PROGRAM: Bachelor of Science in Accountancy
LEVEL: 2
COURSE TITLE: INTERMEDIATE ACCOUNTING II
COURSE CODE: ATAE16
NO. OF UNITS: 6
PRE-REQUISITE: Intermediate Accounting I
MODULE TITLE: NOTES PAYABLE
MODULE NO. : 2a
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%.
Case 1: Lump sum
The note is due lump sum on June 30, 20x2.
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).
The entries are as follows:
July 1, 20x1
Cash 880,000
Discount on notes payable 120,000
Notes payable 1,000,000
To record the note payable
December 31, 20x1
Interest expense (1,000,000x12%x6/12) 60,000
Discount on notes payable 60,000
To record interest expense
June 30, 20x2
Interest expense (1,000,000x12%x6/12) 60,000
Discount on notes payable 60,000
To record interest expense
June 30, 20x2
Notes payable 1,000,000
Cash 1,000,000
To record settlement of 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.
DATE OUTSTANDING BAL. OF ALLOCATION INTEREST
NOTE EXPENSE
9.30.x1 1,000,000 120,000x 1/2.5 48,000
12.31.x1 750,000 120,000x.75/2.5 36,000
3.31.x2 500,000 120,000x.5/2.5 24,000
6.30.x2 250,000 120,000x.25/2.5 12,000
TOTALS 2,500,000 120,000
The entries are as follows:
July 1, 20x1
Cash 880,000
Discount on notes payable 120,000
Notes payable 1,000,000
Sept. 30, 20x1
Notes Payable 250,000
Interest expense 48,000
Cash 250,000
Discount on notes payable 48,000
Dec. 31, 20x1
Notes Payable 250,000
Interest expense 36,000
Cash 250,000
Discount on notes payable 36,000
March 31, 20x2
Notes Payable 250,000
Interest expense 24,000
Cash 250,000
Discount on notes payable 24,000
June 30, 20x2
Notes Payable 250,000
Interest expense 12,000
Cash 250,000
Discount on notes payable 12,000
Illustration 2-Long-term note with reasonable interest-
simple interest
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
Dec. 31, 20x1
Interest expense (1M x 12% x 3/12) 30,000
Interest payable 30,000
Oct. 1, 20x2
Interest expense (1M x 12% x 9/12) 90,000
Interest payable 30,000
Cash 120,000
Dec. 31, 20x2
Interest expense 30,000
Interest payable 30,000
Oct. 1, 20x3
Interest expense 90,000
Interest payable 30,000
Cash 120,000
Notes payable 1,000,000
Cash 1,000,000
Illustration 3: Long-term note with reasonable interest –
Compounded interest
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
Dec. 31, 20x1
Interest expense (1M x 12%) 120,000
Interest payable 120,000
Dec. 31, 20x2
Interest expense [(1,000,000 + 120,000) x 12%] 134,400
Interest payable 134,400
Dec 31, 20x3
Interest expense [(1,000,000 + 120,000 + 134,400) x 12%] 150,528
Interest payable (120,000 + 134,400) 254,400
Cash 404,928
Notes payable 1,000,000
Cash 1,000,000
Illustration 4: Noninterest-bearing note – Lump sum
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
Subsequent measurement: Amortization table (Lump sum)
DATE INTEREST EXPENSE DISCOUNT ON NP PRESENT VALUE
Jan 1, 20x1 288,220 711,780
Dec 31, 20x1 85,414 202,806 797,194
Dec 31, 20x2 95,663 107,143 892,857
Dec 31, 20x3 107,143 - 1,000,000
288,220
=======
Dec. 31, 20x1
Interest expense 85,414
Discount on notes payable 85,414
Dec. 31, 20x2
Interest expense 95,663
Discount on notes payable 95,663
Dec. 31, 20x3
Interest expense 107,143
Discount on notes payable 107,143
Jan. 1, 20x4
Notes payable 1,000,000
Cash 1,000,000
Illustration 5: Noninterest-bearing note – Installment
On Jan. 1, 20x1, ABC Co. acquired equipment in exchange for P100,000 cash and a 4-year
noninterest bearing P1,000,000 note payable due in 4 equal annual installments starting Dec. 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 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
Subsequent measurement: Amortization table (Installment)
DATE PAYMENTS INTEREST EXP AMORTIZATION PRESENT VALUE
Jan 1, 20x1 759,337
Dec 31, 20x1 250,000 91,120 158,880 600,458
Dec 31, 20x2 250,000 72,055 177,945 422,513
Dec 31, 20x3 250,000 50,702 199,298 223,215
Dec 31, 20x4 250,000 26,785 223,215 0
Dec. 31, 20x1
Notes payable 250,000
Interest expense 91,120
Cash 250,000
Discount on notes payable 91,120
Dec. 31, 20x2
Notes payable 250,000
Interest expense 72,055
Cash 250,000
Discount on notes payable 72,055
Dec. 31, 20x3
Notes payable 250,000
Interest expense 50,702
Cash 250,000
Discount on notes payable 50,702
Dec. 31, 20x4
Notes payable 250,000
Interest expense 26,785
Cash 250,000
Discount on notes payable 26,785
