CHAPTER 7

Part 2: NOTE RECEIVABLES

7-1
 Recognition of Notes Receivable

Short-Term Long-Term
Record at Record at
Face Value, Present Value
less allowance of cash expected to
be collected

Interest Rates Note Issued at

Stated rate = Market rate Face Value
Stated rate > Market rate Premium
Stated rate < Market rate Discount

7-2 LO 6 Explain accounting issues related to recognition of notes receivable.

7-3
7-4
 Note Issued at discount
Illustration: Morgan Corp. makes a loan to Marie Co. and
receives in exchange a three-year, $10,000 note bearing interest
at 10 percent annually. The market rate of interest for a note of
similar risk is 12 percent. How does Morgan record the receipt of
the note?

i = 12%
$10,000 Principal

$1,000 $1,000 $1,000 Interest

0 1 2 3 4
n=3

7-5 LO 6 Explain accounting issues related to recognition of notes receivable.

7-6
 Note Issued at discount

PV of Interest

Interest Received Factor Present Value

7-7 LO 6 Explain accounting issues related to recognition of notes receivable.

 Note Issued at discount

PV of Principal

Principal Factor Present Value

7-8 LO 6 Explain accounting issues related to recognition of notes receivable.

 Note Issued at discount

Illustration: How does Morgan record the receipt of the note?

Illustration 7-13

7-9 LO 6 Explain accounting issues related to recognition of notes receivable.

7-10
 Note Issued at discount
Illustration 7-14

7-11 LO 6 Explain accounting issues related to recognition of notes receivable.

 Note Issued at discount

Journal Entries for Interest-Bearing Note

Date Account Title Debit Credit

Beg. yr. 1 Notes receivable 9,520
Cash 9,520

End. yr. 1

($9,520 x 12%)

7-12 LO 6 Explain accounting issues related to recognition of notes receivable.

 On January 1, 2019, Ellison Co. issued 16-year, €1,000,000 note with a
stated interest rate of 3%, payable annually on December 31. Notes with
similar risk yield 4%. Table values are:

Present value of 1 for 16 periods at 3% .623

Present value of 1 for 16 periods at 4% .534
Present value of annuity for 16 periods at 3% 12.561
Present value of annuity for 16 periods at 4% 11.652

The issue price of the bonds is

a. €883,560.
b.€884,820.
c.€889,560.
d.€999,600.

7-13
7-14
 On January 1, Patterson Inc. signed €5,000,000, 9%
note for €4,695,000. The market rate of interest for this
note is 10%. Interest is payable annually on December
31. At the end of the first year, Patterson should report
note receivable of

a. €4,725,500.
b. €4,714,500.
c. €258,050.
d. €4,745,000.

7-15
7-16
 Note Issued at Premium
Illustration: Balance Bar Co. made a loan to Bio Foods and
received in exchange a 5-year, $100,000 note bearing interest 8
percent. The market rate of interest for a note of similar risk is 6
percent. What is the present value of this note?

7-17
7-18
 Note Issued at Premium
Record (a) the receipt of the note on January 1, and (b) the
cash receipt of revenue on December 31.

7-19
. On January 1, 2019, Ellison Co. issued eight-year notes with a face value of €1,000,000 and a stated interest

rate of 6%, payable semiannually on June 30 and December 31. The Notes were sold to yield 8%. Table values

are:

Present value of 1 for 8 periods at 6% ............................................ .627

Present value of 1 for 8 periods at 8% ............................................ .540

Present value of 1 for 16 periods at 3% .......................................... .623

Present value of 1 for 16 periods at 4% .......................................... .534

Present value of annuity for 8 periods at 6% .................................. 6.210

Present value of annuity for 8 periods at 8% .................................. 5.747

Present value of annuity for 16 periods at 3% ................................ 12.561

Present value of annuity for 16 periods at 4% ................................ 11.652

The issue price of the Notes is

a. €883,560.

b. €884,820.

c. €889,560.

d. €999,600.

7-20
7-21
 Note Issued at Face Value

Illustration: Bigelow Corp. lends Scandinavian Imports $10,000

in exchange for a $10,000, three-year note bearing interest at 10
percent annually. The market rate of interest for a note of similar
risk is also 10 percent. How does Bigelow record the receipt of
the note?
i = 10%
$10,000 Principal

$1,000 $1,000 $1,000 Interest

0 1 2 3 4
n=3

7-22 LO 6 Explain accounting issues related to recognition of notes receivable.

7-23
 Note Issued at Face Value

PV of Interest

Interest Received Factor Present Value

7-24 LO 6 Explain accounting issues related to recognition of notes receivable.

 Note Issued at Face Value

PV of Principal

Principal Factor Present Value

7-25 LO 6 Explain accounting issues related to recognition of notes receivable.

 Note Issued at Face Value

Summary Present value of interest $ 2,487

Present value of principal 7,513
Note current market value $10,000

Date Account Title Debit Credit

Jan. yr. 1

Dec. yr. 1

7-26 LO 6 Explain accounting issues related to recognition of notes receivable.

 Notes Receivable

Interest-bearing (has a stated rate of interest)

Zero-interest-bearing (interest included in face

amount).

7-27
 Zero-Interest-Bearing Note

Illustration: Jeremiah Company receives a three-year, $10,000

zero-interest-bearing note. The market rate of interest for a
note of similar risk is 9 percent. How does Jeremiah record the
receipt of the note?

i = 9%
$10,000 Principal

$0 $0 $0 Interest

0 1 3 3 4
n=3

7-28 LO 6 Explain accounting issues related to recognition of notes receivable.

 Zero-Interest-Bearing Note

PV of Principal

Principal Factor Present Value

7-29 LO 6 Explain accounting issues related to recognition of notes receivable.

7-30
 Zero-Interest-Bearing Note
Illustration 7-14

7-31 LO 6 Explain accounting issues related to recognition of notes receivable.

 Zero-Interest-Bearing Note

Journal Entries for Zero-Interest-Bearing note

Present value of Principal $7,721.80

Date Account Title Debit Credit

Jan. yr. 1 Notes receivable 7,721.80
Cash 7,721.80

Dec. yr. 1 Notes receivable 694.96

Interest revenue 694.96
($7,721.80 x 9%)

7-32 LO 6 Explain accounting issues related to recognition of notes receivable.

 Special Issues Related To Receivables

Fair Value Option

Companies have the option to record fair value in their accounts for
most financial assets and liabilities, including receivables. [6]

The IASB believes that fair value measurement for financial

instruments provides more relevant and understandable information
than historical cost because it reflects the current cash equivalent
value of financial instruments.

[6] International Accounting Standard 39, Financial Instruments: Recognition and Measurement
(London, U.K.: International Accounting Standards Committee Foundation, 2003), paras. IN16 and 9.

7-33 LO 8 Understand special topics related to receivables.

7-34
 Special Issues Related To Receivables

Fair Value Measurement

► Receivables are recorded at fair value on the statement of
financial position.

► Unrealized holding gains or losses reported as part “Other

income and expense” on the income statement.

► If a company elects the fair value option, it must continue to

use fair value measurement for that receivable.

► If the company does not elect the fair value option at the date
of recognition, it may not use this option on that specific
receivable in subsequent periods.

7-35 LO 8 Understand special topics related to receivables.

 Special Issues Related To Receivables

Illustration (Recording Fair Value Option): Assume that Escobar

Company has notes receivable that have a fair value of $810,000
and a carrying amount of $620,000. Escobar decides on December
31, 2011, to use the fair value option for these receivables. This is
the first valuation of these recently acquired receivables. At
December 31, 2011, Escobar makes an adjusting entry to record
the increase in value of Notes Receivable and to record the
unrealized holding gain, as follows.

7-36 LO 8 Understand special topics related to receivables.

 Financing With Receivables

Companies may use their

receivables to obtain immediate
cash.

7-37
7-38
 Sales of Receivables

7-39 LO 8 Understand special topics related to receivables.

 Sales of Receivables

Sale without Guarantee

Purchaser assumes risk of collection.

Transfer is outright sale of receivable.

Seller records loss on sale.

Seller use Due from Factor (receivable) account to cover

discounts, returns, and allowances.

7-40 LO 8 Understand special topics related to receivables.

 Sales of Receivables

Illustration: Crest Textiles, Inc. factors €500,000 of accounts

receivable with Commercial Factors, Inc., on a non-guarantee (or
without recourse) basis. Commercial Factors assesses a finance
charge of 3 percent of the amount of accounts receivable and retains
an amount equal to 5 percent of the accounts receivable (for probable
adjustments). Crest Textiles and Commercial Factors make the
following journal entries for the receivables transferred without
recourse.
Illustration 7-20

7-41 LO 8 Understand special topics related to receivables.

7-42
 Sales of Receivables

Sale with Guarantee

Seller guarantees payment to purchaser.

Transfer is considered a borrowing—sometimes referred to

as a failed sale.

Assume Crest Textiles sold the receivables on a with guarantee basis.

Illustration 7-21

7-43 LO 8 Understand special topics related to receivables.

 Secured Borrowing - Exercise

E7-14: On April 1, 2010, Prince Company assigns $500,000 of its

accounts receivable to the Hibernia Bank as collateral for a $300,000 loan
due July 1, 2010. The assignment agreement calls for Prince Company to
continue to collect the receivables. Hibernia Bank assesses a finance
charge of 2% of the accounts receivable, and interest on the loan is 10% (a
realistic rate of interest for a note of this type).

Instructions:
a) Prepare the April 1, 2010, journal entry for Prince Company.
b) Prepare the journal entry for Prince’s collection of $350,000 of the
accounts receivable during the period from April 1, 2010, through
June 30, 2010.
c) On July 1, 2010, Prince paid Hibernia all that was due from the loan it
secured on April 1, 2010. Prepare the entry to record this payment.

7-44 LO 8 Understand special topics related to receivables.

7-45
 Secured Borrowing - Exercise
E7-14 continued

Date Account Title Debit Credit

(a) Cash 290,000
Finance Charge 10,000
Notes Payable 300,000
($500,000 x 2% = $10,000)

(b) Cash 350,000

Accounts Receivable 350,000

(c) Notes Payable 300,000

Interest Expense 7,500
Cash 307,500
(10% x $300,000 x 3/12 = $7,500)

7-46 LO 8 Understand special topics related to receivables.

Which of the following is true when accounts receivables are factored without recourse?

a. The transaction may be accounted for either as a secured borrowing or as a sale, depending upon

the substance of the transaction.

b. The receivables are used as collateral for a promissory note issued to the factor by the owner of the

receivables.

c. The factor assumes the risk of collectability and absorbs any credit losses in collecting the

receivables.

d. The financing cost (interest expense) should be recognized ratably over the collection period of the

receivables.

7-47