Components of a Note

Notes Receivable represents claims for which formal instruments of credit are
issued as evidence of debt, such as a promissory note.

A negotiable 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 determinable future time a sum certain in money to order or to bearer.

LEARNING OBJECTIVES
Explain the purpose of a note receivable and its format

Key Points

 A notes receivable normally requires the debtor to pay interest and extends
for time periods of 30 days or longer.
 Often a business will allow a customer to convert their overdue accounts into
a notes receivable. Doing so gives the debtor more time to pay.
 The principle is the face value of the note. The principle equals the initial
amount of credit provided.
 The maker of a note is the party who receives the credit and promises to pay
the note’s holder.
 Notes generally specify an interest rate, which is used to determine how
much interest the maker of the note must pay in addition to the principal.

Key Terms

 DEBTOR: One who owes another anything, or is under obligation, arising

from express agreement, implication of law, or principles of natural justice, to
pay money or to fulfill some other obligation; in bankruptcy or similar
proceedings, the person who is the subject of the proceeding.
 PROMISSORY: Stipulating the future actions required of the parties to an
insurance policy or other business agreement.
 PROMISSORY NOTE: a document saying that someone owes a specific
amount of money to someone else, often with the deadline and interest fees
  MAKER: the party issuing a promissory note
 PAYEE: the party receiving the promissory note

Dishonored notes
 When a promissory note matures and is not paid, it is said to be dishonored.
 Theoretically, dishonored notes receivable should be remove from the notes
receivable account and transferred to accounts receivable.
 The amount debited to accounts receivable should include the face amount,
interest and other charges.
 Such approach is defended on the ground that the overdue note has lost part
of its status as a negotiable instrument and really represents only an ordinary
claim against the maker.
Notes Receivable

Notes Receivable represents claims for which formal instruments of credit are
issued as evidence of debt, such as a promissory note. Often a business will allow a
customer to convert their overdue accounts into a notes receivable. Doing so gives
the debtor more time to pay. Occasionally, the notes receivable will include a
personal guarantee by the owner of the debtor.

A notes receivable normally requires the debtor to pay interest and extends for time
periods of 30 days or longer. Notes receivable are considered current assets if they
are to be paid within 1 year and non-current if they are expected to be paid after one
year.

 Receivables are initially recognize at fair value plus transaction costs.

However, trade receivables that do not have a significant financing
component are measured at the transaction price.
 Short-term receivables are initially measured at whichever of the following is
most appropriate: face amount, present value, or transaction price.
 Long-term receivables with reasonable interest rate are initially recognized at face
amount and subsequently measured at recoverable historical cost.
 Long -term noninterest - bearing receivables and Long term receivables with
unreasonable interest rate are initially measured at present value and
subsequently measured at amortized cost.
  If the cash price equivalent of the non-cash asset forgone in exchange for a
receivable is available, the receivable is initially measured at the cash price
equivalent and subsequently measured at amortized cost.
 Stated interest rate(nominal rate, coupon rate, or face rate) is the rate appearing on
the face of interest-bearing note.
 Effective interest rate (imputed rate of interest, current market rate or yield rate) is
the rate used in present value computations.
Analysis:
 A noninterest-bearing note has an unspecified principal and unspecified interest.
 Type
Theseof receivable:
elements Long term receivable
are separated bearing
through reasonable
present interest
value rate - nominal rate of
computations.
 10%
PV isofequal to thewhen
1 is used currentthe
ratefuture
on initial recognition
cash flow is of
in10%.
lump sum.
 Initial measurement: Face amount
 PV of an ordinary annuity of 1 is used when the future cash flows are in
 Subsequent measurement: Recoverable historical cost
 Type of interest: and
installments the
Simple first installment
Interest begin
does notbased
- interest is computed immediately.
only on the outstanding
 principal an annuity due of 1 is used when the future cash flows are in
PV of balance
installments and the first installment begins immediately.
 Total interest income recognized over the life of a noninterest-bearing note is
equal to the unearned interest income on initial recognition.
 The formula in the "trial and error" approach is:
 Future cash flows x PV factor at x% = Present Value.
 Interest receivable= nominal rate x face amount
 Interest income= effective interest rate x present value.
 Only post-acquisition accrued interests are recognized as interest income.

Illustration 1: SIMPLE INTEREST

On April 1, 20x1, ABC Co. received a 1,500,000, 10%, 3years note receivable in
exchange for land with carrying amount of 850,000. Principal, in theee equal
installments, plus interest are due annually starting April 1, 20x2. Current market
rates as of April 1, 20x1, December 31, 20x1, and December 31, 20x2 are 10%, 12%
and 13%, respectively.
The entries relating to the note receivable are as follows:

April Notes Receivable 1,500,000

1,
Land 850,000
20x1
Gain on sale 650,000

to record the sale of land

Dec. Interest receivable (1.5M x 10% x 9/12) 112,500

31, Interest income 112,500

20x1 to record the accrued interest for 20x1

April Cash (principal plus interest) 650,000

1, Notes receivable (1,500,000÷3) 500,000

20x2 Interest income(1.5M x 10%x3/12) 37,500

Interest receivable 112,500

To record the receipt of 1st installment on

note receivable

Dec. Interest receivable [(1.5M- 75,000

5M)x10%x9/12)]
31, 75,000
Interest income
20x2
To record the accrued interest for 20x2

April Cash (principal plus interest) 600,000

1, Notes receivable 500,000

20x3 Interest income (1Mx 10% x 3/12) 25,000

 Interest receivable 75,000

To record the receipt of 2nd installment on

note receivable

Analysis:
Dec. Interest receivable
Type of receivable: [(1.5M-5M)
Long-term x 10%
receivable x 37,500
bearing reasonable interest rate- nominal rate of
10% is assumed equal to the current rate on initial recognition because no additional
9/12]
31, information is given. 37,500
 Initial measurement:
Interest income Face amount
20x3 Subsequent measurement: Recoverable historical cost
 Type of interest: Compounded interest- interest is computed based on both principal
To record the accrued interest for 20x3
principal and accrued interest balances.
April Cash(principal plus interest) 550,000

1, Notes receivable 500,000

20x4 Interest income (5Mx10%x3/12) 12,500

Interest receivable 37,500

To record the receipt of last installment on

note receivable

Illustration 2: COMPOUNDED INTEREST

On January 1, 20x1, ABC Co. extended a 1,000,000 loan to one of its officers. The note
received is due on January 1,20x4 and bears 10% interest compaounded annually.

The entries relating to the note receivable are as follows:

 Jan. Note receivable 1,000,000

1, Cash 1,000,000

20x1 To record the loan

Dec. Interest Receivable (1Mx10%) 100,000

31,
Interest income 100,000
20x1
To record the accrued interest income for 20x1

Dec. Interest receivable (1M + 100K) x 10% 110,000

31, Interest income 110,000

20x2 To record the accrued interest income for 20x2

Dec. Interest receivable (1M+100K+110K)x 10% 121,000

31, Interest income 121,000

20x3 To record the accrued interest income for 20x3

Analysis:

 Type of receivable: Long-term noninterest-bearing receivable

 Initial measurement: present value
Jan. Cash ( 1M+100K+110K+121K) 1,331,000
 Present value factor: " PV of 1" because the note is collectible on a lump sum basis.
 Subsequent measurement: Amortized cost using the effective interest method.
1, Note receivable 1,000,000

20x4 Interest Receivable (100K+ 110K+ 121K) 331,000

To record the collection of the loan together with

accrued interests

Illustration 3: NONINTEREST-BEARING NOTE- LUMPSUM

On January 1, 20x1, ABC Co. sold a transportation equipment with a historical

cost of 2,000,000 and accumulated depreciation of 700,000 in exchange for cash of
100,000 and a noninterest-bearing note receivable of 1,000,000 due on January 1,20x4.
The prevailing rate of interest for this type of note is 12%.
The present value of the note on January 1, 20x1 is computed as follows:

Future cash flow(face amount) 1,000,000

Multiply by: PV of 1 @12%,n=3 0.711780

Present Value of note receivable 711,780

The rate used in the present value factor is the effective interest rate on initial
recognition. The "n" of 3 covers the period Jan. 1, 20x1 to Jan. 1, 20x4.

The difference between the face amount and the present value of the note
represents the unearned interest income. The unamortized balanced of the unearned
interest
Analysis: income is a valuation account (deduction) to the note receivable when
determining its carrying
Type of receivable: amount.
Long-term noninterest-bearing receivable

Initialreceivable
Note measurement: present value 1,000,00
Present value
Unearned factor: income
interest " PV of ordinary annuity of 1" because
(1M-711,780) the note is collectible in installment
(277,220)
and the first installment is due after one period from initial recognition.
Carrying amount of note receivable-Jan. 1, 711,780
Subsequent measurement: Amortized cost using the effective interest method.
20x1

Illustration 4: NONINTEREST-BEARING NOTE- INSTALLMENT

On January 1, 20x1, ABC Co. sold a transportation equipment with a historical

cost of 2,000,000 nd accumulated depreciation of 700,000 in exchange for cash of
100,000 andsolution
Alternative a noninterest-bearing
on a non-scientific calculator: 1.12 ÷ ÷ =of3times.
note receivable 1,000,000 due in 4 equal annual
installment starting
Multiply by lump onflow
sum cash December 31, =20x1
of 1,000,000 and every December 31 thereafter. The
711,780
prevailing rate of interest for this type of note is 12%.
Alternative solution on a non-scientific calculator: 1.12 ÷ ÷ = 4times, then - 1=÷12% =, then diregard
negative sign. Multiply by 250,000 annual cash flow = 759,337.

The present value of the note as of January 1, 20x1 is computed as follows:

Future cash flows-annual installments (1M÷4) 250,000

Multiply by: PV of an ordinar annuity of 1 @12%,n=-4 3.037349

Present value of note receivable 759,337

The rate used in the present value factor is the effective interest rate on initial
recognition. The "n" of 4 is the number of installment collections.

The difference between the face amount and the present value of the note
represents the unearned interest income. The unamortized balanced of the unearned
interest income is a valuation account (deduction) to the note receivable when
determining its carrying amount.

Note receivable 1,000,000

Unearned interest income(1M-759,337) 243,663

Carrying amount of note receivable-Jan. 1, 20x1 759,337

The note receivable is initially recorded as follows:

Jan.1, Cash 100,000

20x1 Note receivable 1,000,000

Accumulated depreciation 700,000

 Loss on sale of equipment (squeeze) 440,663

Transportation equipment 2,000,000

Unearned interest income 240,663

An amortization table is prepared to serve as basis for subsequent journal entries:

Date Collections Interest income Amortization Present value

a
b=d x effective c=a-b d=prev. Bal.-
interest rate c

1/1/20x1 759,337

12/31/20x1 250,000 91,120 158,880 600,458

12/31/20x2 250,000 72,055 177,945 422,513

12/31/20x3 250,000 50,702 199,298 223,214

12/31/20x4 250,000 26,786 223,214 0

Analysis:
Illustration 5: NONINTEREST-BEARING NOTE- INSTALLMENT IN
Type of receivable: Long-term noninterest-bearing receivable
ADVANCE
Initial measurement: present value
On January 1, 20x1, ABC Co. sold a transportation equipment with a historical cost
Present value factor: " PV of ordinary annuity of 1" because the note is collectible in installment
ofand
2,000,000
the first and accumulated
installment depreciation of 700,000 in exchange for cash of 100,000
is due immediately.
and a noninterest-bearing
Subsequent note cost
measurement: Amortized receivable of 1,000,000
using the effective interestdue in 4 equal annual
method.
installment starting on January 1,, 20x1 and every January 1 thereafter. The
prevailing rate of interest for this type of note is 12%.
Future cash flows-annual installments (1M÷4) 250,000

Multiply by: PV of an annuity due of 1 @12%,n=-4 3.40183

Present value of note receivable 850,458

The present value of the note as of January 1, 20x1 is computed as follows;

The entries on January 1, 20x1 are as follows:

Jan.1, Cash 100,000

20x1 Note receivable 1,000,000

Accumulated depreciation 700,000

Loss on sale of equipment (squeeze) 349,542

Transportation equipment 2,000,000

Unearned interest income 149,542

To record the sale of equipment

Jan. 1, 20x1 Cash 250,0000

Note Receivable 250,000

To record the first Installment due in

Advance

(1,000,000 face amount less 850,458 present value)

Amortization table: installment allowance

Date Collections Interest income Amortization Present value

a
b=d x effective c=a-b d=prev. Bal.-c
interest rate
850,458.
1/1/20x1 850,458
then diregard negative sign then increase the value by 1. Multiply by 250,000 annual cash flow =

1/1/20x1 250,000 - 250,000 600,458

Alternative solution on a non-scientific calculator: 1.12 ÷ ÷ = 3times (i.e.,n minus 1), then - 1=÷12% =,
1/1/20x2 250,000 72,055 177,945 422,513

1/1/20x3 250,000 50,702 199,298 223,214

1/1/20x4 250,000 26,786 223,214 0

Illustration 6: NONINTEREST-BEARING NOTE- SEMIANNUAL CASH FLOWS

On January 1, 20x1, ABC Co. sold machinery with a historical cost of 2,000,000
Discounting semiannual cash flows
and accumulated depreciation of 1,100,000 in exchange for a 3-years, 1,200,000
When discounting cash note
noninterest-bearing flows Receivable
that are due indue
semiannual
in equalinstallments,
semi annual the "n" (period) used
payments everyin the
July
present value factor is multiplied by 2 because there are two semiannual installments per year.
1 and December 31 starting on July 1,20x1. The prevailing rate of interest for this
Furthermore, the effective interest rate is divided by 2 because interest rates are normally
type of note
expressed on aisper
10%.
annum basis.

When cash flows re due quarterly, "n" is multiplied y 4 and the interest rate is
divided by 4 because there are 4 quarter in a year. When cash flows are due
monthly, "n" is multiplied by 12 and the rate is divided by 12 because there aare
12months in a year. When cash flows are due weekly, "n" is multiplied by 52 and the
rate is divided by 52. When cash flows are due daily, "n" is multiplied by 365 and the
rate is divided by 365. When cash flows are due per minute.... Oh well, you get what
i mean....whew! (Panting)

Therefore, the "n" to be used in the illustration above is 6years. (I.e., 3years x 2) and the
discount rate is 5% (i.e., 10%÷2).

Future cash flows-semiannual installments (1.2M÷6) 200,000

Multiply by: PV of an ordinary annuity of 1 @5%,n=-6 5.075692

Present value of note receivable 1,015,138

The present value of the note as of January 1,20x1 is computed as follows;

The note receivable is initially recognized as follows:

Jan.1, Note receivable 1,200,000

20x1 Accumulated depreciation 1,100,000

Machinery 2,000,000

Unearned interest income 184,862

Gain on sale of machinery 115,138

(1,200,000 face amount less 1,015,138 present value)

This amount is squeeze

Amortization table- semiannual installments

Date Collections Interest income Amortization Present value

a
b=d x effective c=a-b d=prev. Bal.-c
interest rate

Jan. 1,20x1 1,015,138

July 1,20x1 200,000 50,757 149,243 865,865

Dec.31,20x1 200,000 43,295 156,705 709,190

July 1, 20x2 200,000 35,460 164,540 544,650

Dec. 3120x2 200,000 27,232 172,768 371,882

July 1, 20x3 200,000 18,594 181,406 190,476

Dec. 31 20x3 200,000 9,524 190,476

Alternative solution on a non-scientific calculator:

Press 1.05÷÷= 6times, then - 1 =÷5% =. Disregard negative sign x 200,000 semiannual cash flow =
1,015,138.
Discounting non-uniform (unequal) cash flows

Annuity factors are applicable only when the series of cash flows are uniform or equal. When the
The
seriesother entries
of cash in 20x1
flows vary, areofas
the PV follows:
1 should be used.

July A1,cash
20x1flow that is due one period from initial recognition
Cash is discounted using PV of 1 for a
200,000
period ('n') of 1. A cash flow that is due two periods from initial recognition is discounted using PV of
1 for a period ('n) of 2, and so on.
Unearned interest income 50,757

Note receivable 200,000

Interest income 50,757

Dec. 31, 20x1 Cash 200,000

Unearned interest 43,295

Note receivable 200,000

Interest income 43,295

Illustration 7: NONINTEREST-BEARING NOTE-NON-UNIFORM CASH

FLOWS

On January 1, 20x1, ABC Co. sold machinery costing 2,000,000 with accumulated
depreciation of 1,100,000 in exchange for a 3-years, 1,200,000 noninterest-bearing note Receivable
due as follows:

DATE AMOUNT OF INSTALLMENT

December 31,20x1 600,000

December 31,20x2 400,000

December 31,20x3 200,000

Total 1,200,000

The prevailing rate of interest for this type of note is 10%.

The present value of the note is computed as follows:

Date Collections PV of 1 @10%, n=1to3* Present value

Dec. 31,20x1 600,000 0.90909 545,455

Dec. 31,20x2 400,000 0.82645 330,579

Dec.31,20x3 200,000 0.75131 150,263

Totals 1,200,000 1,026,296

*PV of 1 @10%:n=1 is 0.90909; n=2 is 0.82645; and n=3 is .75131

Amortization table-non-uniform installments

Date Collections Interest Amortization Present value

income

Jan. 1,20x1 1,026,296

Dec. 31,20x1 600,000 102,630 497,370 528,926

Dec. 31,20x2 400,000 52,893 347,107 181,818

Dec.31,20x3 200,000 18,182 181,818 0

The entries in 20x1 are as follows:

 Jan.1, Note receivable 1,200,000

20x1 Accumulated depreciation 1,100,000

Machinery 2,000,000

Unearned interest income 173,704

Gain on sale of machinery 126,296

Dec. 31, Cash 600,000

20x1
Unearned interest 102,630

Note receivable 600,000

Interest income 102,630

Illustration 8: Receivable with cash price equivalent

On January 1,20x1 , ABC Co. Sold inventory costing 800,000 with a list price of
1,100,000 and a casg price of 1,000,000 in exchange for a 1,200,000 noninterest-
bearing note due on December 31,20x3.

Analysis:

 Intial measurement: The fair value of the receivable on initial recognition is the cash price
equivalent of the non-cash asset given up.
 Subsequent measurement: Amortized cost using the effective interest method.
The note receivable is initially recognized as follows:

Jan 1, 20x1 Note receivable 1,200,000

Sales 1,000,000

Unearned interest (1.2M - 1M) 200,000

Illustration 9:NOTE WITH BELOW-MARKET INTEREST (SIMPLE INTEREST) -

PRINCIPAL DUE AT MATURITY, INTERESTS DUE PERIODICALLY
 On January 1, 20x1, ABC Co. sold machinery with historical cost of 2,000,000
and accumulated depreciation of 950,000 in exchange for a 3year, 3%, 1,000,000 note
receivable. Principal is due on January 1, 20x4 but interest is due annually every
January 1. The prevailing interest rate for this type of note is 12%.

Analysis:

 Type of receivable: Long-term receivable bearing unreasonable interest rate- the nominal
rate of 3% is below the current rate of 12%.

 Initial measurement: present value

 Present value factor: " PVof 1" for the principal because it is due in lump sum at maturity
date. "PV of ordinary annuity of 1" for the interest because they are due periodically..

To compute for the present

 Subsequent value ofAmortized
measurement: the note,cost
theusing
future
thecash flowsinterest
effective are themethod.
first identified then
multiplied by the present value factors.

Future cash flows Present value factors Present value

@12%,n=3

Principal 1,000,000 0.71178 711,780

Annual interest (1Mx3%) 30,000 2.40183 72,055

Total 783,835

(PV of 1@12%,n=3)

(PV of ordinary annuity of 1@12%,n=3

Amortization table: (installment)

Date Collections Interest Amortization Present value

income

Jan. 1,20x1 783,835

 Jan. 1,20x2 30,000 94,060 64,060 847,895

Jan. 1,20x3 30,000 101,747 71,747 919,642

Jan. 1,20x4 30,000 110,357 80,357 1,000,000

Amount rounded off

The entries relating to the note receivable are as follows:

Jan. Note receivable 1,000,000

1,
Accumulated depreciation 950,000
20x1
Loss on sale of machinery 266,165

Machinery 2,000,000

Unearned interest income 216,165

Dec. Interest receivable (1Mx3%) 30,000

31,
Unearned interest income 64,060
20x1
Interest income 94,06

Jan. 1, Cash 30,000

20x2
Interest receivable 30,000

Dec. Interest receivable 30,000

31,
Unearned interest income 71,747
20x2
Interest income 101,747

Jan. 1, Cash 30,000

20x3
Interest receivable 30,000

Dec. Interest Receivable 30,000

31,
Unearned interest income 80,357
20x3
Interest income 110,357

Jan. 1, Cash 30,000

20x4 Interestre receivable 30,000

Cash 1,000,000

Note Receivable 1,000,000

Illustration 10: NOTE WITH BELOW-MARKET INTEREST (SIMPLE INTEREST)

- PRINCIPAL DUE AT MATURITY, INTERESTS DUE IN SEMIANNUAL
INSTALLMENTS

On January 1, 20x1 ABC, Co. Sold machinery costing 2,000,000 with

accumulated depreciation of 950,000 in exchange for a 3year, 3% 1,000,000 note
receivable. Principal is due on January 1, 20x4 but interest are due semiannually
every July 1 and January 1. The prevailing interest rate for this type of note is 12%.

The present value of the note is computed as follows:

Future cash flows Present value factors Present value

@6%,n=6

Analysis:Principal 1,000,000 0.70496 704,961

Annual interest
 Type (1Mx1.5%)
of receivable: 15,000receivable bearing4.91732
Long-term 73,760
unreasonable interest rate- the nominal
rate of 3% is below the current rate of 12%.
Total
 Initial measurement: present value 778,720
Present value factor: " PV of 1" for the principal because it is due in lump sum at maturity
(PV of1 @6%,n=6)
date. "PV of ordinary annuity of 1" for the interest because they are due periodically.
 Frequency of cash flows: semiannual collections for interests. Therefore, the effective
(PV of ordinary annuity of 1@6%,n=6)
interest rate to be used is 6% (12%÷2) and the "n" to be used is 6(3yrs. x 2).
 Subsequent measurement: Amortized cost using the effective interest method.
Amortization table: (Installment)
 Date Collections Interest Amortization Present value
income

Jan. 1,20x1 778,720

Jan. 1,20x1 15,000 46,723 31,723 810,443

Analysis:
Jan. 1,20x2 15,000 48,627 33,627 844,070
Type of receivable: Long-term
July 1,20x2 15,000 receivable bearing
50,644 unreasonable35,644
interest rate- the nominal rate
879,714
of 3% is below the current rate of 12%.
Initial
Jan. measurement:15,000
1,20x3 present value 52,783 37,783 917,497
 Present value factor: " PV of 1" Although cash flows for both principal and interest are due
July 1,20x3 the cash15,000
periodically, 55,050
flows are non-uniform. 40,050 957,547
 Subsequent measurement: Amortized cost using the effective interest method.
Jan. 1,20x4 15,000 57,453 42,453 1,000,000

Illustration 11: NOTE WITH BELOW-MARKET INTEREST (SIMPLE INTEREST)

- PRINCIPAL AND INTEREST COLLECTIBLE IN INSTALLMENTS

On January 1, 20x1 ABC, Co. Sold machinery costing 2,000,000 with accumulated
depreciation of 950,000 in exchange for a 3year, 3% 1,200,000 note receivable.
Principal is due in three equal annual installments. Interests on the outstanding
principal balance are also due annually and are to be collected together with the
periodic collections on the principal. The prevailing interest rate for this type of note
is 12%.

The future cash flows from the note are determined as follows:

Date Collections on Interest on Total cash flows

principal (a) outstanding (c)=(a)+(b)
principal balance
(b)
 Dec. 31,20x1 400,000 (1,200,000 x 3%)= 436,000
36,000

Dec. 31,20x2 400,000 (800,000 x 3%)= 424,000

24,000

Dec. 31,20x3 400,000 (400,000 x 3%) = 412,000

12,000

The present value of note is computed as follows:

Date Future cash flows PV of 1 factors Present Value

@12%,=1 to 3

Dec. 31,20x1 436,000 0.89286 389,287

Dec. 31,20x2 424,000 0.79719 338,009

Dec. 31,20x3 412,000 0.71178 293,253

Total 1,020,549

(PV of 1@12%:n=1); (n=2); (n=3)

Amortization table:

Date Collections Interest Amortization Present value

income

Jan. 1,20x1 1,020,549

Jan. 1,20x2 436,000 122,466 313,534 707,015

Jan. 1,20x3 436,000 84,842 339,158 367,857

Jan. 1,20x4 436,000 44,144 367,857 0

The entries relating to the note receivable are as follows:

Jan. 1, 20x 1 Note Receivable 1,200,000

Accumulated depreciation 950,000

Loss on sale of machinery 29,451

Machinery 2,000,000
 Unearned interesy income 179,451

Dec. 31, 20x1 Cash 436,000

Unearned interest (400k-313,534) 86,466

Note Receivable 400,000

Interest income 122,466

Dec. 31, 20x2 Cash 424,000

Unearned interest (400k-339,158) 60,8242

Note receivable 400,000

Interest income 84,842

Dec. 31, 20x3 Cash 412,000

Unearned interest (400k-367,857) 32,143

Note Receivable 400,000

Interest income 44,143

Analysis:
Illustration 12: NOTE WITH BELOW-MARKET INTEREST (SIMPLE INTEREST)
 Type of receivable: Long-term receivable bearing unreasonable interest rate- the nominal
- PRINCIPAL AND INTEREST DUE AT MATURITY
rate of 3% is below the current rate of 12%.
 Initial measurement: present value
On January
 Present1, value
20x1 factor:
ABC," Co.
PVof Sold machinery
1" Although costing
cash flows 2,000,000
for both principal with accumulated
and interest are due
on maturity
depreciation date. in exchange for a 3year, 1,000,000 note receivable. Principal
of 950,000
 Type of interest- Compounded- interest is based on both the principal and any accrued
and interest at receivable.
interest 3% are due on January 1, 20x4.The prevailing interest rate for this
Subsequent
 note
type of is 12%.measurement: Amortized cost using the effective interest method.
 The future cash flow from the note consists of both the principal and interest.
Accordingly, the future cash flow represents the future value of the note. The
relevant future value factor is provided below:

The future cash flow is computed as follows:

Future cash flow 1,092,727

PV of 1@12%, n=3 0.71178

PV of note receivable-Jan. 1,20x1 777,781

Conclusion:

In conclusion, “receivables management is the diligent tracking and methodical

practice of following up on and collecting payments” (Wertz, n.d). A company can
properly manage its accounts receivable if it knows what the accounts receivable
turnover rate is and the average collection period. By using this information, a
company can evaluate its credit policy and make changes to ensure a higher rate of
accounts receivable turnover and increase its cash flow.

EXERCISES: TRUE OR FALSE

1. Trade receivables occur when two companies trade or exchange notes
receivables.
2. Other receivables include nontrade receivables such as loans to company
officers.
3. Both accounts receivable and notes receivable represent claims that are
expected to be collected in cash.
4. Receivables are valued and reported in the balance sheet at their gross
amount less any sales returns and allowances and less any cash discount.
Future value of 1 @3%, n =3. 1.092727
 5. Note is also called a promissory note, and unconditional written promise by a
borrower (maker) to pay a definite sum of money to the lender (payee) on
demand or on a specific date.
6. Principal is the face value of the note
7. Interest is stated in percentage, usually on an annual basis.
8. Accruing interest is not necessary when the fiscal (reporting) year end comes
before the maturity date of note.
9. Time is the amount of time in days or months.
10. Interest calculation is ( interest = Principal x Rate x Time (# of days)/365).

PROBEM 1
On December 31, 2018, chang company sold a machine in the ordinary course of
business to Door company in exchange for a noninterest bearing note requiring ten
annual payments of 1,000,000. The entity made the first payment on December 31,
2018. The market interest rate for similar notes at date of issuance was 8%.

PV of an ordinary annuity of 1 at 8% for 9 periods 6.25

PV of an ordinary annuity of 1 at 8% for 10 periods 6.71

ANSWER THE QUESTIONS:

a) What is the amount of sales revenue?
b) On December 31, 2018, what is the carrying amount of the note receivable?
c) What is the interest income for 2019?
d) What is the carrying amount of the note receivable on December 31, 2019?

PROBLEM 2
On December 31, 2018, London Bank granted a 5,000,000 loan to a borrower with
10% stated rate payable annually and maturing in 5 years.

The loan was discounted at the market interest rate of 12%

Unfortunately, the financial condition of the borrower worsened because of lower

revenue.
On December 31, 2020, the bank determined that the borrower would pay back only
3,000,000 of the principal at maturity.

However, it was considered likely that interest would continue to be paid on the
5,000,000 loan.
The present value of 1 at 12% is .57 for five periods and .71 for three periods. The
present value of an ordinary annuity of 1 at 12% is 3.60 for five periods and 2.40 for
three periods.

ANSWER THE QUESTIONS:

a) What is the amount of cash paid to the borrower on December 31, 2018?
b) What is the carrying amount of the loan receivable on December 31, 2020?
c) What is the impairment loss for 2020?
Key Answers and Solutions:

1. F 6. T
2. T 7. F
3. T 8. F
4. F 9. T
5. T 10. T

Problem 1 Solutions:

Question a

Cash 1,000,000
Note receivable 9,000,000
Sales 7,250,000
Unearned interest income 2,750,000

First payment on December 31, 2018 1,000,000

Present Value of remaining nine payments
(1,000,000 x 6.25) 6,250,000
Total sales revenue 7,250,000

Question b

Present value of remaining nine payments 6,250,000

Question c

Interest income for 2019( 8% x 6,250,000) 500,000

Question d

Note receivable- December 31, 2018 9,000,000

Collection on December 31, 2019 (1,000,000)
Note receivable- December 31, 2018 8,000,000
Unearned interest income- December 31,2019
(2,750,000 – 500,000) (2,250,000)
Carrying amount- December 31, 2019 5,750,000
PROBLEM 2 Solutions:

Question a

PV of principal (5,000,000 x .57) 2,850,000

PV of interest (10% x 5,000,000 x 3.60) 1,800,000
Cash paid to borrower 4,650,000
Principal 5,000,000
Present value (4,650,000)
Unearned interest income 350,000

Journal entry:

Loan receivable 5,000,000

Cash 4,650,000
Unearned interest income 350,000

Question b

DATE INTEREST INTEREST AMORTIZATION PRESENT

RECEIVED INCOME VALUE
10% 12%
12/31/2018 4,650,000
12/31/2019 500,000 558,000 58,000 4,708,000
12/31/2020 500,000 564,960 64,960 4,772,960
Loan receivable- December 31, 2020 5,000,000
Unearned interest income (350,000 – 58,000 – 64,960) (227,040)
Carrying amount- December 31, 2020 4,772,960

Question c

PV of principal (3,000,000 x .71) 2,130,000

PV of interest (500,000 x 2.40) 1,200,000
Total present value 3,330,000
Carrying amount- December 31, 2020 4,772,960
Impairment loss for 2020 1,442,960

Original interest (10% x 5,000,000) 500,000