CHAPTER 2: NOTES PAYABLE

Notes payable – are obligations supported by debtor promissory notes.

Initial measurement – 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.

Classifications:
1. Short-term payable
a. matures within 1 year.
b. fair value may be equal to its face value (however, if the transaction contains a significant
financing component, the fair value will be equal to the present value)
2. Long-term payables
a. Long-term payable that bears a reasonable interest – fair value is equal to face amount.
i. An interest rate is deemed ‘reasonable’ if it approximates the market rate at the
transaction date.
b. Long-term payable that bears no interest (long-term non-interest bearing payable) – fair value
equals the present value of the future cash flows on the instrument discounted using an imputed
interest rate.
c. Long-term payable that bears an unreasonable interest – fair value equal to the present value of
the future cash flows on the instrument discounted using an imputed interest rate.

Effective interest rate – is the rate that exactly discounts the future cash payments of a financial liability equal to
its carrying amount.
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.
- normal selling price minus the discount for outright payment.
Amortized cost – is the amount at which the financial asset or financial liability is measured at initial
recognition minus principal repayments, plus or minus the cumulative amortization using the effective interest
method of any difference between that initial amount and the maturity amount and for financial adjusted for any
loss allowance.
Effective interest method
i. used to determine the amortized cost
ii. is a method calculating the amortized cost of a financial asset or a financial liability and of allocating the
interest income or interest expense over the relevant period.

Short-term a. face amount a. Expected settlement

b. present value amount
b. Amortized cost
Long-term with reasonable interest rate Face amount Expected settlement amount
Long-term noninterest-bearing Present value Amortized cost
Long-term with unreasonable interest rate Present value Amortized cost

*The term ‘discounted the note’ means the lender has deducted the interest in advance.
If interest expense has been incurred, it will be credited to discount on notes payable.
Discount on notes payable – is a contra-liability account. It is deducted when determining the carrying amount
of the note.

Exceptions (when can we NOT measure liabilities at present value):

a. the effect is immaterial
b. discounting is prohibited by the Standard
c. transactions are made in the usual or customary terms.

*If the effect of discounting in short-term is not immaterial, then it’s up to the entity’s judgment.
*The Standards DO NOT require short-term notes to be measured at face amount NOR prohibit their
discounting.