Loan Receivable

Definition: Financial asset arising from a loan granted by a bank or other financial institution to a
borrower or client.

Term: May be short term but in most cases, repayment periods cover several years.

Initial Measurement of Loan Receivable

Initial Recognition: FV + transaction costs (directly attributable to the acquisition of financial asset)

Fair Value = Transaction Price = Amount of the loan granted

Transaction Costs = Direct Origination Costs

Direct Origination Costs should be included in the initial measurement of the loan receivable.

Subsequent Measurement of Loan Receivable

PFRS 9 provides that if the business model in managing financial asset is to collect contractual cash flows
on specified dates and the contractual cash flows are solely payments of principal and interest, the
financial asset shall be measured at amortized cost.

Loan receivable is measured at amortized cost using effective interest method.

Amortized cost is the amount at which the LR is measured initially minus principal repayment, plus or
minus the cumulative amortization of any difference between the initial amount recognised and the
principal maturity amount, minus reduction for impairment or uncollectibility.

Amortized Costs = initial amount – principal repayment +/- cumulative amortization – reduction for

impairment or uncollectibility

Cumulative Amortization = Initial Amount recognised – Principal Maturity Amount

Initial Amount < Principal Amount (amortization is added to carrying amount)

Initial Amount > Principal Amount (amortization is deducted from carrying amount)

Origination Fees – fees charged by the bank against the borrower for the creation of loan.

- Include compensation for activities such as evaluating the borrower’s financial

condition, evaluating guarantees, collateral and other security, negotiating the
terms of the loan, preparing and processing documents and closing the loan
transaction.
- Recognized as unearned interest income and amortized over the term of the loan.
Direct Origination Costs – if origination fees are not chargeable against the borrower

- Are deferred and also amortized the term of the loan.

- Preferably costs are offset directly against any unearned origination fees received

OF received exceed DOC

OF received - DOC = unearned interest income (amortization will increase interest income)

DOC exceed OF received

DOC - OF received = unearned interest income (amortization will decrease interest income)

OF received and DOC are included in the measurement of the loan receivable.

ILLUSTRATION:

Global Bank granted a loan to a borrower on January 1, 2010. The interest on the loan is 12% payable
annually starting December 31, 2010. The loan matures in three years on December 31, 2012. The other
data related to the loan are:

Principal Amount 5,000,000.00

OF received from borrower 331,800.00

Direct Origination Costs Incurred 100,000.00
Initial Carrying Amount: 5,000,000.00 – 331,800.00 + 100,000.00 = 4,768,200.00

Entries:
1. Loan Receivable 5,000,000.00
Cash 5,000,000.00

2. Cash 331,800.00
Unearned Interest Income 331,800.00

3. Unearned Interest Income 100,000.00

Cash 100,000.00

Unearned Interest Income Balance = 231,800.00 (to be amortized over the term of the loan using
effective interest method)
New effective rate must be computed because of OF received and DOC. Either “trial and error” method
or “interpolation” approach is used in computing effective rate.
Initial Carrying Amount < Principal Amount = Nominal Rate < Effective Rate

(Amortization is added to carrying amount)

ER is the rate that would equate the PV of the future cash flows of the loan to the initial carrying amount
of Loan Receivable.

Effective Rate of 14%

PV of Principal ( 5M x 0.675) 3,375,000.00

PV of Interest ( 5M x 12% = 600T x 2.322) 1,393,200.00

4,768,200.00

Amortization of Unearned Interest Income using effective interest method

Date Interest Received Interest Income Amortization Carrying Amount

01/01/10 4,768,200.00

12/31/10 600,000.00 667,548.00 67,548.00 4,835,748.00

12/31/11 600,000.00 677,005.00 77,005.00 4,912,753.00

12/31/12 600,000.00 687,247.00 87,247.00 5,000,000.00

Formulas:

Interest received = Principal x Nominal rate

Interest income = Carrying Amount x Effective Rate

Entries:

Cash 600,000

Interest Income 600,000

Unearned Interest Income 67,548

Interest Income 67,548

Presentation:

Loan Receivable 5,000,000

Unearned Interest Income ( 231,800 - 67,548) ( 164,252)

Carrying Amount- 12/31/10 4,835,748

The above presentation is in accordance with the standard requirement that a loan receivable is
measured at amortized cost. The Carrying amount is actually the amortized cost.

12/31/11 entries

Cash 600,000

Interest Income 600,000

Unearned Interest Income 77,005

Interest Income 77,005

12/31/12 entries

Cash 600,000

Interest Income 600,000

Unearned Interest Income 87,247

Interest Income 87,247

Cash 5,000,000

Loan Receivable 5,000,000

Impairment of Loan

PAS 39, par 58, provides that an entity shall assess at every end of reporting period whether there is
objective evidence that a financial asset or group of financial assets is impaired. If such exists, the entity
shall determine and recognize the amount of any impairment loss.

Objective evidence of impairment may result from the following “loss events” occurring after the intitial
recognition of the financial asset:

1. Significant financial difficulty of the issuer or obligor.

2. Breach of contract, such as default or delinquency in interest or principal payment.
3. Debt restructuring – The lender, for economic or legal reasons relating to the borrower’s
financial difficulty, grants to the borrower a concession that the lender would not otherwise
consider.
4. Probability that the borrower will enter bankruptcy or other financial reorganization.
5. The disappearance of an active market for the financial asset because of financial difficulty.
6. Observable data indicating that there is a measurable decrease in the estimated future cash
flows from a group of financial assets since the initial recognition of those assets, although the
decrease cannot yet be identified with the individual financial assets in the group.
Measurement of Impairment

PAS 39, par 63, provides that if there is evidence that an impairment loss on loan receivable carried at
amortized cost has been incurred, the amount of the loss is measured as the “difference between the
carrying amount of the loan and the present value of estimated future cash flows discounted at the
original effective rate of the loan.

The carrying amount of the LR shall be reduced either directly or through the use of allowance account.
The amount of the loss shall be recognized in profit or loss.