BM1907

NOTES PAYABLE AND DEBT RESTRUCTURING

MEASUREMENT OF NOTES PAYABLE
Notes payable are obligations accompanied by a written promise to pay a certain amount of money to the
holder or bearer on a specified future date. In addition, notes payable may arise from certain transactions,
such as purchases (either goods or services) and financing (e.g., borrowing money from a bank).
In accounting, notes are classified as current or non-current depending on its due date and may bear an
interest or not.
Initial Measurement
Applying PFRS 9 Financial Instruments, notes payable that are not designated at fair value shall be measured
initially at fair value less transaction cost, which are directly attributable to the issuance of the said notes.
However, if notes are designated at fair value through profit or loss, the transaction costs shall be treated as
an expense immediately.

The fair value of the notes payable is equal to the present value of the future cash payment to settle the note
liability.
Subsequent Measurement
Applying the same standard, after initial recognition, notes payable are measured either:
• At amortized cost, using the effective interest method; or
• At fair value through profit or loss.
ISSUANCES OF NOTES PAYABLE
Issuance of Notes for Cash
When a company issued notes payable for cash, the present value to be recognized is the cash proceeds.
Illustrative Example 1:
On November 1, 2X19, ABC Company discounted its own note of P1,000,000 at 12% for one (1) year.
Computation for net cash proceeds:

Notes payable 1,000,000

Less: Discounts (12% X 1,000,000) 120,000
Net proceeds 880,000
The journal entry for the transaction is as follows:

Cash 880,000
Discount on notes payable 120,000
Notes payable 1,000,000
Note that discount amounting to P120,000 is the total interest for the year. Hence, on December 31, 2X19,
ABC should amortize the discount on note payable and recognized an interest expense for two (2) months
amounting to 20,000 (120,000 x 2/12).
In preparing the financial statement for 2X19, ABC would classify and report the note payable as current
liability as follows:

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Notes payable 1,000,000

Less: Discount on note payable 100,000
Carrying amount 900,000
Issuance of an Interest-Bearing Notes Payable
At initial measurement, an entity should record an interest-bearing note at face value. This face value
represents the present value of the notes payable. In addition, after initial measurement, an interest-bearing
note should be measured at face value plus accrued interest.
Illustrative Example 2:
On March 1, 2X19, AB Bank agrees to lend LB Corporation a sum of money amounting to P100,000. Assuming
LB Corporation signs a P100,000, 4-month, 12% note for this transaction, the entry to record the cash received
by LB on March 1 is as follows:

Cash 100,000
Notes payable 100,000
Assuming that LB prepares its financial statement semi-annually, then, an adjusting entry is required to
recognize the four (4) months interest expense and payable amounting to P4,000 (P100,000 x 12% x 4/12) on
June 30, 2X19. The adjusting entry is as follows:

Interest expense 100,000

Notes payable 100,000
On its due date on July 1, 2X19, LB Corporation pays P104,000 which comprises the note’s face value of
P100,000 and the accrued interest amounting to P4,000. The entry to record the payment of the note and
accrued interest is as follows:

Notes payable 100,000

Interest payable 4,000
Cash 104,000
Issuance of a Zero-Interest-Bearing Note
A zero-interest-bearing note may be issued instead of an interest-bearing note. Despite its name, a zero-
interest-bearing note does have an interest component. The interest is just not added on top of the note’s
face or maturity value; instead, it is included in the face amount. The interest is the difference between the
amount of cash received when the note is signed and the higher face amount that is payable at maturity. The
borrower receives the note’s present value in cash and pays back the larger maturity value (Kieso et al., 2016).
Illustrative Example 3:
On March 1, 2X19, assuming LB Corporation signs a P100,000, 4-month, 12% note for this transaction. Based
on the 12% bank’s discount rate, the note’s present value is P96,154. The entry to record this transaction is
as follows:

Cash 96,154
Notes payable 96,154
Assuming that LB prepares its financial statement semiannually, then, an adjusting entry is required to
recognize the four (4) months interest expense and the increase on notes payable amounting to P3,846
(P96,154 x 12% x 4/12) on June 30, 2X19. The entry for this is as follows:

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Interest expense 3,846

Notes payable 3,846
On due date, the note payable balance would be P100,000 (P96,154 + P3,846). The entry to record the
payment made by LB Corporation is as follows:

Notes payable 100,000

Cash 100,000

NATURE AND FORMS OF DEBT RESTRUCTURING

Debt restructuring refers to the alteration made by the creditor to the terms of a loan. This enables the debtor
to pay the amount owed.
According to Valix, Peralta, and Valix (2015), the objective of the creditor in a debt restructuring is to make
the best out of a bad situation or maximize the recovery of investment.
There are three (3) types of debt restructuring. These are:
1. Asset Swap - It is the transfer by the debtor to the creditor of any asset, such as real estate, inventory,
receivables, and investment, in full payment of an obligation. Under PFRS 9, an asset swap is treated as a
derecognition of a financial liability or extinguishment of an obligation. Any difference between the
carrying amount of the financial liability and the consideration given shall be recognized in profit or loss
(Valix, Peralta, & Valix, 2015).
Illustrative Example 4:
An entity provided the following balances on December 31, 2X19:

Notes payable 2,000,000

Accrued interest payable 400,000
On December 31, 2X19, the entity transferred to the creditor land with a carrying amount of P1,500,000
and fair value of P2,200,000.

Notes payable 2,000,000

Accrued interest payable 400,000
Total liability 2,400,000
Less: Carrying amount of land 1,500,000
Gain on extinguishment of debt 900,000
The journal entry to record this transaction is as follows:

Notes payable 2,000,000

Accrued interest payable 400,000
Land 1,500,000
Gain on extinguishment of debt 900,000
2. Equity Swap - It is a transaction whereby a debtor and creditor may renegotiate the terms of a financial
liability with the result that the liability is fully or partially extinguished by the debtor issuing equity
instrument to the creditor (Valix, Peralta, & Valix, 2015). Basically, an equity swap is the issuance of share
as payment of an obligation.

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The equity instruments issued to extinguish a financial liability shall be measured at the following amounts
in the order of priority (Valix, Peralta, & Valix, 2015):
a. Fair value of equity instrument issued;
b. Fair value of liability extinguished; and
c. Carrying amount of liability extinguished.
The difference between the carrying amount of the financial liability and the initial measurement of the
equity instruments issued shall be recognized in profit or loss. The gain or loss on extinguishment shall be
reported as a separate line item in the income statement (Valix, Peralta, & Valix, 2015).
Illustrative Example 5:
An entity showed the following data on December 31, 2X19:

Bonds payable 5,000,000

Accrued interest payable 500,000
On December 31, 2X19, the entity issued share capital with a total par value of P2,000,000 and fair value
of P4,500,000 in full settlement of the bonds payable and accrued interest. On the other hand, the fair
value of the bonds payable is P4,700,000.
The computation for the gain on extinguishment is as follows:
Bonds payable 5,000,000
Accrued interest payable 500,000
Carrying amount of bonds payable 5,500,000
Less: Fair value of shares issued 4,500,000
Gain on extinguishment of debt 1,000,000

The journal entry for this transaction is:

Bonds payable 5,000,000

Accrued interest payable 500,000
Share capital 2,000,000
Share premium 2,500,000
Gain on extinguishment of debt 1,000,000
3. Modification of Terms - It is the change of either the interest, maturity value, or both. Applying IFRS 9,
the substantial modification of terms of an existing financial liability shall be accounted for as an
extinguishment of the old financial liability, and the recognition of a new financial liability (Valix, Peralta,
& Valix, 2015).
There is a substantial modification of terms if the gain or loss on extinguishment is at least 10% or more
than 10% of the old financial liability.

Illustrative Example 6:
An entity showed the following data on January 1, 2X19:

Note payable (due January 1, 2X15 at 14%) 5,000,000

Accrued interest payable 1,000,000

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The entity is granted by the creditor the following concessions on January 1, 2X19:
a. The accrued interest of P1,000,000 is forgiven.
b. The principal obligation is reduced to P4,000,000.
c. The new interest rate is 10% payable every December 31.
d. The new date of maturity is December 31, 2X22.
The get the gain on extinguishment. The computation is as follows:

PV of principal (4,000,000 x .5921) 2,368,400

PV of interest payments (400,000 x 2.9137) 1,165,480
Present value of new notes payable 3,533,880
4,000,00
Discount on note payable 466,120

Note payable - old 5,000,000

Accrued interest payable 1,000,000
Carrying amount of old liability 6,000,000
Present value of new notes payable 3,533,880
Gain on extinguishment of debt 2,466,120

References
Kieso, D. E., Weygandt, J. J., Warfield, T. D., Young, N. M., Wiecek, I. M., & McConomy, B. J. (2016).
Intermediate accounting (11th ed.). Toronto: John Wiley & Sons Canada, Ltd.
Robles, N. S. & Empleo, P. M. (2016). Intermediate accounting (Vol 2.). Mandaluyong: Millenium Books, Inc.
Valix, C. T., Peralta, J. F., & Valix, C. A. (2015). Financial accounting (Vol. 2). Manila: GIC Enterprises & Co., Inc.

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