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LEVEL: 2
COURSE TITLE: INTERMEDIATE ACCOUNTING II
COURSE CODE: ATAE16
NO. OF UNITS: 6
PRE-REQUISITE: Intermediate Accounting I
NOTES PAYABLE
Notes payable are obligations supported by debtor promissory notes. The accounting for notes payable
is similar to the accounting of notes receivable.
Initial measurement:
Notes payable are initially recognized at fair value minus transaction costs.
Fair value – is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.
For measurement purposes, notes payable are classified into the following:
a. Short-term payable
b. Long-term payable that bears reasonable interest rate
c. Long-term payable that bears no interest (noninterest bearing)
d. Long-term payable that bears an unreasonable interest rate (below market interest rate)
A short-term payable matures in 1 year or less, while a long-term payable matures beyond 1 year.
SHORT-TERM PAYABLE
The fair value of a short-term payable may be equal to its face amount. However, if it is clear that the
arrangement effectively constitutes a financing transaction and the imputed rate of interest can be
determined without undue cost or effort, the fair value of the short-term payable is equal to its present
value.
LONG-TERM PAYABLES
The fair value of a long-term payable that bears a reasonable interest rate is equal to the face
amount. An interest rate is deemed reasonable if it approximates the market rate at the
transaction date.
The fair value of a long-term payable that bears no interest (long-term noninterest bearing
payable) is equal to the present value of the future cash flows on the instrument discounted
using an imputed interest rate.
The fair value of a long-term payable that bears an unreasonable interest rate is also equal to
the present value of the future cash flows on the instrument discounted using an imputed
interest rate.
CASH PRICE EQUIVALENT
The fair value of a payable may be measured in relation to the cash price equivalent of the noncash
asset (noncash consideration) received in exchange for the payable.
Cash price equivalent is the amount that would have been paid if the transaction was settled
outright on cash basis, as opposed to installment basis or other deferred settlement.
(discuss examples)
Illustration 1: Short-Term Note
On July 1, 20x1, ABC Co. borrowed P1,000,000 and issued a one-year note payable. The lender
discounted the note at 12%.
Analysis:
The note is short-term and the effect of discounting is immaterial. Therefore, the note is initially
measured at face amount (net of the advanced interest).
July 1, 20x1
Cash 880,000
Discount on notes payable 120,000
Notes payable 1,000,000
To record the note payable
Case 2: Installment
The note is due in equal quarterly installments starting September 30, 20x1.
Analysis:
The note is also measured at face amount. However, because the note is due in installments, the
P120,000 advanced interest is allocated over the installment periods.
Cash 880,000
Discount on notes payable 120,000
Notes payable 1,000,000
On Oct. 1, 20x1, ABC Co. issued a two-year, 12%, P1,000,000 note payable in exchange for a piece of
land. Principal is due on Oct. 1, 20x3 but interest is due annually.
Analysis:
Type of payable: Long-term with reasonable interest rate-the 12% nominal rate is assumed
to be equal to the current rate on initial recognition because no additional information is
given.
Initial measurement-face amount
Subsequent measurement-Face amount of expected settlement account
Type of interest-simple interest-interest is computed only on the outstanding principal
balance
Journal entries:
Oct. 1, 20x1
Land 1,000,000
Notes payable 1,000,000
Oct. 1, 20x2
Interest expense (1M x 12% x 9/12) 90,000
Interest payable 30,000
Cash 120,000
Oct. 1, 20x3
Interest expense 90,000
Interest payable 30,000
Cash 120,000
On Jan. 1, 20x1, ABC Co. issued a three-year, 12%, P1,000,000 note payable in exchange for a piece
of land. Principal and interest are due on Dec. 21, 20x3.
Analysis:
Type of payable and measurement- same as illustration 2
Type of interest: Compounded interest – interest is compounded on both the outstanding
balances of principal and accrued interest
Journal entries:
Jan 1, 20x1
Land 1,000,000
Notes payable 1,000,000
On Jan. 1, 20x1, ABC Co. acquired equipment in exchange for P100,000 cash and a 3-year noninterest-
bearing P1,000,000 note payable due on Jan. 1, 20x4. The prevailing interest rate is 12%.
Analysis:
Type of payable: Long-term noninterest-bearing (lump sum)
Initial measurement: Present value (using PV of P1)
Subsequent measurement: Amortized cost
Initial measurement:
Future cash flow (face amount) 1,000,000
Multiply by : PV of P1 @ 12%, n=3 0.711780
Present value of note payable-Jan. 1, 20x1 711,780
========
Jan. 1, 20x1
Equipment (100,000 + 711,780) 811,780
Discount on notes payable (1,000,000 – 711,780) 288,220
Cash 100,000
Notes payable 1,000,000
Jan. 1, 20x4
Notes payable 1,000,000
Cash 1,000,000
Analysis:
Type of payable – Long-term noninterest-bearing (Installment)
Initial measurement: Present value (using PV of ordinary annuity of P1)
Subsequent measurement : Amortized cost
Initial measurement:
Future cash flows – annual installments (1,000,000/4) 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
=======
Jan 1, 20x1
Equipment (100,000 + 759,337) 859,337
Discount on notes payable (1,000,000 – 759,337) 240,663
Cash 100,000
Notes payable 1,000,000