CHAPTER 11

RECEIVABLE FINANCING:
Discounting of Note Receivable
Ninia C. Pauig-Lumauan, MBA, CPA
2nd Semester 2020-2021
Lyceum of Aparri

Intermediate Accounting Part 1

 CONCEPT OF DISCOUNTING
• As a form of receivable financing,
discounting specifically pertains to note
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.

Intermediate Accounting Part 1

 CONCEPT OF DISCOUNTING

• When a note is negotiable, the payee

may obtain cash before maturity 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.

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 ENDORSEMENT
• Endorsement is the transfer of right to a
negotiable instrument by simply signing at
the back of the instrument.
• Endorsement may be with recourse which
means that the endorser shall pay the
endorsee if the maker dishonors the note.

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 ENDORSEMENT

• In the legal parlance, this is the

secondary liability of the endorser. In
the accounting parlance, this is the
contingent liability of the endorser.
• Endorsement may be without recourse
which means that the endorser avoids
future liability even if the maker refuses
to pay the endorsee on the date of
maturity.
Intermediate Accounting Part 1
TERMS RELATED TO DISCOUNTING OF NOTE
• In the absence of any evidence to the
contrary, endorsement is assumed to be
with recourse.
1. Net Proceeds Refer to the discounted value of the note received
by the endorser from the endorsee.
Net Proceeds = Maturity Value minus Discount
2. Maturity Value Is the amount due on the note at the date of
maturity. Principal plus interest for the full term of
the note equals the maturity value.
3. Maturity Date Is the date on which the note should be paid.
4. Principal Is the amount appearing on the face of the note. It
is also referred to as the face value.

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 TERMS RELATED TO DISCOUNTING OF
NOTE
5. Interest Is the amount of interest for the full term of the note.
Interest is computed as Principal x rate x time
6. Interest Rate Is the rate appearing on the face of the note.
7. Interest Income Is the accrued interest as of the date of discounting.
8. Time Is the period within which interest shall accrue. For
discounting purposes, it is the period from date of note
to maturity date.
In other words, the term “time” is the entire period or
“full term” of the note.

9. Discount Is the amount of interest deducted by the bank in

advance. Discount is equal to maturity value times
discount rate times discount period.
10. Discount Rate Is the rate used by the bank in computing the discount.
The discount rate should not be confused with the
interest rate.

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 TERMS RELATED TO DISCOUNTING OF NOTE

10. Discount Rate The discount rate and interest rate are different from
each other. If no discount is given, the interest rate is
safely assumed as the discount rate.

11. Discount Period Is the period of time from date of discounting to

maturity date.
Simply computed, discount period equals term of the
ILLUSTRATION note minus DISCOUNTING
the expiredWITHOUT RECOURSE
portion up to the date of
discounting. The discount period is the unexpired term
of the note and can be computed as the “full term of
the note less the expired term”.

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ILLUSTRATION - WITHOUT RECOURSE
Computation:
Maturity Value which is equal to the principal plus interest.
Principal 1,000,000
Interest (1,000,000 x 12% x 180/360) 60,000
Maturity Value 1,060,000
vvvvvvvvv
Observe that the interest must be for the full term of the note in
determining the maturity value.
Discount which is equal to the “maturity value times discount rate
times discount period.”
Discount (1,060,000 x 15% x 120/360) 53,000
vvvvvv
The discount period is the remaining term of the note on the date of
discounting.

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 ILLUSTRATION - WITHOUT RECOURSE
Term of Note 180 days
Less: Days expired from July 1 to August 30 60 days
Discount Period – Remaining Term 120 days
vvvvvvvv
In counting, “exclude the first day but include the last day.”
NET PROCEEDS FROM DISCOUNTING
Maturity Value 1,060,000
Discount (53,000)
Net Proceeds 1,007,000
vvvvvvvvv
CARRYING AMOUNT OF THE NOTE RECEIVABLE
Principal 1,000,000
Accrued Interest Receivable (1,000,000 x 12% x 60/360) 20,000
Carrying Amount of Note Receivable 1,020,000
vvvvvvvvv

Intermediate Accounting Part 1

 ILLUSTRATION - WITHOUT RECOURSE
The accrued interest receivable is interest earned from July 1 to the date
of discounting on August 30, or 60 days.
GAIN OR LOSS ON NOTE DISCOUNTING
Net Proceeds 1,007,000
Carrying amount of note receivable 1,020,000
Loss on Note Discounting (13,000)
vvvvvvv
The difference between the net proceeds from discounting and the
carrying amount of the note receivable is recognized as gain or loss.
ACCOUNTING FOR NOTE RECEIVABLE DISCOUNTING
The accounting for note receivable discounting depends on whether the
discounting is with or without recourse.
In the illustration, the discounting is without recourse, meaning, the
sale of the note receivable is absolute and therefore, there is no
contingent liability.

Intermediate Accounting Part 1

 ILLUSTRATION - WITHOUT RECOURSE
JOURNAL ENTRY
Cash 1,007,000
Loss on Note Receivable Discounting 13,000
Note Receivable 1,000,000
Interest Income 20,000
The note receivable is credited directly because the sale of the note
receivable is without recourse or absolute.
The interest income is credited for the actual interest earned on the date
of discounting.

ILLUSTRATION - WITHOUT RECOURSE

A P 2,400,000, 6-month 12% note dated February
1 is received from a customer by an entity and
discounted by First Bank on March 1 at 15%.
Intermediate Accounting Part 1
 ILLUSTRATION - WITH RECOURSE
Principal 2,400,000
Interest (2,400,000 x 12% x 6/12) 144,000
Maturity Value 2,544,000
Discount (2,400,000 x 15% x 5/12) (159,000)
Net Proceeds 2,385,000
vvvvvvvvv
Term of Note 6 months
Less: Age of Note (February 1 to March 1) 1 month
Discount Period 5 months
vvvvvvvv
Since the term of the note is expressed in “months”, the counting is by months
regardless of the number of days in a month.
Principal 2,400,000
Accrued Interest Receivable (2,400,000 x 12% x 1/12) 24,000
Carrying amount of note receivable 2,424,000
vvvvvvvvv

Intermediate Accounting Part 1

 ILLUSTRATION - WITH RECOURSE
The accrued interest receivable is for one month from February 1 to the date of
discounting on March 1.
Net Proceeds 2,385,000
Carrying amount of note receivable 2,424,000
Loss on note receivable discounting (39,000)
vvvvvvv

• If the discounting is with recourse, the

transaction is accounted for as either of the
following:
a. Conditional sale of note receivable
recognizing contingent liability
b. Secured borrowing
Intermediate Accounting Part 1
 CONDITIONAL SALE
• If the discounting is treated as a conditional
sale of note receivable, the journal entry to
record the transaction on March 1 is as
follows: Cash 2,385,000
Loss on Note Receivable Discounting 39,000
Note Receivable Discounted 2,400,000
Interest Income 24,000

• The note receivable discounted account is

deducted from the total notes receivable
when preparing the statement of financial
position with disclosure of the contingent
liability. Intermediate Accounting Part 1
NOTE IS PAID BY MAKER ON MATURITY
• On August 1, date of maturity, the note is
paid by the maker to the First Bank. The
contingent liability is extinguished as
follows:
Notes Receivable Discounted 2,400,000
Note Receivable 2,400,000

• The note is dishonored by the maker on

August 1, and the entity pays the First
Bank the maturity value of the note, P
2,544,000, plus protest fee and other
bank charges of P 6,000. The total
payment is charged to accounts
receivable.
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 NOTE IS DISHONORED BY MAKER
JOURNAL ENTRIES:
1. Accounts Receivable 2,550,000
Cash 2,550,000
To record the payment to First Bank.
2. Notes Receivable Discounted 2,400,000
Notes Receivable 2,400,000
To cancel the contingent liability.

SECURED BORROWING
• If the discounting is treated as a 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.
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 SECURED BORROWING

JOURNAL ENTRY:
Cash 2,385,000
Interest Expense 39,000
Liability for Note Receivable Discounted 2,400,000
Interest Income 24,000

• There is no objection if the interest expense is

“netted” against the interest income or net
interest expense of P 15,000 because the
discounting transaction is a borrowing.
• There is no gain or loss on discounting if the note
discounting is accounted for as secured borrowing.

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 NOTE IS PAID BY MAKER ON MATURITY
• If the note is paid by the maker to the First
Bank, the liability for note receivable
discounted and note receivable are
derecognized as follows:
JOURNAL ENTRIES:
Liability for Note receivable Discounted 2,400,000
Note Receivable 2,400,000

• The note is dishonored by the maker on

August 1, and the entity pays the First Bank
the maturity value of the note, P 2,544,000,
plus protest fee and other bank charges of P
6,000.
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 NOTE IS DISHONORED BY MAKER
JOURNAL ENTRIES:
1. Accounts Receivable 2,550,000
Cash 2,550,000
To record the payment to First Bank.
2. Liability for Notes Receivable Discounted 2,400,000
Notes Receivable 2,400,000
To derecognize the liability for note receivable discounted and note
receivable.

•
Intermediate Accounting Part 1
 CONDITIONAL SALE OR SECURED BORROWING

• PFRS 9, paragraph 3.2.3, provides than an

entity shall derecognize a financial asset when
either one of the following criteria is met:
a. The contractual rights to the cash flows of
the financial asset have expired.
b. The financial asset has been transferred
and the transfer qualifies for derecognition
based on the extent of transfer of risks and
rewards of ownership.
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 CONDITIONAL SALE OR SECURED
BORROWING
• The first criterion is easy to apply. The
contractual rights to the cash flows may
expire, for example, when a note receivable
from a customer is fully collected.
• The application of the second criterion is
often complex. It relies on the assessment
of the extent of the transfer of risks and
rewards of ownership.

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CONDITIONAL SALE OR SECURED BORROWING

• PFRS 9, paragraph 3.2.6, provides the

following guidelines for derecognition
based on transfer of risks and rewards:
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.
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 CONDITIONAL SALE OR SECURED BORROWING

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. Intermediate Accounting Part 1
 EVALUATION
• Unquestionably, the contractual rights to the
cash flows of the note receivable discounted
with recourse have not yet expired. Thus,
the first criterion does not apply.
• The discounting of note with recourse does
not also fall squarely within a single
guideline in the second criterion of “transfer
of risks and rewards of ownership.”

Intermediate Accounting Part 1

 EVALUATION
• 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.
Intermediate Accounting Part 1
 CONCLUSION
• Much debate on this accounting issue can
go on among academicians 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.
Intermediate Accounting Part 1
 CONCLUSION
• 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 the asset to a third party without
attaching any restrictions to the transfer.
Intermediate Accounting Part 1
 DISCOUNTING OF OWN NOTES
• In the previous discussion, the maker of
note discounted is a customer. In other
words, the party discounting is the payee
and a mere endorser and therefore only a
person secondarily liable.
• Where the note discounted is made by
the party discounting, a primary liability,
not a contingent liability, exists.
• In effect, the party discounting is entering
into a contract of loan with the endorsee.
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 DISCOUNTING OF OWN NOTES
• For example, an entity discounted at the
bank its own note of P 500,000 at 12%
for one year on September 1, 2019.
JOURNAL ENTRY
Cash 440,000
Discount on Notes Payable 60,000
Notes Payable-Bank 500,000

Principal 500,000
Discount (500,000 x 12%) (60,000)
Net Proceeds 440,000
vvvvvvv

Intermediate Accounting Part 1

 DISCOUNTING OF OWN NOTES
• On December 31, 2019, using the
straight line method, the discount on
notes payable is amortized as interest
expense for four months from
September 1 to December 31.

Interest Expense (60,000 x 4/12) 20,000

Discount on Notes Payable 20,000

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 DISCOUNTING OF OWN NOTES

• In December 31, 2019 Statement of

Financial Position, the Notes Payable
minus the discount on note payable is
presented as current liability.

Notes Payable-Bank 500,000

Discount on Notes Payable (40,000)
Carrying amount 460,000
vvvvvvv

Intermediate Accounting Part 1