Chapter 8

NOTE PAYABLE
 Note Payable

A promissory note is an unconditional promise in

writing made by one person to another, signed by the
maker, engaging to pay on demand or at a fixed or
determinable future time a certain in money to order
or to bearer.

Basically, is a written promissory note.

 Initial Measurement of Note Payable

 PFRS 9, paragraph 5.1.1, provides that a note payable not

designated at fair value through profit or loss shall be
measured initially at fair value minus transaction costs that
are directly attributable to the issue of the note payable.
 In other words, transaction cost are included in the
measurement of note payable.
 However, if it is irrevocably designated at FV through profit
or loss, the transaction costs are expensed immediately.
 The FV of the NP is equal to to the PV of the future cash
payment to settle the NP using market rate interest.
 Subsequent Measurement of Note Payable

PFRS 9, par. 5.3.1, provides that after initial

recognition, a note payable shall be measured:
a. At amortized cost using the effective interest
method.
b. At fair value through profit or loss if the NP is
designated irrevocably measured at FV through
profit or loss.
 Amortized Cost of Note Payable

The amortized cost of note payable is the amount at

which the note payable is measured initially:
a. Minus principal payment
b. Plus or minus the cumulative amortization using
the effective interest method of any difference
between the face amount and present value of the
note payable
Actually, the difference bet. the face amount and
present value is either discount or premium on the
issue of note payable.
 Note issued solely for cash

When a note is issued solely for cash, the present value is equal to the
cash proceeds.

Actually, the discount on payable of P120,000 is the total interest expense for 1
year.
Thus, on Dec. 31, 2020, after 2 months, the discount on NP is amortized as
interest expense.
Interest Expense 20,000
Discount on NP (12x2/12) 20,000
Next
The straight line method is used in amortizing the discount on note
payable for simplicity. Besides, the note payable has only a term for 1
year.

If a statement of financial position is prepared on December 31,2020, the

note payable is classified and reported as current liability.

Note Payable 1,000,000

Discount on Note Payable ( 100,000)
Carrying Amount 900,000

Observe that the discount on note payable is a direct deduction from the
face amount of the note payable.

The carrying amount of P900,000 is actually the “amortized cost” of the

note payable.
 Interest bearing note issued for property
When a property of noncash asset is acquired by issuing a promissory note
which is interest bearing, the property or asset is recorded at the purchase
price.
The purchase price is reasonably assumed to be the present value of the
note and therefore, the fair value of the property because the note issued is
interest bearing.

Journal Entries
2020
Jan. 1 Equipment 1,000,000
Note Payable 1,000,000
Dec. 31 Interest Expense (10%x 1,000,000) 100,000
Note Payable 200,000
Cash 300,00
Next
2021
Dec. 31 Interest Expense (10% x 800,000) 80,000
Note Payable 200,000
Cash 280,000
Payment for second installment and interest for 2o21
Noninterest bearing note issued for property

When a noninterest bearing note is issued for property, the

property is recorded at the cash price of the property.

The cash price is assumed to be the present value of the note

issued.

The difference between the cash price and the face of the note
issued represent imputed interest.

The imputed interest is based on the philosophy that no lender

would part away with his money or property interest-free.
Illustration
On January 1, 2020, an entity acquired an equipment with a cash price of
P350,000 for P500,000, P100,000 down and the balance payable in 4
equal annual installments.

Journal Entries for 2020

Jan. 1 Equipment 350,000

Discount on note payable 150,000
Cash 100,000
Note Payable 400,000

Dec. 31 Note Payable 100,000

Cash 100,000
Payment for annual installment.

31 Interest Expense 60,000

Discount on note payable 60,000
Amortization of the discount for 2020.
 Table of amortization
Year Note Payable Fraction Amortization

2020 400,000 4/10 60,000

2021 300,000 3/10 45,000
2022 200,000 2/10 30,000
2023 100,000 1/10 15,000
1,000,000 150,000

Note payable represents the amount outstanding every year.

The note was issued on Jan.1,2020 and the first payment was made on December
31, 2020.
Thus, fro 2019, the note payable outstanding is P400,000.

Fraction is developed from the note payable outstanding every year.

Amortization is the amount of discount multiplied by the fraction developed.

Thus, for 2020, P150,000 times 4/10 equals P60,000.
 Another Illustration – no cash price

On January 1, 2020, an entity acquired an equipment for P1,000,000

payable in 5 equal annual installments on every December 31 of each
year.

Observe that there is no agreed interest and no cash price is available

for the equipment.

In such case, the cost of the equpiment is equal to the Present value of the
P200,000 annual installments in 5 years at an appropriate rate of 10%.

The rate of 10% is assumed to be the prevailing market rate of interest.

The present value of an ordinary annuity of 1 for 5 years at 10% is 3.7908.

Therefore, the present value of five P200,000 installments is 758,160,

computed by multiplying P200,000 by the PV factor of 3.7908.
Journal Entries for 2020

Jan. 1 Equipment 758,160

Discount on note payable 241,840
Note Payable 1,000,000

Dec. 31 Note Payable 200,000

Cash 200,000
First installment payment.

31 Interest Expense 75,816

Discount on note payable 75,816
Amortization of the discount on Note Payable for 2020.

The “effective interest” method is followed in the amortization of the discount.

Table of amortization
Date Payment Interest Principal Present
Value
Jan. 1, 2020 758,160
Dec. 31,2020 200,000 75,816 124,184 633,976
Dec. 31,2021 200,000 63,398 136,602 497,374
Dec. 31,2022 200,000 49,737 150,263 347,111
Dec. 31,2023 200,000 34,711 165,289 181,822
Dec. 31,2024 200,000 18,178 181,822 ---

Payment represents the annual installment.

Interest is equal to the preceding present value multiplied by the implied

interest rate. Thus, for 2020, P758,160 time 10% equals P75,816.

Principal is the potion of the payment after deducting interest representing

principal.
Thus, on December 31,2020, P200,000 minus the interest of P75,816 equals
P124,184.

Present Value is the balance of the preceding present value after dedudting
the principal payment. Thus, on December 31,2020, P758,160 minus the
principal payment of P124,184 equals P633,976.

On December 31, 202, the current portion of the note payable would be
reported as current liability.

Note Payable 200,000

Discount on note payable ( 63,398)
Carrying amount- amortized cost 136,602

The noncurrent portion of the note payable would be reported as noncurrent

liability.

Note Payable 600,000

Discount on note payable (102,626)
Carrying amount- amortized cost 497,374
 Noninterest bearing note payable lump sum

On January 1, 2020, an entity acquired an equipment for P1,000,000. The entity

paid P100,000 down and signed a noninterest bearing note for the balance which
due after 3 years on January 1, 2023.

There was no established cash price for the equipment. The prevailing interest
rate for this type of note is 10%. The present value of 1 for 3 periods is .7513.

Computation
Downpayment 100, 000
PV of note (P900,000x .7513) 676, 170
Cost of equipment 776, 170
Imputed Interest
Face value of note 900, 000
Present value of note 676, 170
Imputed interest 223, 830
Journal Entries
1. To record the purchase of equipment on January 1, 2020.

Equipment 776, 170

Discount on note payable 223, 830
Cash 100, 000
Note payable 900, 000
2. To record the Interest expense for 2020:

Interest Expense 67, 617

Discount on Note Payabe 67, 617
The discount on note payable is amortized as interest expense using the
“effective interest” method.
3. To record the full payment of the note on January 1, 2023:

Note Payable 900,000

Cash 900,000
Table of amortization
Date Interest Discount on Present
expense note payable Value
1/1/2020 223,830 676,170
12/31/2020 67,617 156,213 743,787
12/31/2021 74,379 81,834 818,166
12/31/2022 81,834 --- 900,000

Interest Expense is equal to the preceding present value multiplied by the

implied interest rate. Thus, for 2020, P676,170 times 10% equals P67,617.

Discount on note payable is the balance minus the interest of P67,617 equals
P156,213.

Present value is the preceding balance plus the interest expense every year.
Thus, on December 31, 2020, P676,170 plus the interest of P67,617 equals
P743,787.
 Fair value option of measuring note payable

PFRS 9, par. 4.2.2, provides that at initial recognition, a note payable may
be irrevocably designated as at fair value through profit or loss.
par. 5.7.7, provides that the gain or loss on financial liability designated at
fair value through profit or loss shall be accounted for as follows:

a. The change in fair value attributable to the credit risk is recognized in

other comprehensive income.

Credit risk is the risk that the issuer of the liability would cause a financial loss to the other
party by failing to discharge the obligation. Does not include market risk such as interest
risk, currency risk and price risk.

b. The remaining amount of the change in fair value is recognized in

profit or loss.
Application Guidance B5.7.9 provides that amount recognized in OCI
income resulting from change in fair value attributable to credit risk shall
not be subsequently transferred to profit or loss.

However, the cumulative gain or loss recognized may be transferred

within equity or retained earnings.

Under Fair value option, any transaction cost is recognized as outright

expense.

There is no amortization of discount and premium on note payable.

As a matter of fact, interest expense is recognized using the nominal or

stated interest rate.
Illustration
On January 1, 2020, an entity borrowed from bank P4,000,000 on a 12%
5-year interest bearing note.

The entity received P4,000,000 which is the fair value of the note on
January 1, 2020. Transaction cost of P100,000 was paid by the entity.

The fair value of the note payable was P3,500,000 on December 31, 2020.

The entity has elected irrevocably the fair value option for
measuring the note payable.

The change in fair value comprised P50,000 attributable to credit risk

and P450,000 attributable to interest risk.
Journal Entries for 2020

Jan. 1 Cash 4,000,000

Note Payable 4,000,000
1 Transaction cost 100,000
Cash 100,000

Dec. 31 Interest Expense (12%x4M) 480,000

Cash 480,000

31 Note Payable 500,000

Gain from change in FV 450,000
Gain from credit risk- OCI 50,000

Carrying amount 4,000,000

Fair value—Dec.31,2020 3,500,000
Decrease in Fair valueof liability- gain 500,000

The gain from change in fair value is recognized in profit or loss.

The gain from credit risk is recognized in other comprehensive income.
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