Notes Receivable

= are claims supported by formal promises to pay usually in the form of notes.
= represents only claims arising from sale of merchandise or service in the ordinary
course of business.
= meaning to say, notes received from officers, shareholders, employees and affiliates
shall be designated separately.

Negotiable promissory note = is an unconditional promise in writing made by one

person to another, sign 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.
= in simple terms, it 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.
= it may be payable on demand or at a definite future date.

Kinds of Notes receivable

1) Short-term notes receivable = are notes due within 12 months or less
= classified as current assets.
2) Long-term notes receivable = are notes due in more than a year.
= classified as noncurrent assets

Kinds of promissory note

1) Interest-bearing note = has stated % of interest.
= principal is equal to face amount.
= interest is equal to principal times interest times time
2) Non-interest bearing note = interest is included in the face amount
= separate the principal amount from the face amount of notes receivable using present
value.
= therefore, the difference is the interest.
Dishonored Notes
= it is said to be dishonored when a promissory note matures and is not yet paid.
= theoretically, it shall be removed from notes receivable and transferred to accounts
receivable at an amount to include as well the interest and other charges.

Entry to record dishonored notes:

Accounts receivable xx
Note receivable xx
Interest income xx

Measurement of notes receivable

1) Initial measurement = it is recognized on transaction date.
= Notes receivable are initially measured at present value.
= Interest bearing note are measured initially at face value
= non-interest bearing note are measured initially at present value
= short-term notes receivable are measured at face value.
= cash flows relating to short-term notes receivable are not discounted because the effect
of discounting is usually not material.
= initial measurement of long-term notes receivable will depend on whether the notes
are interest or non-interest bearing notes.
= interest bearing long-term notes are measured at face value which is actually the
present value upon issuance.
= non-interest bearing long-term notes are measured at present value which is the
discounted value of the future cash flows using the effective interest rate.

Present value = is the sum of all future cash flows discounted using the prevailing market
rate of interest for similar notes.
Face value = is the amount stated in the promissory note.
The prevailing market rate of interest is actually the effective interest rate.
2) Subsequent measurement = it is recognized on reporting date or when the
accountants prepare the financial statements on the financial statement date.
= interest bearing note are measured subsequently at net realizable value
= non-interest bearing note are measured subsequently at amortized cost
= subsequent to initial recognition, long-term notes receivable shall be measured at
amortized cost using the effective interest method.

Net realizable value = face amount less all payments made by the maker.
Amortized cost = is the amount at which the note receivable is measured initially minus
principal repayment, plus or minus the cumulative amortization of any difference between
the initial carrying amount and the principal maturity amount minus reduction for
impairment or uncollectibility.

Interest bearing note – Illustration

Marmol Company owned a tract of land costing P850,000 and sold the land for
P1,200,000.
Marmol Company received a 3-year note for P1,200,000 plus interest of 12%
compounded annually.

When interest is compounded, in the mathematical parlance it means that any accrued
interest receivable also earns interest.

The selling of P1,200,000 is reasonably assumed to be the present value of the note
because the note is interest bearing.

Journal entries are:

First year:
Note receivable 1,200,000
Land 850,000
Gain on sale of land 350,000
Accrued interest receivable 144,000
Interest income 144,000
(12% x 1,200,000)

Second year:
Accrued interest receivable 161,280
Interest income 161,280

Face value 1,200,000

Interest accrued for first year 144,000
Total 1,344,000
Interest for second year (12% x 1,344,000) 161,280

Third yaer;
Cash 1,685,914
Note receivable 1,200,000
Accrued interest receivable 305,280
Interest income 180,634

Face value 1,200,000

Interest accrued:
First year 144,000
Second year 161,280 305,280
Total 1,505,280
Interest for third year (12% x 1,505,280) 180,634
Cash received 1,685,914
Noninterest bearing note – Illustration 1
Devenecia Company manufactures and sells machinery. On January 1, 2021, the
company sold machinery costing P300,000 for P400,000
The buyer signed a noninterest bearing note for P400,000, payable in four equal
installments every December 31. The cash sale price of machinery is P340,000.

Face value of note 400,000

Present value cash sale price 340,000
Unearned interest income 60,000

Cash sale price 340,000

Cost of machinery 300,000
Gross income 40,000

Journal entries for 2021

1) To record the sale
Note receivable 400,000
Sales 340,000
Unearned interest income 60,000

2) To record the first installment collection

Cash 100,000
Note receivable 100,000

3) To recognize the unearned interest as income over the term of the note
Unearned interest income 20,000
Interest income 20,000
 (a) (b) (c)
Notes Interest
receivable Fraction income
2021 400,000 4/10 20,000
2022 300,000 3/10 15,000
2023 200,000 2/10 10,000
2024 100,000 1/10 5,000
1,000,000 50,000

a) The first installment is received on December 31, 2021. Thus, for 2021, the note
outstanding is P400,000. It is decreased by P100,000 each year.
b) The fractions are developed from the note receivable balance every day
c) The fractions developed are multiplied by the total unearned interest for P50,000 to get
the yearly interest income. Thus, for 2021, 4/10 x P50,000 equals P20,000 and so on.

Noninterest bearing note – Illustration 2

On January 1, 2021, Rondolo Company sold an equipment with a cost of P300,000 for
P400,000.
The buyer paid a down of P100,000 and signed a noninterest bearing note for P300,000
payable in equal annual installment of P100,000 every December 31.
This type of note has a prevailing interest rate of 10%. The present value of an ordinary
annuity of 1 for three periods at 10% is 2.4869.
With that case, the present value of the note is computed by multiplying the annual
installment of P100,000 by the present value of 2.4869 or P248,690.
Therefore, the unearned interest income and gain on sale of equipment are computed as
follows:

Face value of note 300,000

Present value of note (100,000 x 2.4869) 248,690
Unearned interest income 51,310

Present value of note 248,690

Cash received-down payment 100,000
Sales price 348,690
Cost of equipment 300,000
Gain on sale of equipment 48,690
Journal entries for 2021:
1) To record the sale of equipment
Cash 100,000
Note receivable 300,000
Equipment 300,000
Gain on sale of equipment 48,690
Unearned interest income 51,310

2) To record the first installment collection

Cash 100,000
Note receivable 100,000

3) To record the interest income for 2021

Unearned interest income 24,869
Interest income 24,869
(248,690 x 12%)

The computation for the interest income is made using the effective interest method in
this case:

Annual Interest Present

Date collection income Principal value
Jan. 1, 2021 248,690
Dec 31, 2021 100,000 24,869 75,131 173,559
Dec 31, 2022 100,000 17,356 82,644 90,915
Dec 31, 2023 100,000 9,085 90,915 0

Interest income is computed by multiplying the present value by 10%. Thus, for 2021,
10% x P248690 equals P24,869.
Principal payment is equal to annual collection minus interest income. Therefore, in 2021,
P100,000 minus P24,869 equals P75,131.
Present value is equal to the preceding balance minus the annual principal payment.
Therefore, on December 31, 2021, P248,690 minus P75,131 is P173,559.

Noninterest bearing note – Illustration 3

On January 1, 2021, Formaran Company sold an equipment costing P700,000 with
accumulated depreciation of P350,000. The company received as consideration of
P200,000 cash and a P400,000 noninterest bearing note due on January 1, 2024.
This type of note has a prevailing interest rate of 10%. The present value of 1 at 10% for
3 years is 0.7513.
As you observe, the note is collectible on lump sum basis after 3 years.

Face of note 400,000

Present value (400,000 x .7513) 300,520
Unearned interest income 99,480

Sometimes, the unearned interest income is referred to as “discount on note

receivable”.

Present value of note 300,520

Cash received 200,000
Sale price 500,520
Carrying amount of equipment (700,000 - 350,000) 350,000
Gain on sale of equipment 150,520

Journal entries for 2021:

2021
Jan. 1
Cash 200,000
Note receivable 400,000
Accumulated depreciation 350,000
Equipment 700,000
Gain on sale of equipment 150,520
Unearned interest income 99,480
Dec. 31
Unearned interest income 30,052
Interest income 30,052

Interest Unearned Present

Date Income interest Value
Jan. 1, 2021 99,480 300,520
Dec. 31, 2021 30,052 69,428 330,572
Dec. 31, 2022 33,057 36,371 363,629
Dec. 31, 2023 36,371 0 400,000

The effective interest method is used.

The computation for interest income is by multiplying the present value by 10%.
Therefore, for 2021, P300,520 x 10% is P30,052
The unearned interest income is computed by subtracting the interest income from
preceding balance. Therefore, on December 31, 2021, P99,480 minus P30,052 is
P69,428.
To compute for the present value, the interest income is added to the preceding present
value balance. Therefore, on December 31, 2021, P300,520 plus P30,052 equals
P330,572. Or face value of note minus unearned interest income equals present value.
Therefore, on December 31, 2021, P400,000 minus P69,428 is P330,572

2013
Dec. 31
Unearned interest income 33,057
Interest income 33,057

2014
Dec. 31
Unearned interest income 36,371
Interest income 36,371
2015
Jan. 1
Cash 400,000
Notes receivable 400,000