: Carrying amount of machinery
Cost P 500,000
Accumulated Depreciation 150,000 350,000
Gain on sale P 114,320

Date Annual Interest Income Amortization Present value

Collection
01/01/18 P 464,320
12/31/18 P 200,000 P 65,005 P 134,995 329,325
12/31/19 200,000 46,105 153,895 175,430
12/31/20 200,000 24,570 175,430 -
Requirement 2
P65,005. See amortization table above.

Requirement 3
Principal collectible next year P 200,000
Less: Unearned interest income 46,105
Carrying amount of notes receivable P 153,895

Requirement 4
Principal collectible beyond one year P 200,000
Less: Unearned interest income 24,570
Carrying amount of notes receivable P 175,430

b. Journal entries for 2018 are as follows:

Jan 1
Notes Receivable 600,000
Accumulated depreciation 150,000
Gain on sale 114,320
Machinery 500,000
Unearned interest income 135,680

Dec 31
Cash 200,000
Notes Receivable 200,000

Unearned interest income 65,005

Interest Income 65,005

ILLUSTRATION: Non-interest Bearing Note, Periodic Payment with Available Cash Price
On January 1, 2018, VV Company sold a machine to BB Company. In lieu of cash payment, BB
gave VV a 3-year, P300,000 note. The machinery has a cost of P500,000 and accumulated
depreciation as of January 1, 2018 of P200,000. The machinery has a cash price of P288,000. The
note is a non-interest bearing and payable in three equal annual installments of P100,000 every
December 31 beginning December 31, 2018.

Required:
a. Compute for the following as of December 31, 2018:
1. Gain or loss on sale of machinery
2. Interest income
3. Current portion of the notes receivable
4. Noncurrent portion of the notes receivable

b. Prepare all the necessary entries in 2018.

Solution:
Requirement 1.
Net selling price P 288,000
Less: Carrying amount of machinery
Cost P 500,000
Accumulated Depreciation 200,000 300,000
Loss on sale (P 12,000)
 Year Notes Outstanding Fraction Allocated interest
income
1/1/18-12/31/18 P 300,000 3/6 P 6,000
1/1/19-12/31/19 200,000 2/6 4,000
1/1/20-12/31/20 100,000 1/6 2,000
Total P 600,000 P 12,000

Requirement 2
P 6,000. See table above.

Requirement 3
Principal collectible next year P 100,000
Less: Unearned interest income 4,000
Carrying amount of notes receivable P 96,000

Requirement 4
Principal collectible beyond one year P 100,000
Less: Unearned interest income 2,000
Carrying amount of notes receivable P 98,000

b. Journal entries for 2018 are as follows:

Jan 1
Notes Receivable 300,000
Accumulated depreciation 200,000
Loss on sale 12,000
Machinery 500,000
Unearned interest income 12,000

Dec 31
Cash 100,000
Notes Receivable 100,000

Unearned interest income 6,000

Interest Income 6,000

LOAN RECEIVABLE
A loan receivable is a financial asset arising from a loan granted by 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
Loans receivable should be initially measured at fair value plus transaction cost. In other words,
the following items should be considered in the initial measurement of loans receivable which is
directly related in granting a loan to a customer or borrower:
1. 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. Origination fees received
from the borrower is recorded as unearned interest income.
2. Direct origination costs refer to origination costs or transaction costs not directly chargeable to
customers.
3. Indirect origination costs shall be treated as expense.

Therefore, the initial carrying amount of the loans receivable may be computed as follows:
Principal amount xx
Less: Origination fee received xx
Add: Direct origination costs xx
Initial present value or carrying amount xx

Journal entries:
1. To record the loan
Loan receivable xxx
Cash xxx

2. To record the receipt of origination fees

Cash xxx
Unearned interest income xxx

3. To record the payment of direct origination cost

Unearned interest income xxx
Cash xxx

4. To record the collection of loan receivable

Cash xxx
Loan Receivable xxx

5. To record the amortization of unearned interest income

Loan receivable xxx
Cash xxx

Subsequent Measurement
Loan receivable is subsequently measured at amortized cost using effective interest method. Since
loans receivable frequently involves transaction costs, a new effective rate should be computed
through interpolation. When computing the effective interest rate, always remember the rule on
present value, that the higher the interest rate, the lower the present value”.

Illustration: Computation of Effective Interest Rate through Interpolation

On January 1, 2018, Happier granted a 4-year loan to a borrower in the amount of P5,000,000. The
company incurs P200,000 of direct loan origination cost and receives nonrefundable origination
fee amounting to P500,000. The stated interest is 10% payable annually every December 31.

Required:
A. Compute for the following:
1. Effective interest rate
2. Interest income on December 31, 2018
3. Carrying amount of loan receivable, December 31, 2018
4. Current portion of loan receivable, December 31, 2018
5. Noncurrent portion of loan receivable, December 31, 2018
B. Prepare the necessary journal entries.

Solution:
Requirement No. 1 – Steps:
1. Compute for the initial present value of the loan receivable.
Principal amount P 5,000,000
Less: Origination fee received 500,000
Add: Direct origination costs 200,000
Initial present value or carrying amount P 4,700,000

2. Get the present value using a higher rate. Use 11%.

Present value of principal (P5,000,000 * 0.6587) P 3,293,500
Add: Present value of interest (P500,000 * 3.1024) 1,551,200
Total present value P 4,844,700

3. Compute the present value using 12%.

Present value of principal (P5,000,000 * 0.6355) P 3,177,500
Add: Present value of interest (P500,000 * 3.0373) 1,518,650
Total present value P 4,696,150

4. Use the following formula in computing the effective interest rate.

(𝑃𝑉 𝑜𝑓 𝐿𝑅−𝑃𝑉 𝑜𝑓 𝑋)
X = Lower rate + [(Higher rate – lower rate) x ]
(𝑃𝑉 𝑜𝑓 𝐿𝑅−𝑃𝑉 𝑜𝑓 𝐻𝑅)
(4,844,700−4,700,000)
X = 11% + [(12% - 11%) x(4,844,700−4,696,150)]
144,700
X = 11% + (1% x148,550)
X = 11% + (1% x 0.97)
X = 11% + 0.0097
X = 11.97%
Amortization Table (Using 11.97%)
Interest Discount
Date Interest Income Present Value
Collection Amortization
01/01/18 P 4,700,000
12/31/18 P 500,000 P 562,590 P 62,590 4,762,590
12/31/19 500,000 570,082 70,082 4,832,672
12/31/20 500,000 578,471 78,471 4,911,143
12/31/21 500,000 587,864 87,864 5,000,000

Requirement No. 2
Interest income = P 562,590

Requirement No. 3
Principal amount collectible beyond one year P 5,000,000
Less: Unearned interest income 237,410
Carrying amount of notes receivable P 4,762,590

Requirement No. 4
Zero, the entire receivable is collectible beyond one year.

Requirement No. 5
Principal amount collectible beyond one year P 5,000,000
Less: Unearned interest income 237,410
Carrying amount of notes receivable P 4,762,590

B. Journal entries
2018
Jan 1
Loan receivable 5,000,000
 Cash 5,000,000

Unearned interest income 200,000

Cash 200,000

Cash 500,000
Unearned interest income 500,000

Dec 31
Cash 500,000
Interest income 500,000

Unearned interest income 62,590

Interest income 62,590

RECEIVABLE FINANCING
Sufficient cash is an essential part of running the operations of a business. However, there are some
instances where an entity may have insufficient funds to use for its operations. An entity may
generate cash from various source of financing. One form of raising fund is through receivable
financing which is the capability or financial flexibility of the company to generate cash out of its
receivables.

The most common forms of receivable financing are as follows:

1. Pledging of receivable
2. Assignment of receivable
3. Factoring of receivable
4. Discounting of receivable

Pledging / Hypothecating
Pledging or hypothecating of receivables refers to borrowing of money from the bank or any
financial institution in which receivables in general are used as collateral or security for a loan.
Since receivables, in general, are used as collateral, pledging is sometimes called general
assignment.

Illustration: Pledging of Accounts Receivable

On October 1 of the current year, JK Company borrowed P1,000,000 for one year from KL Bank
with a stated interest rate of 12%. As a security for the loan, JK Company hypothecated its accounts
receivable amounting to P1,500,000. KL Bank deducted the one year interest in advance.

Required: Prepare the entries in relation to the pledging of accounts receivables, assuming
amortization of interest deducted in advance is to be made equally for the entire loan term.

Solution:
Oct 1
Cash 880,000
Discount on Notes Payable 120,000
Notes payable - bank 1,000,000

Dec 31
Interest Expense 30,000
Discount on notes payable 30,000
120,000 * 3/12

Assignment
Assignment is a more formal borrowing arrangement in which the specific receivables are
identified and used as security. The assignor or borrower transfers its rights in some of its accounts
receivables to a lender or assignee inconsideration for a loan. The following are some of the
characteristics of an assignment:
a. The loan is at a specified percentage of the face value of the collateral and interest and service
fees are charged to the assignor or borrower.
b. The debtors are occasionally notified to make payments to the assignee (lender) but most
assignments are not on a notification basis.
c. Assigned accounts are segregated from other accounts. The notes payable should be deducted
from the balance of Accounts Receivable assigned to determine the equity in assigned accounts
receivable.

Assignments may either be:

1. Non-notification basis – buyer is not informed of the assignment arrangement and will continue
to remit its payment to the seller (assignor)

2. Notification basis – buyer is informed of the assignment arrangement and will remit payment
directly to the assignee (e.g. bank)

NON-NOTIFICATION NOTIFICATION
To separate the assigned accounts
Accounts Receivable – assigned xx Accounts Receivable – assigned xx
Accounts Receivable xx Accounts Receivable xx
To record the loan
Cash xx Cash xx
Service charge xx Service charge xx
Notes payable - bank xx Notes payable - bank xx
Issued credit memo (sales return)
Sales return xx Sales return xx
Accounts receivable – assigned xx Accounts receivable – assigned xx
To record collection
Cash xx Notes payable - bank xx
Sales discount xx Sales discount xx
Accounts receivable – assigned xx Accounts receivable – assigned xx
To record remittance
Notes payable – bank xx
Interest expense xx Interest expense xx
Cash xx Cash xx
To record write-off of accounts assigned
Allowance for bad debt xx Allowance for bad debt xx
Accounts receivable - assigned xx Accounts receivable - assigned xx
To transfer the remaining balance of Accounts Receivable – assigned to Accounts
Receivable (unassigned)
Accounts receivable xx Accounts receivable xx
Accounts receivable - assigned xx Accounts receivable - assigned xx

Illustration: Assignment – Non-notification Basis

On November 1 of the current year, HJ Company assigned customers’ accounts in the amount of
P1,000,000 to NM Company as a security for a loan in the amount of P750,000 and a stated interest
rate of 10%. NM Company charges 5% in relation to the amount borrowed. HJ Company will
continue to collect the accounts from customers and will remit payment to NM Company.
On December 30 of the current year, cash collections on the assigned accounts amounted to
P450,000.
On December 31, HJ Company remitted in full the amount collected plus interest due on the
outstanding balance of the loan.

Required:
1. Compute the cash received from assignment.
2. Prepare the journal entries in relation to the assignment of the accounts receivables.
3. Compute for the amount of equity over the assigned accounts to be disclosed on December 31.

Solution:
Requirement No. 1
Notes payable P 750,000
Less: Service charge (5% * P750,000) 37,500
Cash received P 712,500

Requirement No. 2
To separate the assigned accounts
Accounts Receivable – assigned 1,000,000
Accounts Receivable 1,000,000
To record the loan
Cash 712,500
Service charge 37,500
Notes payable - bank 750,000
To record collection
Cash 450,000
Accounts receivable – assigned 450,000
To record remittance
Notes payable – bank 450,000
Interest expense 12,500
Cash 462,500

Requirement No. 3
Accounts receivable – assigned (1,000,000 – 450,000) P 550,000
Less: Notes Payable (750,000 – 450,000) 300,000
Equity in assigned accounts to be disclosed in the notes P 250,000

Illustration: Assignment – Notification Basis

Canon Company finances some of its current operations by assigning accounts receivable on a
notification basis to Josiah Finance. On July 1 of the current year, it assigned under guarantee
specific accounts amounting to P2,000,000. Josiah Finance shall advance to Canon Company 80%
of the accounts assigned, less a finance charge of 1% of the total accounts assigned.
On August 1, Canon Company received a statement that Josiah had collected P1,100,000 of these
accounts and had made an additional charge of 1% of the total outstanding payable as of July 31.
This charge is to be deducted at the time of the first remittance due to Canon Company from the
Josiah Finance.
On September 1, Canon Company received a second statement from Josiah Finance together with
a check for the amount due. The statement indicated that the Josiah Finance had collected an
additional of P600,000 and had made a further charge of 1% of the balance outstanding as of
August 31.

Required:
1. Compute for the cash received from assignment.
2. Prepare the entries in relation to the assignment of the accounts receivable.

Solution:
1.
Notes payable (2,000,000 * 80%) P 1,600,000
Less: Finance charge (1% * P2,000,000) 20,000
Cash received P 1,580,000

Requirement No. 2
Jul 7
Accounts Receivable – assigned 2,000,000
Accounts Receivable 2,000,000

Cash 1,580,000
Service charge 20,000
Notes payable - bank 1,600,000

Aug 1
Notes payable - bank 1,084,000
Service charge 16,000
Accounts receivable – assigned 1,100,000

Sept 1
Notes payable - bank 516,000
Service charge 5,160
Cash 78,840
Accounts receivable – assigned 600,000

Accounts receivable 300,000

Accounts receivable - assigned 300,000

Factoring
Factoring involves the sale of receivables to a finance company which is called the factor. The
factor or buyer assumes the risk of collectivity and generally handles the billing and collection
function.

Factoring may either be:

1. Casual factoring – this is treated as an outright sale of receivable. A gain or loss is recognized
for the difference between the proceeds received and the net carrying amount of the receivables
factored. Casual factoring may either be with or without recourse basis.
2. Regular factoring – the cost of factoring is debited to appropriate expense account. Just like in
casual factoring, factoring of this kind may either be with or without recourse basis.

Factors holdback
Factors holdback is the portion retained for a purchase price to cover probable sales return,
discount and allowance. Receivable from factor is presented as current asset.

Gross amount of receivable xx

Less: Factoring fee xx
Finance charge and interest expense xx
Net Selling Price xx
Less: Factors holdback xx
 Net cash received xx

Gross amount of receivable xx

Less: Factoring fee xx
Finance charge and interest expense xx
Net Selling Price xx
Less: Recourse obligation (if any) xx
Net Proceeds xx
Less: Book value of Accounts Receivable xx
Gain (loss) on sale xx

Illustration: Factoring of Accounts Receivable

Corny Company factored P100,000 of its accounts receivable to Maisy Company for P85,000. An
allowance for bad debts equal to P3,000 was previously established for the account factored. Maisy
Company withheld 5% of the purchase price as protection against sales returns and allowance.

Case 1: Sale of receivable is without recourse

Case 2: Sale of receivable is with recourse and the recourse obligation has an estimated fair value
of P5,000.

Required:
For each of the above cases, determine the following:
1. Cash received
2. Cost of factoring
3. Journal entry to record the transaction

Solution:
Case 1:
Requirement 1
Net Selling Price P 85,000
Less: Factors holdback 4,250
Net cash received P 80,750

Requirement 2
Net Selling Price P 85,000
Less: Recourse obligation (if any) 0
Net Proceeds 85,000
Less: Book value of Accounts Receivable 97,000
Gain (loss) on sale (P 12,000)

Cost of factoring is equal to loss on factoring of P12,000.

Requirement 3
Cash 80,750
Allowance for doubtful accounts 3,000
Loss on factoring 12,000
Receivable - factor 4,250
Accounts receivable 100,000

Case 2:
Requirement 1
Net Selling Price P 85,000
Less: Factors holdback 4,250
Net cash received P 80,750
Requirement 2
Net Selling Price P 85,000
Less: Recourse obligation (if any) 5,000
Net Proceeds 80,000
Less: Book value of Accounts Receivable 97,000
Gain (loss) on sale (P 17,000)

Cash 80,750
Allowance for doubtful accounts 3,000
Loss on factoring 17,000
Receivable - factor 4,250
Accounts receivable 100,000
Estimated recourse obligation 5,000

Illustration: Factoring of Accounts Receivable

AA Company factored P600,000 of its accounts receivable to SS Company on October 1. Control
was surrendered by AA Company. The factor assessed a fee of 3% and retained a holdback equal
to 5% of the accounts receivable. In addition, the factor charged 15% interest computed on a
weighted average time to maturity of the accounts receivable of 54 days. (Use 365 days in the
computation of the interest.)

Required:
1. What is the amount of cash initially received by AA Company from the factoring?
2. If all accounts are collected, what is the cost of factoring the accounts receivable?

Solution:
1.
Gross amount of receivable P 600,000
Less: Factoring fee 18,000
Finance charge and interest expense 13,315
Net Selling Price P 568,685
Less: Factors holdback 30,000
Net cash received P 538,685

2.
Factoring fee P 18,000
Interest expense 13,315
Cost of factoring P 31,315

Net Selling Price P 568,685

Less: Recourse obligation (if any) 0
Net Proceeds 568,685
Less: Book value of Accounts Receivable 600,000
Gain (loss) on sale (P 31,315)

Discounting of Notes
Discounting of notes is a sale of the note to a third party, usually a bank. The sale is usually on a
with recourse basis which means that upon the default of the debtor, the seller of the note becomes
liable for its maturity value.

Discounting may either be:

1. Without recourse – endorser avoids future liability even if the maker refuses to pay the endorsee
on the date of maturity
2. With recourse – the endorser shall pay the endorsee if the maker dishonors the note. This is the
contingent or secondary liability of the endorsee. Discounting with the recourse may be accounted
as either:
a) Conditional sale recognizing contingent liability
b) Secured borrowing

Illustration: Notes Receivable Discounting

On January 16, Gerry Co. accepted a P600,000, 10%, 90-day note from a customer. On February
15, the note was discounted at 12%.
At maturity date, the note was dishonored and the bank charged a P2,500 protest fee.

Required: Prepare all the necessary entries assuming the notes receivable was
1. Discounted without recourse
2. Discounted with recourse
a) Conditional sale recognizing contingent liability
b) Secured borrowing

Solution:
1. Maturity value = Principal + Interest
= P 600,000 + (P600,000 * 10% * 90/360)
= P615,000

Net Proceeds = P 615,000 – (P 615,000 * 12% * 60/360)

= P 602,700

Net Proceeds P 602,700

Less: Carrying amount of notes receivable
Principal P 600,000
Add: Accrued interest (600k * 10% * 30/360 5,000 605,000
Loss on notes receivable discounting ( P2,300)

Requirement No. 1
1. Discounted without recourse
Cash 602,700
Loss on notes receivable discounting 2,300
Notes receivable 600,000
Interest income 5,000

Requirement No. 2
2.a.
Cash 602,700
Loss on notes receivable discounting 2,300
Notes receivable discounted 600,000
Interest income 5,000

Notes receivable dishonored 617,500

Cash 617,500
Notes receivable discounted 600,000
Notes Receivable 600,000

2.b.
Cash 602,700
Interest expense 2,300
 Liability for notes receivable discounted 600,000
Interest income 5,000

Notes receivable dishonored 617,500

Cash 617,500
Notes receivable discounted 600,000
Notes Receivable 600,000

Discounting Own Note

Discounting own note is accounted for as a regular loan. Discounting simply means that the interest
is deducted in advance. The pertinent journal entry to record discounting of company’s own note
would be:
Cash xx
Discount on notes payable xx
Notes payable - bank xx

Illustration: Discounting Own Note

On July 1, 2018, GG Co. discounted its own P500,000, 1-year note at a bank, at a discount rate of
12% when the prime rate is 10%.

Required:
1. Determine the following:
a) Net proceeds from discounting
b) Effective rate
2. Prepare all the necessary entries for 2018.

Solution:
Requirement No. 1
Note payable P 500,000
Less: Discount on note payable (60,000)
Net proceeds P 440,000

Effective interest rate = Discount / Net proceeds

= P60,000 / 440,000
= 13.6%

Requirement No. 2
Jul 1
Cash 440,000
Discount on notes payable 60,000
Notes payable - bank 500,000

Dec 31
Interest expense 30,000
Discount on notes payable 30,000

References:

Asuncion, et. al. (2018). Applied Auditing Book 1 of 2, Baguio City: Real Excellence Publishing
Valix, et. al. (2016). Financial Accounting Volume 1, Manila Philippines