RECEIVABLE FINANCING

Discounting of Notes Receivable

Valix, C. T. et al. Intermediate Accounting Volume 1. (2019). Manila: GIC
Enterprises & Co.; Inc.
Concept of Discounting
 As a form of receivable financing, discounting specifically pertains to notes
receivable.
 In a promissory note, the original parties are the maker and the payee.
 The maker is the one liable and the payee is the one entitled to payment
on the date of maturity.
 When a note is negotiable, the payee may obtain cash before maturity
date by discounting the note at a bank or other financing company.
 To discount the note, the payee must endorse it.
 Thus legally, the payee becomes an endorser and the bank becomes an
endorsee.

Payee Endorser
Bank/Financial Institution Endorsee
Endorsement

 Is the transfer of right to a negotiable instrument by simply signing at the

bank of the instrument.

With Recourse Without Recourse

Endorser shall pay the endorsee if Endorser avoids future liability
the maker dishonors the note even if the maker refuses to pay
Legal: This is the secondary liability the endorsee on the date of
of the endorser maturity.

Accounting: This is a contingent

liability

In the absence of any evidence to the contrary, endorsement is

assumed to be with recourse.
 Terms related to discounting of note
Term Description Formula

Net Proceeds Discounted value of the NP = Maturity Value – Discount

(NP) note received by the
endorser from the endorsee

Maturity Value The amount due on the MV = Principal + Interest

(MV) note at the date of maturity

Maturity Date The date on which the note MD = Date of Note + Terms
(MD) should be paid

Principal The amount appearing on Principal = Face Value

the face of the note
 Terms related to discounting of note
Term Description Formula

Interest (I) The amount of interest for I = Principal x rate x time

the full term of the note

Interest Rate The rate appearing on the

face of the note

Time Period in which interest shall Time = period from date of note to
accrue maturity date

Discount (D) The amount of interest D = MV x Disc. Rate x Disc. Period

deducted by the bank in
advance
 Terms related to discounting of note
Term Description Formula

Discount Rate The rate used by the bank If no discount rate is given:
in computing discount. Discount Rate = Interest Rate

Discount Period Period of time from date of Discount Period = Term of Note –
discounting to maturity Expired portion up to date of
date discounting
OR
Discount Period = Unexpired Term of
Note
Steps in Accounting for Discounting of
Note
Step # Description
1 Compute for the Interest for the full term of the note
I = Principal x rate x time for the full term of the note

2 Compute for the Maturity Value

MV = Principal + Interest

3 Determine the Discount Period

Discount Period = Unexpired Term of the Note

4 Compute for the Discount

Discount = MV x Disc. Rate x Disc. Period

5 Compute for the Net Proceeds from Discounting (NP)

NP = Maturity Value – Discount
Steps in Accounting for Discounting of
Note
Step # Description
6 Compute for the Accrued Interest on the Note (AI)
AI = Principal x rate x time from date of note to date of discounting

7 Compute for the Carrying Amount of the Note (CA)

CA = Principal + AI

8 Determine the Gain or Loss on Discounting

Gain or Loss on Discounting = Difference between NP and CA

Gain: NP > CA

Loss: NP < CA
Discounting without recourse
Journal Entries
To record discounting of Notes Receivable
Cash (Net Proceeds) xxx
Loss on Note Receivable Discounting xxx
Notes Receivable (Face Value) xxx
Interest Income (Accrued Interest) xxx

The note receivable account is credited directly because the sale of the note
receivable is without recourse or absolute.
Discounting of Note with Recourse

 If the discounting is with recourse, the transaction is

accounted for either as:

Conditional Sale of Note Receivable Recognizing

Contingent Liability

Secured Borrowing
 Discounting with Recourse:
Conditional Sale Journal Entries
To record discounting of Notes Receivable
Cash (Net Proceeds) xxx
Loss on Note Receivable Discounting xxx
Notes Receivable Discounted (Face Value) xxx
Interest Income (Accrued Interest) xxx

Case 1: Note is paid by maker on Maturity Case 2: Note is dishonored by maker

Notes Receivable Discounted xxx Accounts Receivable xxx
Notes Receivable xxx Cash xxx

Notes Receivable Discounted xxx

Notes Receivable xxx

The Note Receivable Discounted account is deducted from the Total Notes Receivable when
preparing the SFP with disclosure of the contingent liability.
Discounting with Recourse:
Secured Borrowing
 If the discounting is treated as secured borrowing, the note
receivable is not derecognized but instead an accounting liability is
recorded at an amount equal to the face amount of the note
receivable discounted.
 There is no objection if the interest expense is “netted” against the
interest income or a net interest expense is recognized because the
discounting transaction is a borrowing.
 There is no gain or loss on discounting if the note receivable
discounting is accounted for as a secured borrowing
 Discounting with Recourse:
Secured Borrowing Journal Entries
To record discounting of Notes Receivable
Cash (Net Proceeds) xxx
Interest Expense (Loss on Discounting under Conditional Sale) xxx
Liability for Notes Receivable Discounted xxx
Interest Income (Accrued Interest) xxx

Case 1: Note is paid by maker on Maturity Case 2: Note is dishonored by maker

Liability for Notes Receivable Discounted xxx Accounts Receivable xxx
Notes Receivable xxx Cash xxx

Liability for Notes Receivable Discounted xxx

Notes Receivable xxx
Conditional Sale or Secured Borrowing
(PFRS9, par 3.2.3)

 An entity shall derecognize a financial asset when either one of the

following criteria is met:

The contractual rights to the cash flows of the financial asset have
expired.

The financial asset has been transferred and the transfer qualifies for
derecognition based on the extent of transfer of risks and rewards of
ownership.
Application: 1st Criterion
Expiration of Contractual Rights
 Usually easy to apply.
 The contractual rights to cash flows may expire, for
example, when a note receivable from a customer is
fully collected.
Application: 2nd Criterion
Transfer of Financial Asset
 Is often complex
 It relies on the assessment of the extent of transfer of risks
and rewards of ownership.
 PFRS 9, par. 3.2.6 provides guidelines for derecognition
based on transfer of risks and rewards
 Derecognition based on transfer of risks
and rewards (PFRS 9, par. 3.2.6)
1. If the entity has transferred substantially all risks and rewards, the financial
asset shall be derecognized.

2. If the entity has retained substantially all risks and rewards, the financial asset
shall not be derecognized.

3. If the entity has neither transferred nor retained substantially all risks and
rewards, derecognition depends on whether the entity has retained control of
the asset.
a. If the entity has lost control of the asset, the financial asset is derecognized in
its entirety.
b. If the entity has retained control over the asset, the financial asset is not
derecognized.
Derecognition based on transfer of risks
and rewards (PFRS 9, par. 3.2.6)
Substantially all risks and rewards Control of the asset
Transferred Derecognize Lost Derecognized
Retained Not Derecognize Retained Not Derecognized
 Unquestionably, the contractual right to
the cash flows of the note receivable
discounted with recourse have not yet
expired. Thus, the 1st criterion does not
apply.
 The discounting of note with recourse
does not also fall squarely within a single
guideline in the 2nd criterion of “transfer of
risks and rewards of ownership”.
 The discounting transaction is a
combination of the guidelines in the
second criterion as follows:
a) The entity has substantially transferred all
“rewards”
b) The entity has retained substantially all
“risks”
c) The entity has lost control of the note
receivable
 Much debate on this accounting issue can go on
among academician and theoreticians until a clear-cut
interpretation of the standard is made by the Financial
Reporting Standards Council.
 Premises considered, it is believed that the discounting
of note receivable with recourse is to be accounted for
as a conditional sale with recognition of a contingent
liability.
 The main justification is that upon discounting or
endorsement of the note receivable, whether with or
without recourse, the transferor or endorser has lost
control over the note receivable.
 Accordingly, the transferee has complete control over
the note receivable because the transferee has the
practical ability to sell to third party without attaching
any restrictions to the transfer.
End of Chapter