NOTES RECEIVABLE
I. Definition of Notes Receivable
A note receivable is a claim supported by a certain promise to pay a certain sum
of money at a specific future date usually in the form of a promissory note. 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.
Additional Info.
Note receivables are fairly liquid, even if long-term, because entities may easily
convert them to cash, although a fee might be paid to do so.
II. Dishonored Notes
- When a promissory note matures and is not paid.
- It 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.
III. Initial Measurement of Notes Receivable
a. Notes receivable shall be measured at its PRESENT VALUE
- What do we mean by “PRESENT VALUE”?
- Sum of FUTURE CASH FLOWS DISCOUNTED using the PREVAILING
MARKET RATE
+ Future cash flows= Amount of total money that is expected to be received over
the life of investment
+ Discounted= Means that the cash flows are adjusted to their present value.
Basically, it accounts for the time value of money
+ Prevailing Market Rate= The interest rate that investors can earn at present
time. Also known as “yield”.
b. SHORT- TERM notes receivable shall be measured at face value.
- Recorded at their original invoice/ bill.
- Why?
- They have straightforward terms and simplifies accounting process
- The discount value of receivable is insignificant
- No need for complex discounting calculations
- aligns with accounting principle of consistency
IV. Interest-bearing Notes Receivable with Illustration/Computation
- Interest-bearing long-term notes are measured at face amount which is
actually the present value upon issuance.
Illustration:
An entity owned a tract of land costing P800,000 and sold the land for
P1,000,000. The entity received a 3-year note for P1,000,000 plus interest of 12%
compounded annually.
Journal entries:
First year
Notes Receivable 1,000,000
Land 800,000
Gain on sale of land 200,000
Accrued interest receivable 120,000
Interest income 120,000
(12% x 1,000,000)
Second year
Accrued interest receivable 134,000
Interest income 134,000
Face amount 1,000,000
Interest accrued for first year 120,000
Total 1,120,000
Interest for second year (12% x 1,120,000) 134,400
Third year
Cash 1,404,928
Note receivable 1,000,000
Accrued interest receivable 254,400
Interest income 150,528
Face amount 1,000,000
Interest accrued:
First year 120,000
Second year 134,400 254,400
Total 1,254,400
Interest for third year (12% x 1,254,400) 150,528
Cash received 1,404,928
V. Noninterest-bearing Notes Receivable with Illustration/Computation
- Noninterest-bearing long-term notes are measured at present value which is the
discounted value of the future cash flows using the effective interest rate.
-
VI. Subsequent Measurement
- All notes receivable in subsequent measurement shall be measured at amortized
cost.
A. For INTEREST BEARING notes, they are measured at AMORTIZED COST
- AMORTIZE
- Refers to the process of gradual allocation of a financial value
- In context of w, amortization refers to the gradual recognition of interest
income over the life of notes receivable
NOTE:
The notes themselves aren’t amortized but rather the interest income associated.
- AMORTIZED COST
- The amount at which minus the note was MEASURED INITIALLY
CONSIDERING:
1. MINUS PRINCIPAL PAYMENT
a. Principal- Original sum of money invested
b. Principal Repayment- Payment made by borrower to reduce the principal
2. PLUS OR MINUS CUMULATIVE AMORTIZATION
a. Cumulative- Used to describe the adding of things up over time.
b. Cumulative Amortization- Represents the total amount of gradual
recognition of interest
3. MINUS IMPAIRMENT OR UNCOLLECTIBILITY
a. Impairment- Refers to a situation when there is doubt about the ability of
debtor
b. Uncollectibility- AKA bad debts expense. A situation where an entity won’t
be able to collect all or a portion of principal and interest.
- For NONINTEREST- BEARING notes:
- Amortized cost= present value + amortization of the discount
- When you issued a note on a discount, the amortization of the
discount represents the recognition of interest expense
VII. Assessment (Five Questions only)
