Notes Payable

Obligations supported by debtor promissory notes. The accounting for notes payable is similar to
accounting for notes recievable.

(Notes Payable may be issued for cash, purchase of goods, or services or other non-cash consideration.)

Initial measurement
Notes Payable are initially recognized at fair value - transaction cost.

I. Fair value - is “ the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.”

(Orderly transaction - a monetary business event for which there has been sufficient time to engage in normal
marketing activities in order to adequately inform the parties about the transaction.)

For measurement purposes, notes p. are classified into the following:

a. Short-term payable
b. Long-term payable that bears a reasonable interest rate
c. Long-term payable that bears no interest (noninterest bearing)
d. Long-term payable that bears an ureasonable interest rate (‘below-market’ interest rate)

A “short-term” payable is one that matures within 1 year.

A “long-term” payable is one that matures beyond 1 year.

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Short term payable

The fair value of a short-term payable may be equal to its face amount.

I. If the transaction contains a significant financing component, the fair value of the short term is
equal to present value.

Long term payable

I. The fair value of a long-term payable that bears a reasonable interest rate is equal to face
amount. An interest rate is deemed “reasonable” if it approximates(estimated) the market rate at
the transaction date.
II. The fair value of a long term payable that bears an unreasonable interest rate is equal to the
present value of the future cash flow on the instrument discounted using an imputed interest
rate.
III. The fair value of a long term payable that bears no interest (long term non interest bearing
payable) is equal to the present value of the future cash flows on the instrument discounted using
an imputed interest rate.

a. Effective Interest rate - the rate that exactly discounts the future cash payment of a financial liability equal to
its carrying amount.

imputed-assign
Imputed rate interest - effective interest rate, market rate and yield rate.
Cash price equivalent

The Fair value of a payable may be measured in relation to the cash price equivalent of the non cash
asset (non cash consideration) received in exchange for the payable.

I. 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 settlement.

Subsequent Measurement

I. Notes payable that are initially measured at face amount are subsequently measured at face amount or
expected settlement amount.
II. Notes payable that are initially measured at present value are subsequently measured at amortized cost.

a. Amortized Cost - amount which financial asset or financial liability is measured at initial
recognition minus principal repayments, plus or minus the cumulative amortization using the
effective interest method of any difference between that initial amount and the maturity amount
and, for financial assets adjusted for any loss allowance.
b. Amortized Cost - Determine using the effective interest method
c. When notes payable is initially measured at present value or cash price Equivalent - ang
pagkakaiba nito sa face amount - is initially recognized as discount ( or premium, in the case of
bonds payable) and subsequently amortized as interest expense using the effective interest
method.

Effective Interest Method - a method calculating the amortized cost of a financial asset of a financial liability and of
allocating the interest income or interest expense over the relevant period.
Summary of initial and subsequent measurement of notes payable

Types of note payable Initial Measurement Subsequent Measurement

(Fair value minus transaction costs.)
The fair value is determined as follows

1. Short-term a. Face amount a. Expected settlement

b. Present Value (if the transaction amount if the initial
measurement is face
contains a significant financing
amount.
component) b. Amortized cost if the
initial measurement is
present value

2. Long term with reasonable a. Face amount a. Expected Settlement

Interest rate amount

3. Long term with non interest a. Present Value b. Amortized Cost

bearing

4. Long term with a. Present Value c. Amortized Costs

unreasonable Interest rate

I. If the cash price equivalent is determinable, the note is initially measured at this amount. The
subsequent measurement is an amortized cost.

Loans Payable
Similar to note payable. Supported by a formal promise to pay a certain sum of money at a specific future
date(s). The term loan payable can be used to connotes bank loans and similar types of financing.

I. Loans payable are accounted for similar to notes payable. Loans transactions normally involve
transaction costs. Recall that financial liabilities are initially recognized at fair value minus
transaction costs.
II. Transaction costs are “incremental costs that are attributable to the acquisition, issue or disposal
of an asset or financial liability. Incremental cost is one that would not have been incurred if the
entity had not acquired, issued or disposed of the financial instrument.
III. Transaction costs include fees and commissions paid to agents, advisers, brokers and dealers;
levies by regulatory agencies and securities exchanges; and transfer taxes and duties.
IV. Transaction costs do not include debt premiums or discounts, financing costs or internal
administrative or holding costs.
Origination Fees
An upfront fee charged by a lender to cover the costs of processing the loan (e.g evaluating the
borrower’s financial condition, evaluating, and recording guarantees, collateral and other security
arrangements, negotiating the terms of the instrument, preparing and processing document and closing
the transaction).

I. Origination fee are deducted when measuring carrying amount of a loan payable
II. Origination fees are subsequently measured using the effective interest method.
III. Origination fees are included in the calculation of the effective interest rate, meaning on
transaction date.
IV. Origination fees are treated as an adjustment to the effective interest rate.

Cost of Bank Loan

The cost of a bank loan may be determined in several ways.
I. SImple Interest for 1 year loan = Interest / Borrowed Amount
II. Discounted Interest for 1 year loan = Net Interest Expense/ Net loan proceeds
III. Add-on installment interest rate for a 1 year loan = Interest/Average borrowed amount.

Secured Loans
One that has a collateral security which the lender can take if the borrower defaults, examples:
I. Mortgage loan - loan secured by a real property (e.g. lot or building). The borrower signs a
mortgage note evidencing the loan and the encumbrance over the property.
II. Chattel mortgage - loan secured by movable personal property (e.g., car, equipment, jewelry, or
livestock).
III. Assets such as inventories, cash surrender value, receivables, cash in bank (e.g., compensating
balance), and investments in securities can also be used as collateral security for loans

Fixed and Variable Interest loans

Fixed Interest loan - where the interest charges are based on fixed rate
Variable Interest Loan - where the interest charges vary as market interest changes.

Credit line
Some loans are obtained through pre-arranged credit lines. A credit line is an arrangement between a
financial institution (e.g bank) and a borrower that establishes the maximum amount of loan (credit limit)
that the borrower can obtain.