Notes Payable Illustration 4: Noninterest-bearing note - Lump sum (On January 1, 20x1, ABC Co. acquired equipment in exchange for 100,000 cash and a 3-year, noninterest-bearing, P1,000,000 note payable due on January 1, 20x4. The prevailing interest rate is 12%. “Analysis: ¥- Type of payable: Long-term: noninterest-bearing (Lump sum) Initial measurement: Presentt value (using PV of P1) v [2 subsequent measurement: Amortized cost & Initial measurement: Future cash flow (face amount) 1,000,000 Multiply by: PV of PI @12%, n=3 0.711780 Present value of note payable ~ Jan. 1, 20x1 711,780 Equipment (100k + 711,780) Discount on notes payable (1M ~ 711,780) Cash Notes payable & Notes: ® The difference between the present value and face amount represents the discount on note payable, The unamortized | balance of the discount is deducted from the face amount when determining the carrying amount of the note. © The ‘discount on note payable’ on initial recognition of a noninterest-bearing note represents the total interest expense tobe recognized over the term of the note. © The equipment is measured at the amount of cash paid plus the present value of the note issued.64 Chapter SC oo) Subsequent measurement: Amortization table (Lump sum) Discount on note payable 288,220 711,780 202,806 797,194 107,143 892,857 — Date Interest expense _ Present value Jan. 1, 20x1 ‘Dec.31,20x1 | 85,414 Dec. 31, 20x2 | 95,663, Dec.31,20x3 | 107,143 Total ‘The total interest expense is equal to the discount on note payable on initial recognition. Other pertinent entries: Pec 31, | Interest expense 85,414 ] i Discount on notes payable 85,414 | Dec.31, | Interest expense 95,663 a Discount on notes payable 95,663 Dec. 31, | Interest expense 107,143 ats Discount on notes payable 107,143 Jan 1, | Notes payable 1,000,000 ] site Cash 1,000,000 | Alternative solution: Determine the carrying amounts of the note on December 31, 20<1 | and December 31, 20%2, respectively » Press 711,780, the PV of note on Jan. 1, 20x1. Multiply the amount by 1.12 (100% « 12%). You should get 797,194, the carrying amount on Dec. 31, 20x1 > Multiply again by 1.12 You should get 892,857, the carrying amount on Dec. 31, | 20x2. (Amounts are rounded off) Illustration 5: Noninterest-bearing note — Installment On January 1, 20x1, ABC Co. acquired equipment in exchange for 100,000 cash and a 4-year, noninterest-bearing, P1,000,000 note Payable due in 4 equal annual installments starting December 31, 20x1. The prevailing interest rate is 12%, Analysis: ¥ Type of payable: Long-term noninterest-bearing (Installment) ¥ Initial measurement: Present value (using PV of ordinary ennuily of P1) ¥ Subsequent measurement: Amortized costInitial measurement: Future cash flows ~ annual installments (PIM + 4) 250,000 Multiply by: PV of an ordinary annuity of P1.@12%, n=4 _ 3.037349 Present value of note payable - Jan. 1, 20x1 759,337, [jm 7, ] Equipment (100K +759,337) 859,337 20st | Discount on notes payable (1M 759,337) | 240,663, Cash 100,000 Notes payable 41,000,000 Subsequent measurement: Amortization table (Installment) | Interest | Present nse Amortization | value [ fan. 1, 20x71 | 759,337 Dec. 31, 20x1_ 91,120 158,880 | 600,458 Dec. 31, 20x2_| 250,000 | _72,055 177,945 | 422,513. 199,298 223,215, 223,215 0 Other pertinent entries: De: 3t, | Notes payable 250,000 201 | Interest expense 91,120 Cash 250,000 I | Discount on notes payable 91,120 De 3l, | Notes payable 250,000 202 | Interest expense 72,055 Cash 250,000 Discount on notes payable 72,055 Dec 31, | Notes payable 203 | Interest expense Cash 250,000 Discount on notes payable 50,702 De. 31, | Notes payable 250,000 204 Interest expense 26,785 Cash 250,000 Discount on notes payable 26,78566 ba ee 5c ateibdamanotecenmannim ae Current and noncurrent portions of a note payable When the principal amount is due in installments, the carrying amount of the note includes both current and noncurrent portions, These portions are presented or disclosed separately in the financial statements. ; To determine the current and noncurrent portions, we simply refer to the amortization table. The current portion is the amortization in the immediately following year. This is the portion of the next year’s payment applied to the principal. The noncurrent portion is the present value in the immediately following year. For example, the carrying amount of the note on December 31, 20x1 is P600,458. The current and noncurrent wrtions of this amount are determined as follows: Interest Present Date Payments expense _| Amortization ___value Jan.1,20x1_| [| 759,337 Dec.31,20x1 | 250,000 | 91,120 | _158,880_ 600,458 | Dec. 31, 20x2 | 250,000 72085 __ Sst > Current portion of the note Noncurrent portion of the note payable on Dec. 31, 20x1 payable on Dec, 31, 20x1 When disclosing in the financial statements, the discount on notes payable is allocated to both the current and noncurrent portions of the note by deducting the present value of the portion from the related future cash payment. Current portion of notes payable: Notes payable (250,000 due in 20x2) ® 250,000 | Discount on notes payable (250K - 177,945 current portion) (72,055) | Notes payable, net (presented in current liabilities) 17,945 Noncurrent portion of notes payable: Notes payable (250,000 due in 20.2 + 250,000 due in 20x3) 500,000 Discount on notes payable (500K - 422,513 noneurrent portion) __"_(77,487) Notes payable - net (presenta in noncurrent liabilities) 422,513 Total notes payable, net - Dec. 31,20x1 P 600,458ble 67 Notes Pat iiustration 6: Noninterest-bearing note - Instaliment in advance On January 1, 20x1, ABC Co. acquired equipment in exchange for 100,000 cash and a 4-year, noninterest-bearing, P1,000,000 note ayable due in 4 equal annual installments. The first installment is due on January 1, 20x1. The succeeding installment payments are due very December 31. The prevailing interest rate is 12%. “Analysis ¥ Type of payable: Long-term noninterest-bearing (Installment in aioance) Initial measurement: Present value (using PV of an annuity due of P1) Subsequent measurement: Amortized cost Initial measurement: Future cash flows — annual installments (P1M +4) 250,000 Multiply by: PV of an annuity due of P1 @12%, n=4 3.401830 Present value of note payable - Jan. 1, 20x1 850458 The entries on January 1, 20x1 are as follows: Jan, | Equipment (100K + 850,458) 950,458 22:1 | Discount on notes payable (1M - 850,458) | 149,542 Cash 100,000 Notes payable 1,000,000 71. | Notes payable 250,000 Cash 250,000 {0 record the fis install payment #% Subsequent measurement: Amortization table (Installment) Interest Date __ Payments expense Amortization Present value Jan. 1, 20% 850,458 Jen.1,20x1 250,000 - 250,000 600,458 Dec.31,20x1 250,000. 72,055 17,945, 422,513 Dec.31, 20x2 250,000 50,702 199,298 223,215, Dec. 31, 20x3 250,000 26,785 223,215 -68 Chapter 3 ek tig No interest is recognized on the first installment because interest is incurred only after passage of time. The entry on December 31, 20x1 is as follows: Dec.31, | Notes payable 250,000 20x | Interest expense 72,085 Cash 250,000 Discount on notes payable 72,055 Query: What is the balance of the ‘Discount on notes payable’ on December 31, 20x1? Answer: Outstanding face amount (1M less payments of 250K & 250K) 500,000 Present value on Dec. 31, 20x1 (422,513) Discount on note payable - Dec. 31, 20x1 77,487 lustration 6.1 - Installments due at the start of each year Use the same information in ‘Illustration 6’ but assume that the succeeding installment payments are due every Jan. 1. Requirement: Compute for the carrying amount of the note on December 31, 20x1. Solution: Interest Date Payments _ expense Amortization Present value Jan, 1, 20x1 850,458 Jan.1,20x1 250,000 - 250,000 600,458 Jan. 1,20x2 250,000 72,055 17,945 422,513 Jan. 1, 20x3 250,000 50,702 199,298 223,215 Jan. 1, 20x4 250,000 26,785 223,215 0 The amortization table above shows carrying amounts on January 1 of each of the subsequent years. These carrying amounts are net of the January 1 payments. To compute for the carryingNotes Payable were lg amount of the note on Decemb: ; er 31, the a the following day (ie, January 1 of next jer inside back to the January 1 present value. fas ee The carrying amount of the note determined as follows: : Carrying amount of note payable - Jan, 1, 20x2 on December 31, 20x1 is ‘Add back: Payment on Jan. 1, 20x2 422,513 Carrying amount of note payable - Dec. 31, 2001 The future cash flow is P1,404,928 (ie, the required payment on the note). > The carrying amount of the note is P1,000,000 (ie, the cash price ‘equivalent or P1,404,928 face amount less P404,928 discount), The amounts are substituted in the equation as follows: > 1,404,928 x PV of 1 @ x% = 1,000,000 The PY of factor is used because the note is due in lump sum, Trial and error approach We will “squeeze” for the effective interest rate (x%) in the equation above using a “trial and error” approach, To do this, we will initially use a random interest rate. Thereafter, we will adjust the interest rate depending on the outcome of the trial using, as a guide, the inverse relationship between the effective interest rate and the amount of present value. This means that if we need a higher amount of present value, we will use a lower interest rate,sows ale 2B nwstamte and vice-versa. We will continue adjusting the interest rate until ive get the rate that balances the equation, OK. let's do this. We'll try a random rate, say 10%. first trial: (at 10%) ature cash flows x PV factor at x% = PY of note > 1,404,928 x PV of Pl @ 10%, n=3 = 1,000,000 y (1,404,928 x 0.7513148009) = 1,055,543 is not equal to 1,000,000 We need a lower amount of present value. Therefore, we need to increase the interest rate. Let's try 12%. second trial (at 12%) Future cash flows x PV factor at x% = PV of note } 1,404,928 x PV of PI @ 12%, n=3 = 1,000,000 > (1,404,928 x 0.7117802478) = 1,000,000 is equal to 1,000,000 The effective interest rate is 12%. This rate exactly discounts the future cash flow to the carrying amount of the note. The amortization table is prepared as follows: Date____Interest expense Discount on N/P___ Present value Jon. 12081 404,928 1,000,000 Dec. 31, 20x1 120,000 284,928 1,120,000 Dec, 31, 20x2 134,400 150,528 1,254,400 Dec, 31, 20x3 150,528 m: 1,404,928 Ilustration 10: Long-term note issued solely for cash On January 1, 20x1, ABC Co. issued a 3-year, P1,000,000 noninterest-bearing note payable to XYZ, Inc,, a related party, in exchange for cash, The prevailing interest rate is 12%. Case #1; Proceeds equal to present value of note |The proceeds received from the note are P711,780.Cha, MO hp > The note is long-term and noninterest-bearing. Therefore, ix, measured at present value (1M x PV of P1 @12%, n=3 = P711, 759) The entry to record the note is as follows: f Jan. 1, 20x Cash’ Discount on note payable (IM -711,780) Note payable 711,780 288,220 —~ | Case #2: Proceeds equal to face amount of note | The proceeds received from the note are 1,000,000, equal to the | face amount. 1,000,009 | > The note is also measured at the present value of P711,789, However, because the proceeds are equal to face amount, rather than the present value (which is usually the case in real- life transactions), a “Day-1 difference” arises. The entry is as follows: Tan. | Cash 1,000,000 aaiz | Discount on note payable (1M ~711,780) 288,220 Note payable 1,000,000 Unrealized gain ~ “Day 1 difference” 288,220 | or loss on initial recognition. The The “Day-1 difference” is recognized immediately in profit iscount on note payable” is amortized using the effective interest method (ie., regular accounting). “Dey dijerence”i discussed in detail in Infermalae Accounting Pat 1A Ilustration 11: Note with ‘below-market’ rate of interest On January 1, 20x1, ABC Co. issued a 3-year, 3%, P1,000,000 note payable in exchange for a machine. Principal is due on January |, 20x4 but interest is due annually every January 1. The prevailing interest rate for this type of note is 12%. Analysis: Y Type of payable: Long-term payable with unreasonable interest rate — the nominal rate of 3% is below the current rate of 12%. ¥ Initial measurement: Present value75 Present value factors: “PV of P1” for the principal because it is due in lump sum at maturity date. “PV of ordinary annuity of PL” for the interests because they are due periodically. Subsequent measurement: Amortized cost 4g Initial measurement: To compute for the present value of the note, the future cash flows are first identified then multiplied by the present value factors. ‘Future cash flows PVF @12%, n=3 Present value Principal 1,000,000 0.71178 « 711,780 Total 783,835, a PV of PI @12% n°) {4 pV of ordinary annuity of PL€12%, ne 4 Subsequent measurement: Payments Interest Present Date yrinterests expense Amortization __ value Jan. 1, 20x1 783,835 Jan. 1,20x2 30,000 94,060 64,060 847,895, Jan. 1, 20x3 30,000 101,747, 71,747 919,642 Jon.1,20x4 30,000 110,358 80,358 1,000,000 Journal entries: Jan. 1, | Machinery 783,835 20x1_| Discount on note payable 216,165 Note payable 1,000,000 Dec. 31, | Interest expense 94,060 201 Interest payable (1M x 3%) 30,000 Discount on note payable 64,060 Jan.1, | Interest payable 30,000 22 Cash 30,000 Dec.31, | Interest expense | 101,747 20x2 Interest payable (1M x 3%) 30,000 Discount on note payable 71,787 “Entries in succeeding periods follow the same patier,76 __Chapter 2 * Notes: & Interest payable is computed by multiplying the nominal rate to the face amount. Interest expense is computed by multiplying the effective interest rate to the present value. * The discount amortization increases the interest expense recognized each period. Total interest expense over the life of the note is greater than the actual payments for interest. * The total interest expense recognized over the life of a note with unreasonable interest rate is equal to the sum of the discount on note payable on initial recognition and the subsequent payments for interest. (216,165 discount on inital recognition + 90K total payments for interests = 306,165 total interest expense; (94,060 * 101,747 + 110,358 = 306,165 total interest expense om the note) The following other present value scenarios are discussed in Intermediate Accounting 1A, under ‘Notes receivable’: * Note with below-market interest (simple interest) - Principal due at maturity, interests due in semi-annual installments © Note with below market interest (simple interest) - Principal and interests due in installments © Note with below market interest (compounded interest) - Principal and interests due at maturity © Non-interest bearing note with deferred payments Loans payable Loan payable is similar to note payable; it is also supported by a formal promise to pay a certain sum of money at specific future date(s). However, the term “loans payable” can be used to connote bank loans and similar types of financing. Loans payable are accounted for similar to notes payable However, loan transactions normally involve transaction costs Recall that financial liabilities are initially recognized at fair value minus transaction costs. > Transaction costs are “incremental costs that are directly attributable to the acquisition, issue or disposal of a financial77 asset or financial liability. An incremental cost is one that would not have been incurred if the entity had not acquired, issued or disposed of the financial instrument.” (PFRS9.Appdx A) 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. Transaction costs do not include debt premiums or discounts, financing costs or internal administrative or holding costs. Origination fees Origination fee is an upfront fee charged by a lender to cover the costs of processing the loan (eg,, evaluating the borrower's financial condition, evaluating and recording guarantees, collateral and other security arrangements, negotiating the terms of the instrument, preparing and processing documents and closing the transaction). Origination fees normally come in the form of a “service fee” which is a percentage of the principal amount and is directly deducted from loan proceeds released to borrower. Origination fees are deducted when measuring the carrying amount of a loan payable. Origination fees are subsequently amortized using the effective interest method. The subsequent amortization increases both the interest expense and the carrying amount of the loan. Origination fees are included in the calculation of the effective interest rate, meaning on transaction date, the origination fees are treated as adjustment to the effective interest rate. Ilustration 1: Origination fees On January 1, 20x1, ABC Co. borrowed P1,000,000 from a bank. The bank charged a 3% loan origination fee. The principal is due on January 1, 20x4 but 10% interest is due annually starting on January 1, 20x2.78 Chapter 2 * Initial measurement: Principal amount 1,000,000 Origination fee aimx3%) (30,000) Carrying amount of loan on Jan, 1, 20x1 970,000 en Tn Cash 970,000 1 | Discount on loan payable 30,000 Loan payable 1,000,000 | * Subsequent measurement: The effective interest rate .\, the loan is not equal to the 10% stated rate because of the origination fee. We will compute for the imputed interest rate using the “trial and error” approach. To limit the number of “tries,” we need to observe the following, concepts: © Ifa financial instrument's carrying amount is less than its face amount, the difference is a discount. @ If a financial instrument's, carrying amount is greater than its face amount, the difference is a premium. Discount _ | Carrying amount is less than Face amount Premium __| Carrying amount is greater than Face amount = When there is discount, the effective interest rate is higher than the nominal rate (stated rate or coupon rate). © When there is premium, the effective interest rate is less than the nominal rate. Discount Effective interest rate is higher than Nominal rate Premium Effective interest rate is less than Nominal rate_-_| There is no discount or premium if the carrying amount is equal to the face amount. Consequently, the effective interest rate is also equal to the nominal rate. Continuing the illustration, we know that the loan is issued at a discount because the initial carrying amount ofNotes P 970,000 is less than the face amount of P1,000,000. Therefore, the effective interest rate must be higher than the nominal rate of 10%. Future cash flows x PV factor atx% = Present value First trial (using 11%): » (Principal of 1,000,000 x PV of 1 @11%, n=3) + (Interest of 100,000 x PV of ordinary annuity @11%, n=3) = 970,000 » (1,000,000 x 0.731191381) + (100,000 x 2.443714715) = 970,000 y (731,191 + 244,371) = 975,562 is not equal to 970,000 We need a lower amount; therefore, we need to increase the rate. Second trial (using 12%) > (1,000,000 x PV of 1 @12%, n=3) + (100,000 x PV of ordinary annuity @12%, n=3) = 970,000 ® (1,000,000 x 0.711780248) + (100,000 x 2.401831268) = 970,000 » (711,780 + 240,183) = 951,963 is not equal to 970,000 Looking at the values derived above, we can reasonably expect that the effective interest rate is between 11% and 12%. To approximate that rate, we need to perform interpolation using the following formula: x = 11% 12% - 11% Let us substitute the values computed earlier on the formula. 970,000 _- 975,562 (5,562) = = 0.2357 951,963 - 975,562 (23,599) © The value substituted for ‘x%' is P970,000, the initial carrying amount of the loan. * We expect the effective interest rate to be higher than 11% but lower than 12%, Thus:80 Chapter» Se - 11% (the lower rate) appears on both the numerator ang denominator. . - 0.2357 is added to 11% to derive the effective interest rate, © The effective interest rate is 11.2357% (11% +.2357%). Amortization table: (Installment) * Interest Interest Date ayments expense _ Amortization Present value ae Ee Jan, 1, 20x1 970,000 Jan. 1, 20x2 100,000 108,986 8,986 978,986 Jan. 1, 20x3 100,000 1996 9,996 988,982 Jan. 1, 20x4 100,000 111,119 11,119 1,000,101 Notice that there is still a small difference of P101, However, if this is deemed immaterial, we can regard the computed rate as the effective interest rate. If a spreadsheet application is used, the exact rate is 11.2326088%, The entry on December 31, 20x1 is as follows: Pec. 31. | Interest expense 108,986 fon Interest payable 100,000 Discount on note payable 8,986 to ncerue interest expense Illustration 2: Amount of loan amortization ‘You want to acquire a car with a cash price of P2,000,000 through a 12-month auto loan that requires equal month-end payments. The effective interest rate is 12%, Requirements: Compute for the following: a, Amount of monthly payment b. Total interest expense on the loan Solutions:es Payable Ps Se Re equirement (a): Amount of monthly Payment Future cash flows x py factor = Present value ture cash flows: This rey Lote nos ora Peto py factor: The payments are due on a monthly basis Accordingly. we will use an “1 (period) of 12 and a discount rate of 1% (12% per annum +12 months). present value: The present value is P2,000,000, ie., cash price, Future cash flows x (PV of ordinary annuity of 1 61% ne12)=2,000,000 Future cash flows x 11.2550775 = 2,000,000 ee Future cash flows = 2,000,000 + 11.2550775 Future cash flows (monthly payment) = 177,697.58 vvvy Requirement (b): Total interest expense over the term of the loan Monthly payment 17,697.58 Multiply by: No. of payments on the loan 12 Total cash payments 2,132,370.96 Present value of loan on initial recognition (2,000,000, Total interest expense 132,371 016753 ‘Amortization table: ‘Monthly Interest Present Date jayments expense Amortization __value " 2,000,000 Ast month 177,697.58 20,000 157,698 1,842,302 audmonth 177,697.58 18423 159,275 1,683,028 3rd month 177,697.58 16,830 160,867 1,522,161 stanonth 177,697.58 15,222 162,476 Sthmonth 177,697.58 13597 164,101 Sthmonth 177,697.58 11,956 168,742 1,029,842 hmonth 177,697.58 10,298 167,399 862,443, Sthmonth 177,697.58 8,624 169,073 693,370 thmonth 177,697.58 6,934 170,764 522,606 ‘kmh 177,697.58 5,226 172.472 350,134 tenon 177,697.58 3,501 174,196 175,938, hm __177,69758_—_—A75)__A75938_ 0 Tells 2,132,370.96__132,371___2,000,000 Aut ATANG EMILIO AGUINALDOChapter 82 ee cone ene determined in several ways. nk loan may be aie wear loan = Interest + Borrowed amount ‘© Simple interest rate for a 1-v- «Discounted interest rate for a 1-year loan = Net interest expense « Net loan proceeds © Add-on installment interest rate Average borrowed amount for a T-year loan = Interest « Illustration: Cost of bank loan On January 1, 20x1, ABC Co. obtained a P1,000,000, 180-day bank Joan at an annual rate of 10%. The loan agreement requires ABC to maintain a P100,000 compensating balance in its bank account at the lending bank, ABC would otherwise maintain a balance of only 50,000 in this account. The bank account earns interest at an annual rate of 2%. Requirement: Based on a 360-day year, compute for the effective interest rate on the borrowing. Solution: Discounted interest rate for a 1-year loan = Net interest expense + Net loan proceeds = [(IM x 10% x 180/360) - (50,000 x 2% x 180/360)] = [1M - 50,000] 19,500 + 950,000 .21% (effective interest for 180 days) = 5.21% x 2 = 10.42% (effective interest for 360 days) Secured loans A secured loan is one that has a collateral security which the lender can take if the borrower defaults. Examples: a. 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. b. Chattel mortgage ~ loan secured by movable personal property (e.g, car, equipment, jewelry, or livestock).Notes Payable 83 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 A fixed interest loan is one where the interest charges are based on a fixed rate. A variable interest loan is one where the interest charges vary as market interest rates change. The loans (notes) in the previous illustrations are examples of fixed interest loans. Variable rate loans are discussed in Advanced Accounting, Credit lines Some loans are obiained through pre-arranged credit lines. A credit line (line of credit) is an arrangement between a financial institution (¢.g,, a bank) and a borrower that establishes the maximum amount of loan (credit limit) that the borrower can obtain. A credit line-assures the borrower of an immediate source _of financing when the need for cash arises, but subject to the credit limit. This provides convenience and saves the borrower cost and time in processing numerous individual loans. Furthermore, interest accrues only on amounts actually borrowed; thus, unnecessary interest expenses can be avoided. For example, you expect to need approximately P100,000 over the next few months to finance a business. However, currently, you only need P20,000. You don’t want to borrow the whole of P100,000 now because you don’t want to incur unnecessary interest expense on the excess cash. Also, you don’t have any alternative investment opportunities for the excess cash. On the other hand, you want to have an immediate source of financing when the need for the additional P80,000 arises. You can remedy your dilemma by obtaining a P100,000 credit line and borrow only P20,000 now. Interest starts to accrue but only on the ?20,000 borrowed. When further financing is needed, you can avail the unused credit line of 80,000.84 Chapter i No journal entry is made when a credit line is obtained, Only the actual amount borrowed is recognized. The unused credit line is only disclosed in the notes and is not treated as cash, or obligation. Credit card ~ a credit card uses a line of credit granted to the cardholder by a bank or a credit card company. The cardholder can use the credit card to borrow cash or make credit purchases, When the credit card is used, the cardholder becomes a debtor to the card provider. When the credit limit is reached, the card can no longer be used until the obligation is settled. A credit card is different from a debit card. A debit card is linked to the cardholder's bank account. Therefore, the funds used for purchases are automatically withdrawn (debited) from the cardholder's bank account. When the funds linked to the debit card are consumed, the card can no longer be used until additional funds are deposited to the account. A debit card is not a credit line because the cardholder actually owns the cash being used. In other words, a credit card allows the cardholder to use the funds of another entity (the card provider) subject to repayment at a future date, while a debit card allows the cardholder to use his own funds but in a cashless and convenient way, electronically. Revolving credit agreement (committed line of credit) imposes a Jegal obligation on the bank, but the borrower pays a commitment fee. A credit line which imposes no legal obligation on the bank is called non-committed line of credit. Commercial paper Commercial paper consists of short-term (usually 270 days or less), unsecured, notes payable issued by large companies with high credit ratings to investors. Commercial papers are traded in money markets and thus highly liquid. Commercial paper is a lower cost of source of funds than bank loans. It is usually issued at below the prime rate.Notes Payable 85 Chapter 2: Summas Notes payable are initially recognized at fair value minus transaction costs. «Short-term notes are initially measured either at face amount or present value. « Long-term notes with reasonable interest rate are initially recognized at face amount. «Long-term noninterest-bearing notes and Long-term notes with anreasonable interest rate are initially measured at present value. ~ « Notes are initially measured at the cash price equivalent of the noneash consideration received if this amount is determinable. «Stated interest rate (nominal rate, coupon rate, ot face rate) is the rate appearing on the face of an interest-bearing note. «Effective interest rate (imputed rate of interest, current market rate or yield rate) is the rate used in present value computations. + Anoninterest-bearing note has an unspecified principal and an unspecified interest. These elements are separated through present value computations, «Future cash flows x PV factor at x% = Present value * PV of P1is used when the future cash flow is in Jump sum. © PV of an ordinary annuity of P1 is used when the future cash flows are in installments and the first installment does not begin immediately. + PVof an annuity due of P1is ised when the future cash flows are in installments and the first installment begins immediately. «Total interest expense recognized over the life of a noninterest- bearing note is equal to the discount on note payable on initial recognition. © Interest payable = Face amount x Nominal rate © Interest expense = Present value x Effective interest rate © Origination fees are deducted from the carrying amount of the loan and subsequently amortized using the effective interest method.i Chapter 86 SE aie PROBLEMS PROBLEM 1: TRUE OR FALSE ; 1, Notes payable are obligations supported by creditor promissory notes. : 2. Financial liabilities are initially recognized at fair value minus transaction costs that are directly attributable to the issuance, except for financial liabilities measured at FVPL whose transaction costs are expensed immediately. 3. Fair value is the price that would be paid to buy an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 4, Transaction costs of issuing financial liabilities are expensed outright. 5. Short-term notes payable are initially measured either at face amount or present value. 6. All short-term notes payable are initially measured at face amount. 7. A note payable may be measured initially on the basis of the cash price equivalent of the asset obtained in exchange for the note payable. 8. If the cash flows on a note payable are due in lump sum, the most appropriate present value factor is “PV of 1.” 9. If the cash flows on a note payable are due in installments and the first installment is due on initial Tecognition, appropriate present value factor is of 1.” 10. Origination fees incurred on issuance of loan payable are deducted from the carrying amount of the loan and subsequently amortized using the effective interest method, the most “PY of an ordinary annuity