250 Qua

Illustration 1: Simple interest

P 1,500,000,10%, 3-year
On April 1, 20x1, ABC Co. received a
receivable in exchange for land with carrying amount of P85(Æe
Principal, in three equal installments, plus interest are
annually starting April 1, 20x2. Current market rates as of Am I
20x1, December 31, 20x1, and December 31, 20x2 are 10%, 12%
13%,respectively.
1,

Analysis:
Type of receivable: Long-term receivablebearing reasonableinterest'
rate nominal rate of 10%is equal to the current rate on
recognition of 10%.
Initial measurement: Faceamount
Subsequent measurement: Recoverable historicalcost
Type of interest: Simpleinterest interest is computed baædmly
on the outstanding principal balance

The entries reladn to the note receivable are as follows:

April Notes receivable
1,
Land
20x1
Gain on sale
to remrd the sale nd
Dec Interest receivable (1.5Mx 10%x 9/12) 112,500
31,
Interest income 1123
20x1
to record the accrued interest 20x1
April Cash (principal plus interest) 650,000
Notes receivable (1,500,000
20x2
Interest income (1.5Mx 10% x 3/12)
Interest receivable
to record the receipt of 1st installment on
note receivable
Dec, Interest receivable
31,
9/12)1 75,000
Interest income
20x2
'toi'eb3åWæ accrued interest or 20x2
April Cash (principal-plusinterest)
Notes receivable
6001000
50
20x3
Interest income (1Mx 10% x 3/12)
 251

receivable
Interest receipt of 2nd installment on 75m
to the

receivable 37,500
Interest .5M) x x 9/121
5M
5M
Interest income 37,500
accrued interest or 20x3
torcc0Tdthe
(principalplus interest) 550,0m
cash
Notesreceivable 500,om
Interest income (.5Mx x 3/12) 12,500
Interestreceivable 375m
to +dithe—t of last installment on
notereceivable

thefollowing:
Observe
Thenotereceivable is not discounted to its present value
it bears reasonable interest rate, i.e., the stated
because
of10%is equal to the April 1, 20x1 current rate of 10%.
simple interest, interest is computed only on
r Under
principal balance.
outstanding
in current market rates after April 1, 20x1 are
t Changes
ignored.
at
and subsequently, the note receivable is measured
Initially
faceamount,However, if the recoverable amount falls below
faceamount,impairment loss should be recognized. This is
to its
needed to bring the carrying amount of the note equal
in the
historical cost. Impairment is discussed-
reCOVerable
nextchapter.

Illuctration
2: Compounded interest
OnJanuary loan to one of
A, 20+1,ABC Co, extended a
ItsOfficers. January 1, 20x4 and bears
The note received is due on
Interest
compounded annually.
 252
Cha

Analysis:
Type of receivable: Long-term receivablebearing
e current
initial recognition because no additional information is rate
given
Initial measurement: Faceamount
Subsequent measurement: Recoverablehistorical cost
Type of interest: Compoundedinterest —interest is computed

The entries relatin to the note receivable are as follows:

Jan. Note receivable
1,
Cash
20x1
to record the loan
Dec• Interest receivable (1M x 10%) 100,000
31,
Interest income
20x1
to record the accrued interest income 20x1
Dec Interest receivable (1M + 100K)x 10% 110,00
31,
Interest income 110m
20x2
to record the accrued interest income r 20x2
Dec• Interest receivable 121,000
31,
20x3
Interest income 121m
to record the accrued interest income 20x3
Jan. Cash (1M + + 121K)

20x4
Note receivable 1,000
Interest receivable(100K+110K+121K) 331m
to record the collectionof the loun together
with accrued interests

Observe thefollowing:
•Under compound interest, interest is computed on both
principal and any existing interest
receivable.
All throughout the life of the note,
the interest element
recognized separately
as/ntrestreceivable.
Illustration 3: Noninterest-bearing
On January 1, 20x1, ABC Co. note —lump sum
sold a transportaåonequipmøtt
with a historical cost of
and accumulated depredadon
of "00m in exchangefor cash of PIOO,O andeanonintere5P
 253
of due on January
rateof interest for this type of note is 12%, 1, 20x4
ailing

ofreceivable: Long-term noninterest-bearing

receivable
measurement: Present value
Initial
present value factor: "PV of PI " because the note
is collectible
suiti basis. on
aliltnp
subsequent measurement: Amortized cost using
the effectiveinterest
method.

present note on January 1, 20x1 is

follows:

cashflow (face amount)

Future
0.711780
value ofnote receivable
Present 711,780

Therate used in the present value factor is the effectiæ

ürestrateon initial recognition. The "n" of 3 covers the period
Jan.1,20x1to Jan. 1, 20x4.

Ahemaåve
solutionon a non-scientific calculator. 1.12 @3 tinws.
bylumpsum cash flow of

Thedifferencebetween the face amount and the present

of the note represents the uneamed interest income.The
marmizedbalance of the unearned interest income is a valuation
(deduction)to the note receivable when deterniiningiB
amount.

Note
receivable
Unearned (288,220)
interest income (1M - 711,780)
of note receivable J
the

receivableis iniüally recorded as follows:

254 Cha

Jan.Cash 100,000 I
Notes receivable
20x1 Accumulated depreciation 700,000
Loss on sale of equipment (squeeze) 488,220
Transportationequipment
Unearned interest income

to serve as basis
An amortization table is prepared
subsequent journal entries.

Amortization table —lum sum:

Date Interest income Unearned int* s
a = c x effective b —prev. bff'.%'a prev.hL+c
interest rate
Jan. 1, 20x1 I 288,220 711,780

Dec. 31, 20x1 85,414 202,806 797,194

Dec. 31, 20x2 95,663 107,143 892/57

Dec. 31, 20x3 107,143

eon Observe thefollowing:

Under the effective interest method, interest incont
computed by multiplying the present value of the note by
effectiveinterest rate.
Periodic interests are added (amortized) to the preselt valued
the note in order to make the present value of the note
to the face amount at maturity date.
At any given point of Hme, the sum of uneamed interd
income and present value equals the face amount, e.g.,(2ø
711,780-1M), + 797,194 -1M), etc.
Uneamed interestincome is decreased as interests are earned,At
maturity date, its balance is zero because, as of this point'
interests have already beat earned.
For a non-interestbearingnote, the initial amoünt of
interestincome represents •to
the total interest income
recognized over the life of the note, e.g., income '
85414'
interest
[(total
95,663+ —288,220initial balance of
unearnd interæt income].
 255

otherentriesrelatin to the note receivableare as follows:

31,
Unearnedinterest income
Interest income
to record the accrued interest income
for thc 'eriod

PX.
31, Unearnedinterest income 95,663
Interest income
95663
Pec. 31,
Unearnedinterest income 107,143
20x3 Interest income 107,143
Jan. 1, Cash
2014 Note receivable l,ommo
to record the settlement o the note

Thecarryingamount of the note receivable is disclosed in

notesto financialstatements as follows:
an. 1, Dec. 31, 20x1 Dec. 31,20x2
Notereceivable
interest income
Unearned 288,220 (202,806) 107,1$)
Ca in amount 711,780 797,194 892,857

Noticethat the carrying amounts are equal to the present

valueson the amortization table above.
Altemative
solution:Determine the carrying amount of the note on December
31,20x1and on December 31, 20x2.
Press711,780, the PV of note on Jan. 1, 20x1 . Multiplythe amount by
1.12(100% + 12%). You should get 797,194, the carrying amount on
December31, 20x1.
Multiply
again by 1.12. You should get 892,857, the carrying amount on
December 31, 20X2. (Amountsare rounded-off)

Illustration
4: Noninterest-bearing note —Installments
January 1, 20x1, ABC Co. sold transportaåon equipment with
historicalcost of and accumulated depreciaüon of
700,000in exchange for cash of PIOO,OOOand a noninterest-
Bearing
note receivable of PI,OOO" due in 4 equal annual
n
Stallments
starting on December 31, 20x1 and every December
1thereafter.The
prevailing rate of interest for this type of note is
256 Cha

Analysis:
noninterest-bearing receivable
Type of receivable: Long-term
Initial measurement: Present value
annuity of PI" becauk
Present value factor: "PV of ordinary
note is collectiblein installments and the first installment
after one period from initial recognition.
SubseqUent measurement: Amortized costusing the effective

method.

The present value of the note as of January 1, 20x1 is

follows:

Future cash flows —annual installments (1M+4) 250m

Multiplyby:PV of an ordinary annuity of PI @12%, n=-4 3.03739
Pregnt value ofnote receivable 75937

The rate used in the present value factor is the effem

interestrate on initial recognition.The "n" of 4 is the numbed
installment collections.

Alternaüve solution on a non-scientific calculator: 1.12@@ @4 jnws,

tier) [A @ + 12% tien disregard negative sigm Multiplyby
annual cash flow = 759,337.

The differencebetween the face amount and the p—

value of the note represents the uneamed
interest income.
unamortized balance of the unearned interest
income is a valuN
account(deduction)to the note receivable
when determining
arrying amount.

Note receivable
Unearned interest (240,663)
income (1M - 759,337)
Carrying amount of note
receivable - Jan. 20x1
The note receivable is
iniüally recorded follows:
 257

100,0
I Cash receivable
11 Note
Accumulated depreciation 700,000
of equipment (squeeze)
Losson sale 440,663
Transportationequipment
Unearned interest income 240,663
Anamortizationtable is prepared to serve as basis for
journal entries:
Ibsequent
table —i s llment:
4nfftizati01i
Interest
Date
CollecTt6ns income Amortization Present value
b = d x effective
interest rate d = prev. bal. - c
t
I l/20x1 759,337
12131/2011250,000 91,120 158,880 600,458
12/31/20x2 250,000 72,055 177,945 422,513
12/31/2013 250,000 50,702 199,298 223,214
12/31/2014 1 250,000 26,786 223,214 0

Observe
thefollowing:
Underthe effective interest method, interest income is
computed
by multiplying the present value of the note by the
effective
interest rate.
Collection
minus interest income equals the amortization of
theprincipalcomponent (i.e., portion of collection applicable
toprincipalcomponent). The amortization is deducted from
the present value
because the note is collectible in
Installments.
Presentvalue is reduced to zero at maturity date becaue,
asofthis has already been collected
in
point&the note receivable
full.
Foranon-interest uneamed
bearing note, the initial amount of
income represents the total interest income to be
Interest
91,120+
recognizedover the life of the note, e.g.,[(totalinterestincome:
72'055+ 50,702+ interest
26,786) —240,663 initial balance of uneamed
lhe other entries relating to the note receivable are as

usin sim le entries: (Dec. 31, 20x1)

Dec Cash 250,000
31, Note receivable
20x1 to record the collectionon the note
Dec Unearned interest income 91,120
31, Interest income
20x1 to record the accrued interest income
T die rid•,

usin mm ound entries: (Dec. 31, 20x2 to 20x4)

Dec. 31, Cash -250,000
20x2
Unearned interest income
Note receivable
Interest income
to remrd the collectionon the note
and the accrud interest Income.or the eriod
DE 31, Cash 250,000
20x3
UlEarned interest income 50,m
Note receivable
Interest income
D", 31, 250,000
Uneamed interest income 26,786
Note receivable
261*
Interest income
Illustration5: Noninterest-bearing note — Installment
advance
OnJanuary1, 20x1, ABC Co. sold transportation equipment Wiff
cost of
a historical and accumulateddepredation of
in exchange for cash of PIUOOOand a
bearingnote receivable of due in 4 equal amtual
installmentsstarting on January T, 20x1 and every Jawary 1
The prevailing rate of interest for this type of note is
thereafter.
12%.

Analysis:
Type of receivable: Long-term noninterest-bearing receivable
Initial measurement: Present value
Presentvalue factor: "PV ofan annuity due of PI note
is collectiblein installments and the first installmett is due
immediately.
Subsequentmeasurement: Amortizedcostusing the effectiteinterst
method.
 '

apter 5

1,
The present value of the note on January 20x1 is computed
follows:

Future cash flows —annual installments (1M+4) 250,00

Multiply by: PV of an annuity due of PI @12%,n=-4 3.40183
Present value of note receivable 850,458

Iternativesolutionon a non-scientific calculator: I 12 E] El @3times

(i.e., n minus 1), then@ | @, disregard the negative signt)en
increase the value by 1. Multiplyby 250,000 annual cash flow@850,458

The entries on Janu 1, 20x1 are as follows:

Jan. 1, Cash 100,000
20x1
Note receivable
Accumulated depreciation 700,000
Loss on sale of equipment (squeeze) 349,542
Transportationequipment
Uneamed interest income a 149,542
to record the saleo e ui ment
Jan, 1, Cash 250,000
20x1 250,0
Note receivable
to record the first installment due in
advance
a face amount less850,458present value)

Amortization table —installment in advance

Interest
Date Collections income Amortization Presentæ
bad x
d prev bd.-c
a effective c-a—b
interest rate
Jan. 1, 20x1 850,458

Jan. 1, 20x1 250,000 600,5

250,000
Jan. 1, 20x2 422,513
250,000 72,055 177,945
Jan. 1, 20x3 223,214
250,000 50,702 199,298
Jan. 1, 20x4 250,000 26,786 223,214
 263

interest income is recognized on the first installment

thereis no passage of time yet. Interest is eamed only
is a passage of time.
there

entrieson December 31, 20x1 and January 1, 20x2 are as

tollows:

Unearned interest 72,055

31, Interest income 72,055
to recordthe accrued inte?est incomefor
20.11

jail,1, Cash 250,000

Note receivable 250,000
to record the 2ndinstallment collection

Theinterest income of P72,055shown on the 'Jan. 1, 20x2'

rowintheamortizationtable above is the interest incomefor 20x1
it is during this period that the interest has been earned.
because
Theamortization table above shows carrying amounts as
ofJanuary1 of each of the subsequent years. These carrying
amounts are net of the January 1 collections.To compute for the
carryingamount of the notes receivable as of December 31, the
amount of collectionon the following day (i.e., January 1 of next
year)
issimplyadded back to the January 1 present value.
The carrying amount of the notes receivable as of
December
31,20x1 is determined as follows:

Carrying
amount of notes receivable - Jan. 1, 20x2
Addback: 422,513
Collection on Jan. 1, 20x2 250,om
Carrying
amount of notes receivable - Dec. 31, 20x1 672,513
264
Cha

Next, multiply by 12%. The resulting amount of 72,054 96

interest income for Deduct this amount from the repretente
second
250,000 (e.g., press EL] then + 250,000). Deduct the collect
resulting
177,945.04 from memory (e.g., Press "memory recall"
(eg
or equivalent). You should get 422,512.96, the carrying amount of
January 1, 20x2. Add back the Jan. 1, 20x2 collection of
should get 672,512.96, the carrying amount of the note of on
Decernb9
31

Illustration 6: Noninterest-bearing note semiannual

flows cath
On January 1, 20x1,ABC Co. sold machinery with historical
of and accumulated depreciation of P
exchange for a 3-year, P1,200,000 noninterest-bearing
receivable due in equal semi-annual payments everyJuly1
December 31 starting on July 1, 20x1. The prevailing rateof
interest for this type of note is 10%.

Discounting semiannual cash flows

When discounång cash flows that are due in semiannual
installments, the "n" (period)-used in the present value factor is
multiplied by 2 because there are two semiannual installments pa
year. Furthermore, the effective interest rate is- dividedby2t
becauæ interest ratæ are normally expressed on a per annum
basis*

When cash flows are due quarterly, "n" is multiplied by 4 and

interestrate is divided by 4 because there are 4 quarters in a year.
flows are due monthly, "n" is multiplied by 12 and the rate is dividedby12
because there are 12 months in a year. When cash flows are due weekly,an'
is multiplied by 52 and the rate is divided by 52. When cash flowsare
daily, "n" is multipliedby 365 and the rate is divided by 365.Whenash
flows are due per minute....oh well, you get what I mean....whew!(pandng)

Therefore, the "n" to be used in the aboveis6

years (i.e., 3 years x 2) and the discount rate is 5% (i.e., is
The present value of the note as of January 1, 20xl
computed as follows:
 -- semiannual installments (1.2M + 6)
of an ordinary annuity of PI @5%,n—-6
Ill/:I'V 5.075692
of note receivable

solutionon a non-scientificcalculator:
6 times, then G] IF 5%
1.05
200 000 semiannual cash flow = 1,015,138,

initiall reco •zed as follows:

notereceivableis
receivable
161', Note
Accumulateddepreciation
Machinery
Unearned interest income a 184,862
Gain on sale of machine b 115,138
i faceamount less 1,015,138 present value)
?Tnisamountis "squeezed."

table —semi-annual
Amortization installments
Interest
Date I Collections income Amortization Present value
Jan. 1, 20x1

July l, 2011 200,000 50,757 149,243 865,895

Dec.31, 20x1 200,000 43,295 156,705 709,190
Julyl, 2012 | 200,000 35,460 164,540 544,650
Dec.31, 2012 i 200,000 27,232 In,768 371,882
Julyl, 20x3 18,594 181,406 190,476
200,000
31, 20x3 200,000 9,524 190,476

Theotherentries in 20x1 are as follows:

July 1,
Cash 200,0
50,757
Unearned interest income
200.000
Note receivable 50,757
Dec. 31
Interest income 200,000
20x1
Cash 43,295
Unearned interest 200,000
Note receivable 43,295
Interest income
Illustration 7: Noninterest-bearing note non-uniform
flows
On January 1, 20x1, ABC Co. sold machinery costingP2,mom
with accumulated depreciation of PI, 100,000in exchange
year, PI,200,000 noninterest-bearing note receivable due
follows:

Date Amount o install

December 31, 20x1 600,000
December 31z20x2 400,000
December 31, 20x3 200,000
Total

The prevailing rate of interest for this type of note is 10%.

Discounting non-uniform (unequal) cash flows

Annuity factors are applicable only when the series of cashmws
are uniformor equal. When the seiies of cash flows vary, thePYM
PI should be uséd.
A cash flow that is due one period from initial recogniti m
is discounted using PV of PI for a period ('n') of 1. A cashflow
that is due two periods from initial recognitionis discmmtd
using PV of PI for a period (tn') of 2, and so on.

The present value of the note is computed as follows:

Date Collections PV0fP1 t03*
545,455
Dec.31,20x1 600,000 0.90909
330,5ß
Dec.31, 20x2 400,000 0.82645
150,263
Dec.31,20x3 200,000 0.75131
Totals
* PV of PI 010%: is is 0.82645;and is 0.75131
 267

installments
Interest
üollcctions income Amortizatlon Preoeuvalue
1,026296
600,000 112,630 497,370 528,926
400,000 52,893 347,107 181,818
2001000 18,182 181,818

in 20x1are as follows:
flffies

Notereceivable 1200,000
depreciation
Accumulated 1,1001000
Machinery 2,ommo
Unearned interest income 173,7M
Gainon sale of machine
Cash 600,000
Uneamedinterest 102,630
Note receivable
20:1
600,000
Interestincome 102,630

8: Receivable with cash price equivalent

Illustration
OnJanuary1, 20x1, ABC Co. sold inventory costing P800,000with
alist in exchange
priceof P1,1001000and a cash price of PI,OOO,OOO
for
a noninterest-bearing note due on December 31,
20û.

kulysis:

Initialmeasurement: The fair Value of Che receivableon initial

is the cash price equivalent of the noncash asset given up.
recognition
Subsequent measurement: Amortized coşt using the efrctive interest
method.

'Iht
notereceivable
jQn,
7 is initiall reco zed as follows:
Note receivable 1,2001000
şales
Uneamed interest (1.2M 200,000
- İM)