3.

Record Indirect Origination Costs

CHAPTER 6: ADDITIONAL CONCEPTS
Administrative Expense 8,000
Cash 8,000
LOANS RECEIVABLE
 It is similar to note receivable, except that it BORROWER’S BOOKS
usually involves transaction costs Principal Amount 1,000,000
 It is more appropriately used with entities whose Origination Fee
main operations involve the lending of money (60,000)
Initial Carrying Amount of Loan Rec.
TRANSACTION COST 940,000
 Incremental costs that are directly attributable to
the acquisition, issue, or disposal of a financial Journal Entry (01/01/20x1) Debit Credit
asset or liability. 1. Record of Loan Payable
 Includes fees and commissions, levies, and Cash 940K
transfer taxes and duties Discounts on Loan Payable 60K
 It does not include that premiums or discounts, Loan Payable
1M
financing costs or internal administrative or
holding costs. Interest Income Computation for Trial & Error
 Subsequent interests will not be computed using
INCREMENTAL COST this stated interest rate of 10% but rather using
 Would not Have been incurred if the entity had an imputed interest rate.
not acquired, issued, or disposed of the financial  There is no discount or premium when the initial
asset. carrying amount of the financial instrument is
CH6.1: ORIGINATION COSTS AND FEES equal to the face amount.
Carrying Effective interest
1. Direct Origination Cost amount is less rate is higher
 Costs incurred by lender in originating loans Discount
than Face than Nominal rate
 Initially added to the carrying amount of the loan amount
 Subsequently amortized using effective interest Carrying Effective Interest
method, which decreases both the carrying amount is rate is lower than
Premium
amount of the loan and interest income greater than Nominal rate
 Decreases the effective interest rate Face amount
Example:
2. Indirect Origination Cost Initial Carrying Amount P952,000 is less than Face
 Not included in the measurement of receivables. Amount P1,000,000. Therefore, the effective interest
rate estimated is higher than the nominal rate of 10%
These are expensed immediately

3. Origination Fees CH6.2: DAY 1 DIFFERENCE

 It is charged to the borrowers by the lenders to
If the transaction price for a financial instrument
recover the costs
differs from the fair value (present value) on initial
 Usually expressed as a percentage of the
recognition, the difference is recognized as gain or
principal amount of the loan and are directly
loss in profit or loss.
deducted from the loan proceeds released to the
borrower
Case 1: Loan Proceeds equal to Present
 Initially the deducted from the carrying amount
Value Process
of the loan
Step 1: Get Present Value of Loan Receivable
 Subsequently amortized using the effective
Future Cash Flow 1,000,000
interest method, which increases both the
Multiply by PV of P1 0.751315
carrying amount of the loan and interest income
Present Value of Loan Receivable 751,315
 Increases the effective interest rate
Step 2: Get Unearned Interest Income
LENDER’S BOOKS Face Amount 1,000,000
Principal Amount 1,000,000 Present Value of Loan Receivable (751,315)
Direct Origination Cost 12,000 Unearned Interest Income 248,685
Origination Fee Step 3: Make Journal Entry for 01/01/20x1
(60,000) Loan Receivable 1M
Initial Carrying Amount of Loan Rec. Cash 751,315
952,000 Unearned Interest 248,685
Step 4: Conclusion
Journal Entry (01/01/20x1) Debit Credit Present Value of Loan Receivable 751,315
1. Record release of loan, net of orig. fees Transaction Price (Cash Paid) (715,315)
Loan Receivable 1M Difference -
Cash (1M – 60k) 940K
Unearned Interest Income 60k Case 2: Loan Proceeds equal to Face Amount
2. Record Direct Origination Costs Step 1 & 2: Same as Case 1
Unearned Interest Income 12,000 Step 3: Make Journal Entry for 01/01/20x1
Cash 12,000 Loan Receivable 1M
 Unrealized Loss – “Day 1” 248,685
diff. 1M
Cash 248,685
Unearned Interest
Step 4: Conclusion
Present Value of Loan Receivable 751,315
Transaction Price (Cash Paid) (1,000,000)
Difference 248,685 GENERAL APPROACH
CH6.3: IMPAIRMENT
 It is intended to reflect the credit deterioration
 Previous Model Is “Incurred Loss Model and improvement of a financial instrument
 Current Model is “ Expected Credit Loss Model” Stage 1 Stage 2 Stage 3
Credit risk has Credit risk has Credit risk has
EXPECTED CREDIT LOSS MODEL not increased increased increased
 An entity will always estimate expected credit significantly significantly significantly
losses using a “multifactor and holistic” analysis since initial since initial since initial
of credit risk that considers not only past events recognition recognition recognition plus
but also forward looking information on current Low credit risk there is objective
conditions and forecasts of future economic expediency evidence of
conditions. impairment
 It shall be applied to ALL debt instruments that Recognize 12- Recognized Recognize
are not measured at fair value through profit or month expected Lifetime Lifetime
credit loss expected credit expected credit
loss
losses losses
Interest revenue Interest revenue Interest revenue
3 TYPES OF APPROACHES OF COMPUTING
is computed on is computed on is computed on
IMPAIRMENT the gross the gross the net carrying
Type of Asset/ Exposure Approach carrying amount carrying amount amount (gross
Trade Receivables, Simplified Approach of the asset of the asset carrying amount
contract assets, and less loss
lease receivables allowance)
Originated/purchased Changes in lifetime Improvement Deterioration
credit-impaired expected credit losses
financial assets approach CH6.4: TERMS FOR EXPECTED CREDIT LOSS
Other General Approach (3 MODEL
assets/exposures stages/bucket approach)
Loss allowance
SIMPLIFIED APPROACH  The allowance for expected credit losses on
 An entity simply measures the loss allowance financial assets that are within the scope of the
equal to the lifetime expected credit losses impairment requirements of PFRS 9

CHANGES IN LIFETIME EXPECTED CREDIT Expected Credit Losses

LOSSES APPROACH  The weighted average of credit losses with the
respective risks of a default occurring as the
Originated or purchased credit impaired weights
financial assets
 are those that are credit impaired on initial Credit Loss
recognition  The difference between all contractual cash
 The loss allowance recognized that the reporting flows that are due to an entity in accordance
date is the cumulative changes in lifetime with the contract and all cash flows the entity
expected credit losses since initial recognition expects to receive, discounted at the original
 The entity shall use credit adjusted effective effective interest rate.
interest rate when discounting cash flows for
purposes of measuring expected credit losses. 12-month expected credit losses
 The portion of lifetime expected credit losses
Credit-adjusted effective interest rate that represent the expected credit losses that
 The rate that exactly discounts the estimated result from default events….that are possible
future cash payments or receipts through the within the 12 months after the reporting date.
expected life of the financial asset to the
amortized cost of a financial asset that is Credit Risk
purchased or originated credit impaired financial  The risk that one party to a financial instrument
asset. will cause a financial loss for the other party by
failing to discharge an obligation

Low credit risk expediency

 An entity may assume that the credit risk has
not increased significantly since initial
recognition
 This optional simplification is designed to relieve  For purposes of determining the change in credit risk on a
entities from tracking changes in the credit risk collective basis and entity can group financial instruments
on the basis of shared credit risk characteristics:
of high-quality assets.
1. Instrument type
2. Credit risk ratings
Lifetime expected credit losses
3. Collateral type
 The expected credit losses that result from all 4. Date of initial recognition
possible default events over the expected life of 5. Remaining term to maturity
a financial instrument 6. Industry
7. Geographical location of the borrower
8. The value of collateral relative to the financial
Next 12 Remaining Loss from asset if it has an impact on the probability of a
Date Total
months Months Default
default occurring
08/01/x1 2% 5% 400K 7%
12/31/x1 3% 12% 350k 15% CH6.5: MEASUREMENT OF EXPECTED CREDIT
12/31/x2 1% 3% 250K 4% LOSSES

Example: ABC Co. Issues a 3- year interest bearing loan Expected credit losses shall be measured in a manner that
of P1,000,000 on August 1 2021. ABC Co. makes the reflects:
following estimates of risk and default losses: 1. Unbiased and Probability-Weighted Amount
Step 1: Initial Recognition (08/01/20x1)  If neither reflects a worst case scenario nor a
Use 12-month expected credit loss best case scenario
Next 12-months x Loss from Default
2% x 400K = P8,000 Initial Recognition 2. Time Value of Money
 Expected credit losses shall be discounted to
Entry to Recognize Loss Allowance (08/01/20x1) the reporting date using the original effective
Impairment Loss 8,000 interest rate, except for:
Loss Allowance 8,000 a. Financial instruments with variable interest
Step 2: 12/31/20x1 rate – current rate
Use “Total” to determine increase or decrease in b. Purchase/originated credit-impaired financial
credit loss. asset – credit-adjusted effective interest rate
In this example, use lifetime expected credit loss
Total x Loss from Default 3. Reasonable and supportive information
15% x 350K = P52,500  Information that is reasonably available at the
reporting date without undue cost or effects. this
includes past events, current conditions, and
Entry to Adjust Loss Allowance forecast of future economic conditions
Impairment Loss 44,500
Loss Allowance (52.5K – 8K) 44,500
CH6.6: CREDIT IMPAIRED FINANCIAL ASSETS
Step 3: 12/31/20X2
Use “Total” to determine increase or decrease in  A financial asset is credit impaired when one or
credit loss. more events that have a detrimental impact on the
In this example, total risk decreased so loss estimated future cashflows of that financial asset
allowance measurement is reverted from Lifetime have occurred
to 12-month expected credit losses 1. Significant financial difficulty
Next 12-months x Loss from Default 2. Breach of contract (default or delinquency)
1% x 250K = P2,500 3. The lender granting to the borrower a
concession
Entry to Adjust Loss Allowance 4. It is probable that the borrower will enter
Loss Allowance (52.5K – 2.5K) 50,000 bankruptcy
Impairment Gain 50,000 5. Disappearance of an active market
6. Purchase or origination of a financial asset
at a deep discount that reflects the incurred
DETERMINING SIGNIFICANT INCREASES IN credit losses
CREDIT RISKS
Impairment Loss Computation:
 PFRS 9 requires an entity to assess, at each
Present Value of Est. FCF xx
reporting date, whether credit risk has increased
Carrying Amount before Impairment (xx)
significantly since initial recognition by
Impairment Loss xx
comparing the risk of default at the reporting
date with the risk of default at initial recognition
Carrying Amount Before Impairment includes any
 PFRS 9 states that there is a reputable
interest receivable accrued up to the date of the loss
presumption that credit risk has increased
event
significantly since initial recognition when
contractual payments are more than 30 days
Original Effect Interest rate is the effective interest
past due.
rate on the date of the receivable was initially
recognized
CHARACTERISTICS OF SHARED CREDIT RISK
Interest Income is computed after impairment by  they expire when the cash flows are collected,
multiplying the original effective interest rate by the cancelled, or uncollectible due of loss events
net carrying amount of the impaired receivable
CH6.7: TRANSFER
Net Carrying Amount of the loan after recognizing
impairment loss is equal to the present value of A financial asset is transferred if the entity either:
future cash flows 1. Transfers the contractual rights to receive the
cashflows of the financial asset, or
2. retains the contractual rights, but assumes an
obligation to remit the collection to a recipient in
an arrangement that meets all the conditions
listed below:
a. The entity is not obligated to pay the
recipient unless it collects an equivalent
Example: Stage 3 – Credit Impaired Financial Asseet amount from the original asset
Step 1: Compute Total Carrying Amount of b. The entity is prohibited from selling or
Receivables Before Impairment pledging the original asset except as
Loan Receivable 1,000,000 security in favor of the recipient
Interest Receivable 100,000 c. The entity is obligated to remit collections to
Total Carrying Amount of Rec. 1,100,000 the eventual recipient without material
Step 2: Compute for Present Value of Est. FCF delay. They are prohibited from reinvesting
Est. FCF (1M ÷ 2 equal annul install.) 500,000 the collections except in cash or cash
Multiplied by: PV of OA at 10%, n=2 1.735537 equivalents and any interest earned on the
Present Value of Est. FCF 867,796 investment is also remitted to the recipient.
Step 3: Compute for Impairment Loss
EVALUATION OF TRANSFERS
Present Value of Est. FCF 867,796
1. If entity substantially transfers ownership
Carrying Amount Before Impairment (1,100,000)
Impairment Loss (232,231)  Derecognize financial asset
DIRECT METHOD  Recognize any rights or obligations created or
Step 4A: Entry of Impairment Loss (Dec.31,20x3) retained in the transfer
Impairment Loss 232,231
Interest Receivable 100,000 2. If entity substantially retains ownership
Loan Receivable 132,231  Recognition of Asset continues
Step 5A: Compute Net Carrying Amount of LR  Ex. Entity is obligated to repurchase
Loan Receivable (before) 1,000,000
Credit to Loan Receivable (132,231) 3. If entity neither substantially transfers or retains
Loan Receivable (after) 867,769 ownership
ALLOWANCE METHOD  Entity determines whether it has retained
Step 4B: Entry of Impairment Loss - Allowance control of the financial asset
Method (Dec.31,20x3)  Derecognize if entity does not retained control
Impairment Loss 232,231  Recognize if entity has retained control
Interest Receivable 100,000
Loss Allowance 132,231 Journal Entry Debit Credit
1. Transfers Substantially (Derecognize)
Step 5B: Compute Net Carrying Amount of LR
Cash 100k
Loan Receivable (before) 1,000,000
Loans Receivable 100k
Loss Allowance (132,231)
Loan Receivable (after) 867,769 2. Obligated to Repurchase (Recognize)
Step 6: Make Amortization Table Cash 100k
Step 7A: Entry on Dec.31, 20x4 – DIRECT METH. Liability on repurchase agree. 100k
Cash 500,000 3. Obligated to Repurchase does not exceed 10k
Interest Income 86,777 Cash 100l
Loan Receivable 413,223 Loans Receivable 90k
Step 7B: Entry on Dec.31,20x4 – ALLOW. METH. Liability on repurchase 10k
Cash 500,000 agree.
Loss allowance 86,777 4. Option to Repurchase
Interest Income 86,777 Cash 100k
Loans Receivable 100k
Loan Receivable 500,000

DERECOGNITION OF RECEIVABLES TRANSFERS THAT QUALIFY FOR DERECOGNITION

1. The contractor rights to the cash flows from the  Recognize Servicing Liability at Fair Value, if
financial asset expire fee is considered Inadequate to compensate
2. The financial asset is transferred and the  Recognize Servicing Asset, if fee is more than
transfer qualifies for derecognition adequate
 Gain/Loss in profit/loss is the difference
EXPIRATION OF CONTRACTUAL RIGHTS TO between the consideration received (assets
CASH FLOWS minus liabilities) and the carrying amount
(measured at the date of derecognition).
 Under traditional US GAAP, transfers of receivables
Transfer of Financial Asset are treated as either sale or secured borrowing
ABC Co. transfers loans receivable with a fair value
of 300,000 and carrying amount of 280,000. ABC 1. Sale
Co. obtains an option to purchase similar loans in  In a transfer that is considered a sale, the
assumes a recourse obligation to repurchase such transferred receivable is derecognized
loans. ABC company also agrees to provide a
 transfer must meet ALL conditions
floating rate of interest to the transferee company.
a. Transferred as it has been isolated from the
The assets and liabilities received as consideration
for the transfer or listed below transferer
Step 1: Entry to Record the Transfer b. Transferee has obtained the right to pledge
or exchange either the transferred asset or
Cash 200k
beneficial interest
Interest Rate Swap 150k
c. Transfer does not maintain effective or
Call Option 50k
control over the transferred asset
Recourse Obligation
100k
2. Secured Borrowing
Loans Receivable (at carrying amount)
280k  A transfer is considered a secured borrowing if
Gain on transfer of loans (squeeze) one of the conditions above is not met. no gain
20k or loss is recognized
Step 2: Compute Gain/Loss on Derecognition
Cash 200k
Interest Rate Swap 150k
Call Option
50k
Less: Recourse Obligation
(100k)
Fair Value of net assets received
300k
Carrying Amount of Loans transferred
(280K)
Gain on transfer of loans (squeeze) CH6.7: RECEIVABLE FINANCING
20k  the act of inducing cash inflows from receivables
or other than from their normal or scheduled
Servicing of a financial Asset payment
Same info above except: ABC company agreed to
service the loans without explicitly stating the COMMON FORMS OF RECEIVABLE FINANCING
compensation. the fair value of the service is 1. PLEDGE (Hypothecation)
15,000.
 Are used as collateral security for a loan. It is
The servicing fee is considered inadequate
treated as secured borrowing.
because it is not explicitly stated. Thus, a servicing
liability at fair value is recognized  Pledged receivables are not derecognized and
Cash 200k are not specially identified from other
Interest Rate Swap 150k receivables.
Call Option 50k  Only the loan transaction is recorded
Recourse Obligation
100k 2. ASSIGNMENT
Loans Receivable (at carrying amount)  A formal form of pledge wherein the receivables
280k used as collateral security for borrowing are
Liability on service obligation specifically identified and stated in the loan
15K contract.
Gain on transfer of loans (squeeze)  Assigned receivables are identified by
5k reclassifying them to “Receivables-assigned”
If explicitly stated, Adequate account (included in trade & other rec.).
If not explicitly stated, Inadequate  Equity in the assigned receivables
- Is the carrying amount of the assigned receivables
minus carrying amount of the related loan
CH6.7: OFFESTTING A FINANCIAL ASSET playable. This is only a note disclosure.
AND A FINANCIAL LIABILITY
 FORMS OF ASSIGNMENT
A financial asset and liability are offset and only the a. Notification Basis
net amount is presented in the statement of financial - A assignor/borrower notifies the debtors
position when the entity has both: about the assignment. Accordingly the
1. A legal right to setoff debtors will remit payments on the
2. An intention to settle the amounts on a net basis receivables directly to the assignee/lender.
or simultaneously
b. Non-notification basis
SALE OR SECURED BORROWING
 - Assignor a borrower does not notify the - The factor assumes the risk of
debtors. unpredictability and absorbs any credit
- Assignments are more commonly made on a losses
non-notification basis - It is an outright sale of the receivable.
- b. With recourse
NOTIFICATION BASIS - The transferrer guarantees payment to the
Debit Credit
Journal Entry factor in the event the debtor fails to pay
1. To record the assignment (Mar. 1, 20x1)  Factor’s Holdback
Acct. Receivable- assigned 4M - Transferrer is responsible for any reduction
Accounts Receivable 4M in the collection of receivables due to sales
2. To record receipt of loan (Mar.1, 20x1) returns and discounts.
Cash 2.92M - The factor usually retains a certain
Discount on L/P (4M x 2%) 80K percentage of the transferred receivable for
Loan Payable (4M x 75%) these items
3M
3. To record collections  Casual Basis vs. Regular means of
NO ENTRY Financing
4. To record the remittance of collections to the a. Casual Basis (isolated event), charges are
bank, plus interest recorded as “loss”
NOT APPLICABLE b. Regularly Factors, charges are recorded
5. Piggy Bank notifies ABC Co. of the collections as “Regular expenses”
Loans Payable 2.5M
Sales Returns & discounts 50K  Cost of Factoring
Accounts Receiv.-assigned - consists of the charges above plus in case of
2.55M debtors default any amount that the transfer has
6. ABC Co. pays the interest guaranteed to pay to the factor.
Interest Expense 30K
(3M x 12% x 1/12)
Cash
30K

NON-NOTIFICATION BASIS
Debit Credit
Journal Entry
1. To record the assignment (Mar. 1, 20x1)
Acct. Receivable- assigned 4M
Accounts Receivable 4M
2. To record receipt of loan (Mar.1, 20x1)
Cash 2.92M On Jan. 1 20x1, ABC Co. factored P60,000 accounts
receivable to XYZ Financing Cor. XYZ charged a 4% service
Discount on L/P (4M x 2%) 80K
fee and retained a 10% holdback to cover the expected sales
Loan Payable (4M x 75%) return. In addition, XYZ charged 12% interest computed on a
3M
weighted average time to maturity of the receivables of 73 days
3. To record collections based on 365 days. (Assume a fair value of P3,000 for the
Cash 2.5M recourse obligation in the “with recourse” scenario)
Sales Return & discounts 50K Journal Entries
Accts. Receivable-assigned Without Recourse With Recourse
2.55M
Casual Basis
4. To record the remittance of collections to the
Cash 50,160 Cash 50,160
bank, plus interest Rec. from Factor 6,000 Rec.from factor 6,000
Loan Payable 2.5M Loss on factoring(sqz) 3,840 Loss on factoring 6,840
Interest Expense 30K AR AR
Cash 60,000 60,000
2.53M Recourse Obligation
3,000
AR-assigned (4M – 2.55M collected) 1,450,000 Regular Means of Financing
Loan Payable (3M-2.5M paid) (500,000) Cash 50,160 Cash 50,160
Rec. from factor 6,000 Rec. from factor 6,000
Equity in assigned receivables 950,000 Service Charge 2,400 Service charge 2,400
Interest expense 1,440 Interest Expense 1,440
3. FACTORING AR 60,000 Loss on recou. obli. 3,000
 Instead of being collateralized receivables can AR
60,000
also be sold to a financial institution “factor”. Recourse Obligation 3,000
 It is usually done on a notification basis on either
without recourse or with recourse basis
Accounts Receivable factored 60,000
a. Without Recourse Service charge (60,000 x 4%) (2,400)
Factor’s holdback (60,000 x 10%) (6,000)
Interest charge (60,000 x 12% x 73/365) (1,440)
Proceeds from Factoring 50,160
Cash in Journal Entries = 50,160  Net Proceeds = Maturity value – Discount
Settlement of Factor’s Holdback  Discount = Maturity value x Discount period x
Without Recourse With Recourse Discount Rate
Sales returns 2,000 Sales returns 2,000
Cash (squeeze) 4,000 Cash (squeeze) 4,000  Discount Period = the remaining period to
Rec. from factor 6,000 Rec. from factor maturity date all the notes as of the date of
6,000 discounting. it is also the unexpired term of the
note and can be computed as “full term” less
Recourse Obli 3,000 “expired term”.
Gain on recourse obli 3,000  Discount Rate = rate at which the note is
Cost of Factoring discounted with a bank
Service Charge 2,400  Interest Income = accrued interest as of date of
In case of debtor’s default, this amount
Interest charge 1,440
is increased by any payment on the discounting
Cost of Factoring
recourse agreement
3,840
DISHONORED NOTES
 Are we classified from “notes receivable” to
4. SECURITIZATION “accounts receivable” because when dishonored
 It takes a pool of assets such as credit card they become an ordinary claim
receivables, mortgage receivables, or car loan  The amount transferred to the accounts
receivables and sells shares in these pools of receivable is the maturity value of the note
interest and principal payments. plus any direct costs attributable to the
 Virtually every asset with a payment stream in dishonor
the long term payment history is a candidate for
securitization

Credit Card Transaction

 It is a form of factoring without recourse. It
qualifies for derecognition
 A seller records a sale to a customer using a
credit card as a receivable from the customer's
credit company rather than the customer.

Credit Card Problem Debit Credit

1. Entity makes total sales of 1,000,000 to
customers using credit card
AR – credit card company 1M
Sales 1M
2. Entity collects from the credit card company
Cash 990K
Service Charge (1M x 1%) 10K
AR – credit card company
1M

5. DISCOUNTING OF NOTES RECEIVABLE

 The holder endorses a note to a bank in
exchange for the maturity value less a discount
a. Without Recourse
- The entity is not liable in case the maker
fails to pay
- Note is sold outright, therefore derecognized

b. With recourse
- Entity is liable in case the maker fails to pay
- The discounting is accounted for us either:
B1. Conditional Sale
A contingent liability equal to the face
amount of the note is only disclosed in the
notes
B2. Secured borrowing
A liability equal to the face amount of the
note is recognized

CH6.8: FORMULAS FOR DISCOUNTING