CHAPTER 7

NOTES RECEIVABLE

Ninia C. Pauig-Lumauan, MBA, CPA

2nd Semester SY 2020-2021
Lyceum of Aparri

Intermediate Accounting Part 1

 DEFINITION
• Notes Receivable are claims supported
by formal promises to pay usually in the
form of promissory 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.
Intermediate Accounting Part 1
 DEFINITION
• Simply stated, a promissory note is a
written contract in which one person,
known as the maker, promises to pay
another person known as the payee, a
definite sum of money.
• The note may be payable on demand or at
a definite future date. The payee may
legally and readily sell or otherwise
transfer the note to others.
Intermediate Accounting Part 1
 DEFINITION
• Standing alone, the term “notes receivable”
represents only claims arising from the sale
of merchandise or service in the ordinary
course of business.
• Thus, notes received from officers,
employees, shareholders and affiliates shall
be designated separately.
• Notes receivable are considered fairly
liquid, even if long term, because entities
may easily convert them to cash, although a
fee might be paid to do so.
Intermediate Accounting Part 1
 KINDS OF NOTES RECEIVABLE
• Interest bearing notes have a stated interest
rate, i.e. the contracted interest stated on
the promissory note. Other terms for stated
interest rate include nominal rate, coupon
rate and face rate.
• Non-interest bearing notes do not have a
stated interest rate because they include the
interest element as part of the face amount.
The face amount of a non-interest bearing
note represents an unspecified principal and
an unspecified interest.
Intermediate Accounting Part 1
 DISHONORED NOTES
• When a promissory note matures and is
not paid, it is 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.
Intermediate Accounting Part 1
 DISHONORED NOTES
• 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.

Intermediate Accounting Part 1

 INITIAL MEASUREMENT OF NOTES
RECEIVABLE
• Receivables are initially recognized at fair value plus
transaction costs. For measurement purposes,
receivables are classified into the following:
a. Short term receivable
b. Long term receivable that bears a reasonable
interest rate
c. Long term receivable that bears no interest (non-
interest bearing)
d. Long term receivable that bears an unreasonable
interest rate (below-market interest rate)

Intermediate Accounting Part 1

 INITIAL MEASUREMENT OF NOTES
RECEIVABLE
• Conceptually, notes receivable shall be
measured initially at present value.
• The present value is the sum of all future
cash flows discounted using the
prevailing market rate of interest for
similar notes.
• The prevailing market rate of interest is
actually the effective interest rate.
Intermediate Accounting Part 1
INITIAL MEASUREMENT OF NOTES RECEIVABLE

• However, short-term notes receivable shall

be measured at face value.
• Cash flows relating to short-term notes
receivables are not discounted because the
effect of discounting is usually not material.
• However, if the transaction contains a
significant financing component, the fair
value of the short term receivable is equal
to the present value.
Intermediate Accounting Part 1
 INITIAL MEASUREMENT OF NOTES
RECEIVABLE
• PFRS 15: EXCEPTIONS ON TRADE
RECEIVABLES
Trade receivables that do not have a
significant financing component shall be
measured at their transaction price.
As a practical expedient, a trade
receivable may not be discounted is if it
is due within 1 year.
Intermediate Accounting Part 1
 LONG TERM RECEIVABLES
• The fair value of a long term receivable that
bears a reasonable interest rate is equal to the
face amount. An interest rate is deemed
“reasonable” if it approximates the market rate
at transaction date.
• The fair value of a long term receivable that
bears no interest (long term non interest
bearing receivable) is equal to the present
value of the future cash flows from the
receivable discounted using an imputed interest
rate.
Intermediate Accounting Part 1
 LONG TERM RECEIVABLES
• The fair value of a long term receivable
that bears an unreasonable interest rate
is also equal to the present value of the
future cash flows from the receivable
discounted using an imputed interest
rate.
• Other terms for imputed rate of interest
include effective interest rate, market
rate and yield rate.
Intermediate Accounting Part 1
 LONG TERM RECEIVABLES
• The imputed rate of interest is the more
clearly determinable of either:
a. The prevailing rate for a similar
instrument of an issuer with a similar
credit rating; or
b. A rate of interest that discounts the face
(nominal) amount of the receivable to
the current cash sales price of the goods
or services.
Intermediate Accounting Part 1
 LONG TERM RECEIVABLES
• The difference between the present value
and the face amount of the receivable is
usually recognized as unearned interest and
subsequently amortized as interest revenue
under the effective interest method.
• The effective interest rate is the rate that
exactly discounts estimated future cash
payments or receipts through the expected
life of the financial instrument.

Intermediate Accounting Part 1

 CASH PRICE EQUIVALENT
• The fair value of receivables may be
measured in relation to the fair value of
the asset given up in exchange for the
receivable. Such fair value is the cash price
equivalent of the non cash asset given up.
• Cash price equivalent is the amount that
would have been paid if the transaction
was settled outright on cash basis as
opposed to installment basis or other
deferred settlements.
Intermediate Accounting Part 1
 CONCEPT OF TIME VALUE OF MONEY
• Time value of money involves interest
calculations. It connotes a relationship
between the value of money and time.
• The concept of time value of money
provides that contractual agreements to
receive cash (or to pay cash) in the future
will earn (or incur) interests due to
passage of time regardless of whether
interests have been agreed upon or not.
Intermediate Accounting Part 1
 CONCEPT OF TIME VALUE OF MONEY
• This is because of the opportunity to
invest today’s peso and receive interest
on than investment.
• There are two types of interest: (a)
simple interest and (b) compound
interest. Under simple interest, interest
is earned only on the principal. Under
compound interest, interest is earned on
both the principal and the interest.
Intermediate Accounting Part 1
 CONCEPT OF TIME VALUE OF MONEY

• Two terms often used in conjunction with

time value of money are: (a) future value
and (b) present value.
1. FUTURE VALUE of an amount (FV of P 1)
The future value of P 1 factor may be
determined by referring to a future value
table, by using a financial calculator, by using
other tools, or by computing manually. It
also answers the question, “how much will
my money be worth in the future?
Intermediate Accounting Part 1
 CONCEPT OF TIME VALUE OF MONEY
• Formula of Future Value of an amount

FV of P 1 = (1 + i)
where:
i = interest rate
n = number of periods

Computation for a deposit of P 10,000 after 3 years which earns 10%

interest compounded annually.

FV of P 1 = (1 x 10%)
FV of P 1 = 1.331
Future value of deposit = (10,000 x 1.331)
= 13,310
vvvvv
Intermediate Accounting Part 1
 CONCEPT OF TIME VALUE OF MONEY
• The future value of the deposit can also be
computed manually as follows:
Principal 10,000
Interest in 1st Year (10,000 x 10%) 1,000
Interest in 2nd Year (10,000 + 1,000 x 10%) 1,100
Interest in 3rd Year (10,000 + 1,000 + 1,100 x 1,210
10%)
Value of Deposit in 3 Years 13,310

• The problem with this approach is that it is

tedious especially when the period (n) is
relatively long.

Intermediate Accounting Part 1

 CONCEPT OF TIME VALUE OF MONEY
2. Present value of a future amount (PV
of P 1)
• The present value of P 1 answers the
question “how much do I have to deposit
today to receive P 1 peso in the future?
The present value of P 1 may be
determined by referring to a present
value table; by using a financial
calculator, by using other tools, and by
using a formula.

Intermediate Accounting Part 1

 CONCEPT OF TIME VALUE OF MONEY
PV of P 1 = (1 + i) -n
PV of P 1 = (1 + 10%) -3
PV of P 1 = .0751315
Present value of future withdrawal = (13,310 x .0751315)
= P 10,000

• Example: You wish to withdraw P 13,310

three years from now. The interest rate
is 10% compounded annually. How
much deposit should you make today?
Notice that present value is the exact
opposite of future value.
Intermediate Accounting Part 1
 CONCEPT OF TIME VALUE OF MONEY
• The application of present value in relation to
the accounting for receivables is based on the
concept that all notes receivable contain an
unspecified principal and an unspecified interest.
These two elements are segregated using
present value computations and accounted for
as follows:
1. Principal element – represents the
measurement of the note receivable
2. Interest element – initially recognized as
unearned income and amortized over the life
of the note as interest income.
Intermediate Accounting Part 1
 CONCEPT OF TIME VALUE OF MONEY
3. Future value of an annuity of P 1
• The future value of an annuity of P 1
answers the question “If I make a series
of equal deposits over several periods,
how much will they accumulate in the
future? There are two types of annuities:
(1) ordinary annuities and (2) annuities
due.

Intermediate Accounting Part 1

CONCEPT OF TIME VALUE OF MONEY
• In the case of ordinary annuity, deposits
are made at the end of each interest
period.
• In the case of annuity due, deposits are
made at the beginning of each interest
period, i.e. the first deposit is made
immediately or in advance.

Intermediate Accounting Part 1

 CONCEPT OF TIME VALUE OF MONEY

4. Present value of an annuity of P 1

The present value of an annuity of P 1 answers
the question “ how much do i have to deposit
today to be able to make several equal
withdrawals of P 1 each over equal periods in
the future?
Under future value of an annuity of P 1, there
are several deposits and one withdrawal.
Under present value of an annuity, there is
one deposit and several withdrawals.
Intermediate Accounting Part 1
 INTEREST BEARING NOTES RECEIVABLE
• The initial measurement of long term
notes will depend on whether the notes
are measured at present value, which is
the discounted value of the future cash
flows using the effective interest rate.
• Interest bearing long term notes are
measured at face value which is actually
the present value upon issuance.

Intermediate Accounting Part 1

 NON-INTEREST BEARING NOTES RECEIVABLE
• Non-interest bearing long term notes
receivable are measured at present value
which is the discounted value of the future
cash flows using the effective interest rate.
• Actually, the term “non-interest bearing” is a
misnomer because all notes implicitly
contain interest.
• It is simply a case of the “interest being
included in the face amount” rather than
being stated as separate note.
Intermediate Accounting Part 1
 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.

Intermediate Accounting Part 1

 MEANING OF AMORTIZED COST
• 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.
c. Minus reduction for impairment or
uncollectibility.
Intermediate Accounting Part 1
 MEANING OF AMORTIZED COST
• For long term non-interest bearing notes
receivable, the amortized cost is the present
value plus amortization of the discount, or the
face value minus the unamortized unearned
interest income.
• Accordingly, only long term notes receivable
will be discussed in conjunction with the
present value concept under the following
situations:
a. Interest bearing note
b. Non interest bearing note
Intermediate Accounting Part 1
 ILLUSTRATION-INTEREST BEARING NOTE
• An entity owned a tract of land costing P
600,000 and sold the land for P 1,000,000.
The entity received a 3 year note for P
1,000,000 plus interest of 12% compounded
annually.
• When interest is compounded, in
mathematical parlance, this means that any
accrued interest receivable also earns interest.
• The selling price of P 1,000,000 is reasonably
assumed to be the present value of the note
because the note is interest bearing.
Intermediate Accounting Part 1
 ILLUSTRATION-INTEREST BEARING NOTE
JOURNAL ENTRIES:
FIRST YEAR
a. Notes Receivable 1,000,000
Land 800,000
Gain on sale of land 200,000
To record sale of land.
b. Accrued Interest Receivable 120,000
Interest Income 120,000
(12% x 1,000,000)
To record accrued interest for the first
year.

Intermediate Accounting Part 1

 ILLUSTRATION-INTEREST BEARING NOTE
SECOND YEAR
a. Accrued Interest Receivable 134,400
Interest Income 134, 400
To record interest for the 2nd year.
Computation:
Face Value 1,000,000
Add: Interest Earned for 1st Year 120,000
Total 1,120,000
Multiply by 12% 12%
Interest Earned for 2nd Year 134,400
vvvvvvv

Intermediate Accounting Part 1

 ILLUSTRATION-INTEREST BEARING NOTE
THIRD YEAR
Cash 1,404,928
Notes Receivable 1,000,000
Accrued Interest Receivable 254,400
Interest Income 150,528
To record collection of the note, including interest earned.
Computation:
Face Value 1,000,000
Interest Accrued:
First Year 120,000
Second Year 134,400 254,400
Total 1,254,400
Interest – Third Year (12% x 1,254,400) 150,528
Cash Received 1,404,928
vvvvvvvvv
Intermediate Accounting Part 1
 ILLUSTRATION 1 – NON-INTEREST BEARING
NOTE
• An entity manufactures and sells
machinery. On January 1, 2019, the entity
sold machinery costing P 280,000 for P
400,000.
• The buyer signed a non interest bearing
note for P 400,000, payable in four equal
installment every December 31. The cash
sale price of the machinery is P 350,000.
Intermediate Accounting Part 1
 ILLUSTRATION 1 – NON-INTEREST BEARING NOTE

Face Value of Note 400,000

Less: Present value – Cash Sale Price 350,000
Unearned Interest Income 50,000
vvvvvv

Cash Sale Price 350,000

Less: Cost of Machinery 280,000
Gross Income 70,000
vvvvvv

Intermediate Accounting Part 1

ILLUSTRATION 1 – NON-INTEREST BEARING
NOTE
JOURNAL ENTRIES for 2019
a. Notes Receivable 400,000
Sales 350,000
Unearned Interest Income 50,000
To record the sale of the equipment.
b. Cash 100,000
Notes Receivable 100,000
To record the first instalment collection
c. Unearned Interest Income 20,000
Interest Income 20,000
To recognize the unearned interest as income over the term of the note.

Intermediate Accounting Part 1

ILLUSTRATION 1 – NON-INTEREST BEARING NOTE
YEAR NOTE RECEIVABLE FRACTION INTEREST INCOME
(a) (b) (c)
2019 400,000 4/10 20,000
2020 300,000 3/10 15,000
2021 200,000 2/10 10,000
2022 100,000 1/10 5,000
1,000,000 50,000
VVVVVVV VVVVV

a. The first instalment is received on December 31,

2019. Thus, for 2019 the notes payable
outstanding is P 400,00 and decreased by P
100,000 each year.
Intermediate Accounting Part 1
ILLUSTRATION 1 – NON-INTEREST BEARING NOTE

b. The fractions are developed from the

note receivable balance every year.
c. The fractions developed are multiplied
by the total unearned interest of P
50,000 to get the yearly interest
income. Thus, for 2019, 4/10 x P
50,000 equals P 20,000 and so on.

Intermediate Accounting Part 1

 ILLUSTRATION 1 – NON-INTEREST BEARING NOTE

• If a statement of financial position is prepared

on December 31, 2019, the current portion of
the note receivable is classified as current
asset.
Notes Receivable – Current Portion 100,000
Unearned Interest Income -15,000
Carrying Amount or Amortized Cost 85,000
vvvvvv
Total Unearned Income 50,000
Realized in 2019 -20,000
Balance, December 31, 2019 30,000
vvvvvv

Intermediate Accounting Part 1

 ILLUSTRATION 1 – NON-INTEREST
BEARING NOTE
• The non-current portion of the note
receivable is classified as non current
asset.
Balance in 2020 – Current Portion 15,000
Realizable beyond 2019 15,000
Total 30,000
vvvvvv

Note Receivable- non current portion 200,000

Unearned Interest Income -15,000
Carrying amount or Amortized Cost 185,000
vvvvvvv

Intermediate Accounting Part 1

ILLUSTRATION 2 – NON-INTEREST BEARING
NOTE
• On January 1, 2019, an entity sold an
equipment with a cost of P 250,000 for P
400,000. The buyer paid a down of P
100,000 and signed a non interest bearing
note for P 300,000 payable in equal annual
instalment of P 100,000 every December
31.
• The prevailing interest rate for a note of this
type is 10%. The present value of an
ordinary annuity of 1 for three periods at
10% is 2.4869.
Intermediate Accounting Part 1
 ILLUSTRATION 2 – NON-INTEREST BEARING
NOTE
• The present value of the note is
computed by multiplying the annual
instalment of P 100,00 by the present
value factor of 2.4869 or P 248,690.
Face Value of Note 300,000
Present value of note (100,000 x 2.4869) 248,690
Unearned Interest Income 51,310
vvvvvv

Intermediate Accounting Part 1

ILLUSTRATION 2 – NON-INTEREST BEARING
NOTE
Present Value of Note 248,690
Cash Received – down payment 100,000
Sale Price 348,690
Cost of Equipment 250,000
Gain on Sale of Equipment 98,690
vvvvvv

JOURNAL ENTRIES
1. Cash 100,000
Notes Receivable 300,000
Equipment 250,000
Gain on Sale of Equipment 98,690
Unearned Interest Income 51,310
To record the sale of equipment.
Intermediate Accounting Part 1
ILLUSTRATION 2 – NON-INTEREST BEARING NOTE
2. Cash 100,000
Notes Receivable 100,000
To record the first instalment collection.
3. Unearned Interest Income 24,869
Interest Income 24,869
To record the interest income for 2019.

• In this case, the computation of the

interest income is made using the
effective interest method.
Intermediate Accounting Part 1
 ILLUSTRATION 2 – NON-INTEREST BEARING NOTE
Date Annual Interest Principal Present Value
Collection Income
Jan. 01, 2019 248,690
Dec. 31, 2019 100,000 24,869 75,131 173,559
Dec. 31, 2020 100,000 17,356 82,644 90,915
Dec. 31, 2021 100,000 9,085 90,915 -0-

• The interest income is computed by

multiplying the present value by 10%. Thus,
for 2019, 10% x P 248,690 equals P 24,869.

Intermediate Accounting Part 1

ILLUSTRATION 2 – NON-INTEREST BEARING
NOTE
• The principal payment is equal to annual
collection minus interest income. Thus, for
2019, P 100,000 minus P 24,809 equals P
75,131.
• The present value is equal to the preceding
balance minus the annual principal
payment. Thus, on December 31, 2019, P
248,690 minus P 75,131 equals P 173,559.

Intermediate Accounting Part 1

ILLUSTRATION 3 – NON-INTEREST BEARING NOTE

• On January 1, 2019, an entity sold an

equipment costing P 600,000 with
accumulated depreciation of P 250,000.
• The entity received as consideration P 100,000
cash and a P 400,000 non interest bearing note
due on January 1, 2022. The prevailing interest
rate for a note of this type is 10%. The present
value of 1 at 10% for 3 years is 0.7513.
Observe that the note is collectible on a lump
sum basis after 3 years.
Intermediate Accounting Part 1
ILLUSTRATION 3 – NON-INTEREST BEARING NOTE
Face of the Note 400,000
Present Value (P 400,000 x .7513) 300,520
Unearned Interest Income 90,480
vvvvvv
The unearned interest income is sometimes described as “discount on
notes receivable.”
COMPUTATION:
Present Value of the Note 300,520
Cash Received 100,000
Sale Price 400,520
Carrying Amount of Equipment (P 600,000-P 250,000) 350,000
Gain on Sale of Equipment 50,520
vvvvvv

Intermediate Accounting Part 1

ILLUSTRATION 3 – NON-INTEREST BEARING NOTE
JOURNAL ENTRIES
Jan 1, 2019 Cash 100,000
Notes Receivable 400,000
Accumulated Depreciation-Equipment 250,000
Equipment 600,000
Gain on Sale of Equipment 50,520
Unearned Interest Income 90,480
To record the sale of the equipment
Dec 31, Unearned Interest Income 30,052
2019
Interest Income 30,052
To record interest income for 2019.

Intermediate Accounting Part 1

 ILLUSTRATION 3 – NON-INTEREST BEARING NOTE
Date Interest Income Unearned Present Value
Interest
Jan. 1, 2019 99,480 300,520
Dec. 31, 2019 30,052 60,428 330,572
Dec. 31, 2020 33,057 36,371 363,629
Dec. 31, 2021 36,371 -0- 400,000

• The effective interest method is used.

• The interest income is computed by
multiplying the present value by 10%. Thus,
for 2019, P 300,520 x 10% equals P 30,052.
Intermediate Accounting Part 1
 ILLUSTRATION 3 – NON-INTEREST BEARING NOTE

• The unearned interest income is arrived at

by deducting the interest income from
preceding balance. Thus, on Dec 31, 2019,
P 99,480 minus P 30,052 equals P 69,428.
• The present value is arrived at by adding
the interest income to the preceding
present value balance. Thus, on Dec 31,
2019, P 300,520 plus P 30,052 equals P
330,572.
Intermediate Accounting Part 1
 ILLUSTRATION 3 – NON-INTEREST BEARING
NOTE
• Or face value of note minus unearned
interest income equals present value.
Thus, on Dec 31, 2019, P 400,000 minus
P 69,428 equals P 330,572.
Dec 31, 2020 Unearned Interest Income 33,057
Interest Income 33,057
Dec 31, 2021 Unearned Interest Income 36,371
Interest Income 36,371
Jan 1, 2022 Cash 400,000
Notes Receivable 400,000

Intermediate Accounting Part 1

 INITIAL & SUBSEQUENT
MEASUREMENTS OF RECEIVABLES
TYPE OF INITIAL MEASUREMENT SUBSEQUENT
RECEIVABLE MEASUREMENT
1. Short – term Fair value plus transaction If the initial measurement is:
receivables costs. a. Face amount, the
(trade and non  Fair value is equal to: subsequent measurement
trade a. Face amount; or is recoverable historical
receivables) b. Present value (if the cost.
transaction contains a b. Present value, the
significant financing subsequent measurement
component); or is amortized cost;
c. Transaction price with c. Transaction price, the
allowed practical measurement is
expedient (for trade subsequently updated
receivables) using the principles of
PFRS 15.

Intermediate Accounting Part 1

INITIAL & SUBSEQUENT MEASUREMENTS OF RECEIVABLES

TYPE OF RECEIVABLE INITIAL MEASUREMENT SUBSEQUENT

MEASUREMENT

2. Long term Fair value plus transaction costs. Recoverable

receivables bearing  Fair value is equal to face historical cost
reasonable interest rate amount.
3. Long term non- Fair value plus transaction costs. Amortized
interest bearing  Fair value is equal to present cost
receivables value of future cash flows from
the receivable.
4. Long term receivables Fair value plus transaction costs. Amortized
bearing unreasonable  Fair value is equal to present cost
interest rate (below value of future cash flows from
market interest rate) the receivable.

Intermediate Accounting Part 1

 INITIAL & SUBSEQUENT MEASUREMENTS OF
RECEIVABLES

 When the cash price equivalent of the non-cash

asset given up in exchange for the receivable is
determinable, the fair value of the receivable is equal
to the cash price equivalent, except when the practical
expedient allowed by PFRS 15 is applicable.
 If the initial measurement is the cash price
equivalent of the non-cash asset given up, the
subsequent measurement is amortized cost.

Intermediate Accounting Part 1