DON HONORIO VENTURA STATE UNIVERSITY

COLLEGE OF BUSINESS STUDIES

Bacolor, Pampanga

CHAPTER 5- LOANS RECEIVABLES

LEARNING OBJECTIVES:

At the end of this chapter, the student should be able to:

1. To understand the initial measurement of loans receivable

2. To understand the subsequent measurement of loans receivable

3. To recognize the impairment of loan receivable

DEFINITION OF LOANS RECEIVABLES

Loans Receivable are financial assets arising from a loan granted by a bank or other financial
institutions to a borrower or client.

The term of the loan may be short term but, in most cases, the repayment period cover several
years.

On the other hand, Loan’s receivable is similar to notes receivable in that it is also a claim supported
by a formal promise to pay a certain sum of money at specific future date (s) usually in the form of a
promissory note. However, the term Loans Receivable is more appropriately used by entities whose
main operations involve lending of money, such as banks, financing companies, lending companies,
insurance companies, pawnshops, non-bank intermediaries like savings and loan associations,
credit cooperatives etc.

Bank and other financial institutions Borrower

Loans Receivable Loans Payable

Interest Income Interest Expense

Process of borrowing a loan from the bank

1. Application

2. Processing (background check etc.)

3. Approval or release of the loan

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

INITIAL AND SUBSEQUENT MEASUREMENT OF LOANS RECEIVABLE

Type of Receivable Initially Subsequently

(Transaction Date) (FS Date)

Loans Receivable Fair Value plus transaction Amortized Cost using the
costs that are attributable to effective interest method
the acquisition of the financial
asset

Notes: a. The fair value of the loan receivable at initial recognition is normally the transaction price,
meaning the amount of the loan granted.

b. Transaction costs that are directly attributable to the loan receivable include direct
origination costs (CAPITALIZED MEANING ADDED TO THE TRANSACTION PRICE)

c. However, Indirect Origination costs should be treated as outright expense

d. Amortized cost is the amount at which the notes receivable is measured minus principal
repayment plus or minus accumulative amortization of any difference between the initial carrying
amount and the principal maturity date minus reduction for impairment or uncollectible.

ORIGINATION FEES

Lending activities usually precede the actual disbursement of funds and generally include efforts to
identify and attract potential borrowers and to originate a loan.

The fees charged by the bank against the borrower for the creation of the loan are known as
“origination fees”

Origination fees include compensation for the following activities:

1. Evaluating the borrower’s financial condition

2. Evaluating guarantees, collateral and other security

3. Negotiating the terms of the loan

4. Preparing and processing the documents related to the loan

5. Closing and approving the loan transaction.

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

ACCOUNTING FOR ORIGINATION FEES

The origination fees received from the borrower are recognized as unearned interest income and
amortized over the term of the loan.

If the origination fees are not chargeable against the borrower, the fees are known as direct
origination costs.

The direct originations costs are deferred and also amortized over the term of the loan.

Preferably, the direct origination costs are offset directly against any unearned origination fees
received.

Origination Fees exceed direct Direct Origination Costs exceed

origination costs Origination Fees

The difference is unearned The difference is charged to

interest income and the direct origination costs and the
amortization will increase amortization will decrease
interest income interest income

Accordingly, the origination fees received and the direct origination costs are included in the
measurement of the loan receivable.

Example:

BTS Bank granted a loan to a borrower on January 1, 2021. The interest on the loan is 12% payable
annually starting December 31, 2021. The loan matures in 3 years on December 21, 2023.

Principal amount P 5,000,000

Origination fees received from the borrower 331,800

Direct origination costs incurred 100,000

Solution: Initial carrying amount of the loan

Principal amount P 5,000,000

Origination fees received ( 331,800)

Direct Origination Costs incurred 100,000

Initial carrying amount of the loan P 4,768,200

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

Journal Entries on January 1, 2021

2021

Jan 1 Loans Receivable P 5,000,000

Cash P 5,000,000

To record the loan

2021

Cash P 331,800

Unearned Interest Income P 331,800

To record the origination

fees received from the borrower

2021

Jan 1 Unearned Interest Income P 100,000

Cash P 100,000

To record the direct

origination costs incurred by the
bank

Thus, the unearned interest income has a credit balance of P 231,800 to be amortized over the term
of the loan using the effective interest method.

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

4.

SUBSEQUENT MEASUREMENT OF LOANS RECEIVABLE USING AN EFFECTIVE INTEREST METHOD

Direct origination costs and origination fees are included in the calculation of the effective interest
rate. On transaction date, direct origination costs and origination fees are treated as adjustments ti
the effective interest rate.

Subsequent interests will not be computed using the stated interest rat but rather using an imputed
interest rate. This rate can be computed using a “trial and error approach”

When the initial carrying amount of a financial instrument is less than its face amount, the financial
instrument is said to be at a discount.

When the initial carrying amount of a financial instrument is higher than its face amount, the
financial instrument is said to be at a premium.

When a financial instrument is at a discount Effective Interest Rate > Nominal Rate

When a financial instrument is at a premium Effective Interest Rate < Nominal Rate

Note: there is no discount or premium when the initial carrying amount of the financial instrument
is equal to the face amount. Consequently, the effective interest rate is also equal to the nominal
rate.

Illustration:

On January 1, 2021, DIY Bank extended a 10%, P 1,000,000 loan to SID Corp. Principal is due on
January 1, 2024 but interests are due annually every December 31 1. DIY Bank incurred direct loan
origination costs of P 12,000 and indirect loan origination costs of P 8,000. In addition, DIY bank
charged SID a 6% non-refundable loan origination fee.

Initial carrying amount of the loan receivable.

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

Principal amount P 1,000,000

Direct Origination Cost 12,000

Origination Fee (1,000,000 x 6%) (60,000)

Initial carrying amount of loan receivable P 952,000

Following the notes stated above:

When the initial carrying amount of a financial instrument is less than its face amount, the financial
instrument is said to be at a discount.

When the initial carrying amount of a financial instrument is higher than its face amount, the
financial instrument is said to be at a premium.

Carrying amount is less than the Principal or Carrying Amount = P 952,000

Face amount = Discount
Principal Amount = 1,000,000

Since the loan is issued at a discount because the initial carrying amount of P 952,000 is less than
the face amount of P 1,000,000. Therefore:

When a financial instrument is at a discount Effective Interest Rate > Nominal Rate of 10%

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

Using the “trial and error” approach. You try a percentage higher than 10% using this formula:

Future cash flows x PV factor @ % = PRESENT VALUE OF NOTE.

LET US TRY 11%

TO COMPUTE FOR THE PRESENT VALUE OF THE PRINCIPAL:

Formula for Present Value of 1 using a Scientific Calculator:

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

USING NON- SCIENTIFIC CALCULATOR:

Formula for Present Value of 1 using Non- Scientific Calculator

Input 1.11 to the calculator and press divide (/) sign once or twice then press equal sign by the
number of periods (3), press three times.

PRESENT VALUE OF THE PRINCIPAL = 1,000,000 X 0.7311913 = 731,191

TO COMPUTE FOR THE PRESENT VALUE OF THE INTEREST:

Formula for Present Value of an ordinary of an annuity of 1 using a Scientific Calculator:

USING NON- SCIENTIFIC CALCULATOR:

Formula for Present Value of an ordinary of an annuity of 1 using a Non- Scientific Calculator

Example: 11% Interest rate in 3 years

a. 1.11 divide divide then click equal 3 times then minus 1 then equal then divide 11% then
equal, disregard the negative sign then multiply by the annual cash flow.

1,000,000 X 10% = 100,000 INTEREST (INSTALLMENT)

PRESENT VALUE OF THE INTEREST = 100,000 X 2.443715 = 242,372

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

PV OF PRINCIPAL 731, 191

PV OF INTEREST 242, 372

TOTAL PRESENT VALUE 973, 563

Note: 973,563 is not equal to 952,000, a difference of P 23,563. So, in order to get roughly an
amount closer to 952, 000, we must try a higher than 11%.

LET US TRY 12% using the same formulas for scientific and non- scientific calculator.

PRESENT VALUE OF THE PRINCIPAL = 1,000,000 X 0.7117801 = 711,780

PRESENT VALUE OF THE INTEREST = 100,000 X 2.4018325= 240,183

PV OF PRINCIPAL 711,780

PV OF INTEREST 240,183

TOTAL PRESENT VALUE 951,963

Note: 951,563 is approximately equal or closer to 952,000, so the effective interest rate is 12%.

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

Amortization Table- Installment

Date Collections of Interest Income Amortization Present Value

Interests
(Present Value x (Interest Income- Previous Balance
Effective Interest Collection) PV Plus
Rate) amortization

January 1, 2021 952,000

December 31, 100,000 114,240 14,240 966,240

2021

December 31, 100,000 115,949 15,949 982,189

2022

December 31, 100,000 117,863 17,863 1,000,052

2023

Note: For discount- The amortization will be added to the Present Value

For Premium- The amortization will be deducted to the Present Value

Journal Entries:

2021

Dec 31 Interest Receivable P 100,000

Unearned Interest 14,240

Interest Income 114,240

2022

Dec 31 Interest Receivable P 100,000

Unearned Interest 15,949

Interest Income 115,949

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

2023

Dec 31 Interest Receivable P 100,000

Unearned Interest 17,863

Interest Income 117,863

IMPAIRMENT OF LOAN

PFRS 9, paragraph 5.5.1 provides that an entity shall recognize a loss allowance for expected credit
losses on financial asset measured at amortized cost.

A loan is impaired when it is not likely that lender will collect the full value of its loan because the
credit worthiness of a borrower has fallen.

MEASUREMENT OF IMPAIRMENT

When measuring expected credit losses, an entity should consider:

1. The probability weighted outcome

The estimate should reflect the possibility that a credit loss occurs and the possibility that
no credit loss occurs.

2. The time value of money

The expected credit losses should be discounted

3. Reasonable and supportable information that is available without undue cost or effort.

PFRS does not describe particular method of measuring credit losses.

An entity may use various sources of data both internal or entity specific and external in measuring
expected credit losses.

The amount of impairment loss can be measured as the difference between the carrying amount
and the present value of estimated future cash flows discounted at the original effective rate.

MEANING OF CREDIT RISK

Credit risk is the risk that one party to a financial instrument will cause a financial loss for the other
party by failing to discharge an obligation.

The risk contemplated is the risk that the issuer will fail to perform a particular obligation.

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

Illustration:

OPPA BANK loaned P 5,000,000 to Korean Company on January 1, 2021.

The terms of the loan require principal repayment of P 1,000,000 each year for 5 years plus interest
at 10%.

The first principal and interest are due on December 31, 2021. Korean Company made the required
payments on December 31, 2021 and December 31, 2022.

However, during 2023, Korean Company began to experience financial difficulties and was unable
to make the required principal and interest payment on December 31, 2023.

On December 31, 2023, OPPA Bank assessed the collectibility of the loan and has determined that
the remaining principal payments will be collected but the collection of interest is unlikely.

The loan receivable has a carrying amount of P 3,300,000 including accrued interest of 300,000 on
December 31, 2023. OPPA Bank projected the cash flows from the loan on December 31, 2023

Date of Cash Flow Amount Projected

December 31, 2021 500,000

December 31, 2022 1,000,000

December 31, 2023 1,500,000

Using the original effective rate of 10%, the present value of 1 for each year

Present Value of 1 for one period 0.9091

Present Value of 1 for two periods 0.8264

Present Value of 1 for three periods 0.7513

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

PRESENT VALUE OF THE CASH FLOWS:

December 31, 2021 500,000 x 0.9091 454,550

December 31, 2022 1,000,000 x 0.8264 826,400

December 31, 2023 1,500,000 x 0.7513 1,126,950

TOTAL PRESENT VALUE OF 2,407,900

CASH FLOWS

COMPUTATION OF IMPAIRMENT LOSS:

CARRYING AMOUNT OF THE LOAN P 3,300,000

PRESENT VALUE OF CASH FLOWS 2,407,900

IMPAIRMENT LOSS 892,100

Journal Entry on December 31, 2023:

2023

Dec 31 Impairment Loss P 892,100

Accrued Interest Receivable 300,000

Allowance for Loan 592,100

Impairment

Note: the accrued interest receivable is credited directly because the collection of interest is
unlikely.

STATEMENT OF PRESENTATION ON DECEMBER 31, 2023

Loan Receivable P 3,000,000

Allowance for Loan Impairment 592,100

Carrying Amount P 2,407,900

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 DON HONORIO VENTURA STATE UNIVERSITY
COLLEGE OF BUSINESS STUDIES
Bacolor, Pampanga

REFERENCES:

Millan, Zeus Vernon. (2022). Intermediate Accounting 1A. Baguio City: Bandolin Enterprise

Valix Conrado T & Valix Christian Aris M. (2022). Intermediate Accounting. Manila: GIC
Enterprises & Co. Inc.

CPAR, RESA, ICARE Review Materials in Intermediate Accounting or Financial Accounting

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