Notes Receivable

Financial Accounting and Reporting

Notes Receivable

• claims supported by formal promises to pay usually in

the form of notes.
• claims arising from sale of merchandise or service in
the ordinary course of business. Thus, notes received
from officers, employees, shareholders and affiliates shall
be designated separately.
Dishonored Notes

• When a promissory note matures and is not paid, it is said

be dishonored.
• Dishonored notes receivable (face amount, including the
interest and other charges) should be transferred to
accounts receivable.
Initial Measurement of Notes Receivable

• Conceptually, at present value.

• The present value is the sum of all future cash flows discounted
using the prevailing market rate of interest (the effective interest
rate) for similar notes.
• However, short-term notes receivable shall be measured at face
value (materiality).
• The initial measurement of long-term notes will depend on
whether the notes are interest-bearing or noninterest-bearing.
– Interest-bearing long-term notes are measured at face value.
– Noninterest-bearing long-term notes are measured at present value.
Subsequent Measurement of Notes Receivable

• At amortized cost, which is the

– initial carrying amount
– minus principal repayment
– plus or minus cumulative amortization (of any difference
between the initial carrying amount AND the principal maturity
amount)
– minus reduction for impairment or uncollectibility.
Example - Interest-Bearing, Compounded Interest

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)

Note receivable 1,000,000
Land 800,000
Gain on sale of land 200,000

Accrued interest receivable 120,000

Interest income 120,000
Example - Interest-Bearing, Compounded Interest

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 (second year)

Accrued interest receivable 134,400
Interest income 134,400

Receivable as of the end of first year

(1,000,000 + 120,000) 1,120,000
Multiply by: Interest rate 12%
Interest for second year 134,400
Example - Interest-Bearing, Compounded Interest

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 (third year)
Cash 1,404,928
Note receivable 1,000,000
Accrued interest receivable 254,400
Interest income 150,528
Receivable as of the end of second year
(1,000,000 + 120,000 + 134,400) 1,254,400
Multiply by: Interest rate 12%
Interest for the third year 150,528
Example - Noninterest-Bearing (No. 1)
An entity manufactures and sells machinery. On January 1, 2017, the entity sold
machinery costing P280,000 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 the machinery is P350,000.

Journal entries for 2017

Note receivable 400,000
Sales 350,000
Unearned interest income* 50,000

Cash 100,000
Note receivable 100,000

* being used when note is noninterest-bearing.

Example - Noninterest-Bearing (No. 1)
An entity manufactures and sells machinery. On January 1, 2017, the entity sold
machinery costing P280,000 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 the machinery is P350,000.

Journal entries for 2017

Unearned interest income 20,000
Interest income 20,000
Note Receivable Fraction Interest Income
2017 400,000 4/10 20,000
2018 300,000 3/10 15,000
2019 200,000 2/10 10,000
2020 100,000 1/10 5,000
1,000,000 50,000
Example - Noninterest-Bearing (No. 1)
An entity manufactures and sells machinery. On January 1, 2017, the entity sold
machinery costing P280,000 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 the machinery is P350,000.

Presentation
Current asset Noncurrent asset
Note receivable 100,000 Note receivable 200,000
Unearned interest income 15,000 Unearned interest income 15,000
85,000 185,000
Example - Noninterest-Bearing (No. 2)
On January 1, 2017, an entity sold an equipment with a cost of P250,000 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. The prevailing interest rate for a note of this type is 10%.
Initial measurement
Present value of note (100,000 × 2.4869) 248,690
Unearned interest income (300,000 - 248,690) 51,310

Journal entry (sale)

Cash 100,000
Note receivable 300,000
Equipment 250,000
Unearned interest income 51,310
Gain on sale of equipment 98,690
Example - Noninterest-Bearing (No. 2)
On January 1, 2017, an entity sold an equipment with a cost of P250,000 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. The prevailing interest rate for a note of this type is 10%.
Journal entry (collection and interest income)
Cash 100,000
Note receivable 100,000

Unearned interest income 24,869

Interest income 24,869*

* Balance (or carrying amount) of P248,690 multiplied by the prevailing interest rate of 10%.
Example - Noninterest-Bearing (No. 2)
On January 1, 2017, an entity sold an equipment with a cost of P250,000 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. The prevailing interest rate for a note of this type is 10%.

Date Annual collection Interest Income Principal Present value

Jan. 1, 2017 248,690
Dec. 31, 2017 100,000 24,869 75,131 173,559
Dec. 31, 2018 100,000 17,356 82,644 90,915
Dec. 31, 2019 100,000 9,085 90,915 -
Example - Noninterest-Bearing (No. 3)
On January 1, 2017, an entity sold an equipment costing P600,000 with
accumulated depreciation of P250,000. The entity received as consideration
P100,000 cash and a P400,000 noninterest bearing note due on January 1,
2020. The prevailing rate of interest for a note of this type is 10%.
Initial measurement
Present value of note (400,000 × 0.7513) 300,520
Unearned interest income (400,000 - 300,520) 99,480

Journal entry (sale)

Cash 100,000
Note receivable 400,000
Accumulated depreciation 250,000
Equipment 600,000
Unearned interest income 99,480
Gain on sale of equipment 50,520
Example - Noninterest-Bearing (No. 3)
On January 1, 2017, an entity sold an equipment costing P600,000 with
accumulated depreciation of P250,000. The entity received as consideration
P100,000 cash and a P400,000 noninterest bearing note due on January 1,
2020. The prevailing rate of interest for a note of this type is 10%.
Journal entry (Dec. 31, 2017)
Unearned interest income 30,052
Interest income 30,052*

Date Annual collection Interest Income Principal Present value

Jan. 1, 2017 300,520
Dec. 31, 2017 -0- 30,052 (30,052) 330,572
Dec. 31, 2018 -0- 33,057 (33,057) 363,629
Dec. 31, 2019 -0- 36,371 (36,371) 400,000
Example - Noninterest-Bearing (No. 3)
Date Annual collection Interest Income Principal Present value
Jan. 1, 2017 300,520
Dec. 31, 2017 -0- 30,052 (30,052) 330,572
Dec. 31, 2018 -0- 33,057 (33,057) 363,629
Dec. 31, 2019 -0- 36,371 (36,371) 400,000

Journal entry (Dec. 31, 2018)

Unearned interest income 33,057
Interest income 33,057

Journal entry (Dec. 31, 2019)

Unearned interest income 36,371
Interest income 36,371

Journal entry (Jan. 1, 2020)

Cash 400,000
Note receivable 400,000