CHAPTER 8 NOTE PAYABLE TECHNICAL KNOWLEDGE To define a promissory note. To know the initial measurement of note payable. To understand the subsequent measurement of note payable at amortized cost. To understand the fair value option of measuring note payable.NOTE PAYABLE A 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 or determinable future time a sum certain in money to order or to bearer. Initial measurement of note payable PFRS 9, paragraph 5.1.1, provides that a note payable not designated at fair value through profit or loss shall be measured initially at fair value minus transaction costs that are directly attributable to the issue of the note payable. In other words, transaction costs are included in the measurement of note payable, However, ifthe note payable is irrevocably designated st fair value through profit or loss, the transaction costs are expensed immediately. The fair value of the note payable is equal to the present value of the future cash payment to settle the note payable using market rate of interest. Subsequent measurement of note payable PFRS 9, paragraph 5.3.1, provides that after initial recognition, a note payable shall be measured: a. At amortized cost using the effective interest method. b. At fair value through profit or loss if the note payable is designated irrevocably as measured at fair value through profit or loss. Amortized cost of note payable The amortized cost of note pay the note payable is measured . Minus principal repaymé . Plus or minus the cum effective interest metho face amount and pre! Actually, the difference b value is either discount payable.Note issued solely for cash When a note is issued solely for cash, the present val, a equal to the cash proceeds. Illustration On November 1, 2020, an entity discoum P1,000,000 at 12% for one year: ted its own note t 1,000,009 Note payable , Less: Discount (12% x 1,000,000) —120,009 Net proceeds $80,009 Journal entry Cash 880,000 Discount on note payable 120,000 Note payable 1,000,009 Actually, the discount on note payable of P120,000 is the total interest expense for one year. Thus, on December 31, 2020, after 2 months, the discount on note payable is amortized as interest expense. Interestexpense 20,000 ~ Discount on note payable 20,000 (120,000x 2/12) The straight line method is used inf amortizing the discount on note payable for simplicity. Besides, the note payable has only a term of one year. If a statement of financial position is prepared on December 31, 2020, the note payable is classified and reported as currestInterest bearing note issued for property When a property or noncash asset is acquired by issuing a promissory note which is interest bearing, the property or asset is recorded at the purchase price. ‘The purchase price is reasonably assumed to be the present value of the note and therefore, the fair value of the property because the note issued is interest bearing. Illustration On January 1, 2020, an entity acquired an equipment for P1,000,000 payable in 5 annual equal installments every December 31 of each year. Interest is 10% on the unpaid balance. Journal entries 2020 Jan. 1 Equipment 1,000,000 Note payable 1,000,000 Dec. 31 Interest expense (10% x 1,000,000) 100,000 Note payable 200,000 Cash 300,000 Payment of the first installment and the interest for 2020. 2021 Dec. 31 Interest expense (10% x800,000) 80,000 Note payable 200,000 Cash ‘ Payment for second int and interest for 202:Noninterest bearing note issued for property When a noninterest bearing note is ee ah Property, the property is recorded at the cash price o! property. The cash price is assumed to be the present value of 4), note issued. The difference between the cash price and the face of th, note issued represents the imputed interest. The imputed interest is based on the sound philosophy tha no lender would part away with his money or property interest-free. Illustration On January 1, 2020, an entity acquired an equipment witha cash price of P350,000 for P500,000, P100,000 down and the ‘balance payable in 4 equal annual installments, Journal entries for 2020 Jan. 1 Equipment 350,000 Discount on note payable 150,000 Cash Note payable Dec. 31 Note payable ; Cash Payment of ann 31 Interest expense Discount on note p lortization ofTable of amortization Year Note payable Fraction Amortization 2020 400,000 4/10 2021 300,000 3/10 2022 200,000, 2/10 2023 100,000 1/10 1,000,000 Note payable represents the amount outstanding every year.. The note was issued on January 1, 2020 and the first payment was made on December 31, 2020. ‘Thus, for 2019, the note payable outstanding is P400,000. Fraction is developed from the note payable outstanding every year. Amortization is the amount of discount multiplied by the fraction developed. Thus, for 2020, P150,000 times 4/10 equals P60,000.Another illustration - no cash price i ired an equipme, On January 1, 2020, an entity acquires Nt fop P1,000,000 payable in 6 equal annual installments on eye, December 31 of each year. Observe that there is no agreed interest and no cash price ;, available for the equipment. In such a case, the cost of the equipment is equal to the present value of the P200,000 annual installments in 5 year, at an appropriate rate of 10%. The rate of 10% is assumed to be the prevailing market rate of interest. ‘The present value of an ordinary annuity of 1 for 5 years a 10% is 3.7908. Therefore, the present value of five P200,000 installments is P758,160, computed by multiplying P200,000 by the present value factor of 3.7908. Journal entries for 2020 Jan. 1 Equipment 758,160 Discounton note payable * 241,840 Note payable : 1,000,000 Dec. 31 Notepayable ’ 200,000 The = amortization of t]Table of amortization Date Payment Interest Principal Present value Jan. 1, 2020 758,160 Dec. 31, 2020 200,000 75,816 124,184 633,976 Dec. 31, 2021 200,000 63,398 136,602 497,374 Dec. 31, 2022 200,000 49,737 150,263 347,111 Dec. 31, 2023 200,000 34,711 165,289 * 181,822 Dec. 31, 2024 200,000 18,178 181,822 me Payment represents the annual installment: Interest is equal to the preceding present value multiplied by the implied interest rate. Thus, for 2020, P758,160 times 10% equals P75,816. Principal is the portion of the payment after deducting interest representing principal. Thus, on December 31, 2020, P200,000 minus the interest of P75,816 equals P124,184. Present value is the balance of the preceding present value . after deducting the principal payment. Thus, on December 81, 2020, P758,160 minus the principal payment of P124,184 equals P633,976. On December 31, 2020, the current portion of the note payable would be reported as current liability. Note payable 200,000 Discount on note payable Carrying amount — amortized cost The noncurrent portion of th reported as noncurrent liabilit Note payable Discount on note payable Carrying amount - amortizedNoninterest bearing note payable lump sum On January 1, 2020, an entity acquired an equipment for P1,000,000. The entity paid P100,000 oe ane Gigned A noninterest bearing note for the balance which is due after three years on January 1, 2023. There was no established cash price for the equipment. The prevailing interest rate for this type of note is 10%. The present value of 1 for 3 periods is .7513. Computation Downpayment 100,000 Present value of note (P900,000 x .7513) 876,170 Cost of equipment 776,170 Imputed interest Face value of note 900,000 Present value of note 676,170 Imputed interest 2: Journal entries 1. To record the purchase of equipment on January 1, 2020: Equipment 776,170 Discount on note payable + 223,830 ‘ash ‘ C Note payable To record the interes Interest expense Discount on note p ‘The discount on expense using 3. To record the on January 1, 2025: ere 900,000. ao 900,000Table of amortization Discount on Date Interest expense note payable Present value _ 1/1/2020 223,830 676,170 12/31/2020 67,617 156,213, 143,187 12/31/2021 74.379 81,834 * 818,166 12/31/2022 81,834 # 900,000 Interest expense is equal to the preceding present value multiplied by the implied interest rate. Thus, for 2020, P676,170 times 10% equals P67,617. Discount on note payable is the balance minus the interest expense every year. Thus, on December 31, 2020, P223,830 minus the interest of | - P67,617 equals P156,213. Present value is the preceding balance plus the interest expense every year. Thus, on December 31, 2020, P676,170 plus the interest of P67,617 equals P743,787.Fair value option of measuring note payable | i initial recognition PERS 9, paragraph 4.2.2, provides that at a a note payable may be irrevocably designated as at fq, value through profit or loss. i the gain or loss oy | PFRS 9, paragraph 5.7.7, provides that t! a financial liability designated at fair value through profit op loss shall be accounted for as follows: a. The change in fair value attributable to the credit risk ig recognized in other comprehensive income. Credit risk is the risk that the issuer of the liability would cause a financial loss to the other party by failing to discharge the obligation. Credit risk does not include market risk such as interest risk, currency risk and price risk. b. The remaining amount of the change in fair value is recognized in profit or loss. Application Guidance B5.7.9 provides that amount recognized in other comprehensive income resulting from change in fair value attributable to credit risk shall not be subsequently transferred to profit dr loss. However, the cumulative gain or loss recognized may be transferred within equity or retained earnings. Under the fair value option, any transaction cost is recognized as outright expense. - There is no amortization of dise pagable, As a matter of fact, interest nominal or stated interestIllustration On January 1, 2020, an entity borrowed from a bank 4,000,000 on a 12% 5-year interest bearing note. The entity received P4,000,000 which is the fair value of the note on danuary 1, 2020. Transaction cost of P100,000 was paid by the entity. The fair value of the note payable was P3,500,000 on December 31, 2020. The entity has elected irrevocably the fair value option for measuring the note payable. The change in fair value comprised P50,000 attributable to credit risk and P450,000 attributable to interest risk. Journal entries for 2020 Jan. 1 Cash 4,000,000 Note payable 4,000,000 1 Transaction cost 100,006 Cash 100,000 Dec. 31 Interest expense (12% x 4,000,000) 480,000 Cash 480,000 31 Note payable 9 500,000 Gain from change in fair value 450,000 Gain from credit risk - OCT 50,000 Carrying amount Fair value — December 31, 2020 Decrease in fair value of liability The gain from change in | profit or loss. The gain from credit comprehensive inco