INTERMEDIATE ACCOUNTING 1A – MODULE #6

NOTES RECEIVABLE - APPLICATION

Learning objectives:

 The students are expected to know the concept of applying present value factors and unearned interest income.
 The students are expected to prepare amortization tables under different circumstances.
 The students are expected to compute for the present value factors and apply it properly.

APPLICATION OF PRESENT VALUE FACTORS

The initial measurement of receivables are measured at fair value plus transaction cost. Subsequently,
receivables measured at amortized cost shall be discounted or to be measured with the application of present value.
These are the circumstances where a receivable is measured at amortized cost:

1. Long term noninterest-bearing receivables

2. Long term interest bearing receivables with unreasonable interest rate (below-market interest rate)
3. Short term receivable with significant financing component

STEPS IN MEASUREMENT OF NOTES RECEIVABLE AND INTEREST INCOME

1. Determine if the notes receivable is an interest-bearing notes or to be measured at amortized cost.

2. If the notes are not to be measured at amortized cost, apply simple interest computation. (Principal x Interest x
Time).
3. If the notes are to be measured at amortized cost, apply present value factors or discounting on the future cash
flows to be received.

UNDERSTANDING PRESENT VALUE

Discounting is the process of determining the present value of a payment or a stream of payments that is to be received
in the future. Given the time value of money, a peso is worth more today than it would be worth tomorrow. Discounting
is the primary factor used in pricing a stream of tomorrow's cash flows.

Knowing this, a value of 1 peso today is equal to 1 peso and its worth decreases as we are pertaining to its future value.
Using this table we can presume the following given the following circumstances:

Effective Interest Rate = 12%

Face Value = 1,000,000
Payment method = LUMP SUM
Date of Note received : January 1, 2022

The present value factor can be illustrated like this:

Date Year Number Present Value Factor for 12%

January 1, 2022 0 1.00
January 1, 2023 1 0.892857
January 1, 2024 2 0.797194
January 1, 2025 3 0.711780
Notice that the present value decreases as the year number increases, showing that the value of peso decreases. If the
notes receivable is to be settled on January 1, 2023, the present value of the note is computed as follows:

Face amount (or future cash flow) 1,000,000

Multiply: PV Factor 0.892857
Equal: PV 892,857

The difference between the face amount and present value of the note represents the unearned interest income.

Face amount P1,000,000

Less: PV (892,857)
Unearned Interest Income 107,143

Consequently, if the notes receivable is to be settled on January 1, 2024 & January 1,2025, the present value of the note
is computed as follows:

For 2024:
Face amount (or future cash flow) 1,000,000
Multiply: PV Factor 0.797194
Equal: PV 797,194

For 2025:
Face amount (or future cash flow) 1,000,000
Multiply: PV Factor 0.711780
Equal: PV 711,780

Using this data, let’s compute create an amortization table for the notes receivable presuming it will be paid on 2025.

Interest Income (a) Unearned Interest Income (b) Carrying Amount (c)
Date
= Prev. (c) x EIR (12%) = Prev bal - (a) = Prev bal + (a)
January 1, 2022 288,220.00 711,780.00
January 1, 2023 85,413.60 202,806.40 797,193.60
January 1, 2024 95,663.23 107,143.17 892,856.83
January 1, 2025 107,143.17 - 1,000,000.00

Upon viewing the table, we can see how all the necessary data are being computed. Interest income is computed by
multiplying the previous carrying amount by the effective interest rate. Unearned interest income for the year is
computed by deducting the year’s interest income by the previous balance. Lastly, carrying amount is computed by
adding the computed interest income for the year to the previous balance.

But what if the notes receivable is to be settled in installment? Using the same data, let’s compute for the present value
of the notes:

Effective Interest Rate = 12%

Face Value = 1,000,000
Annual payment = 250,000
Payment method = Installment Payment
Date of Note received : January 1, 2022
Date of 1st payment : January 1, 2023
Using the data, the computation for the present value can be illustrated as follows:

Description Date Present Value Factor Collection Present value

Receipt of Notes Receivable January 1, 2022 1.00 - -
Payment of 1st installment January 1, 2023 0.892857 250,000.00 223,214.25
Payment of 2nd installment January 1, 2024 0.797194 250,000.00 199,298.50
Payment of 3rd installment January 1, 2025 0.711780 250,000.00 177,945.00
Payment of 4th installment January 1, 2026 0.635518 250,000.00 158,879.50
Present Value of the Notes 759,337.25

Or for an easier approach, we can add all the present value factors from 1 st installment to the last installment payment
and multiply it by the annual collection (January 1, 2023 – January 2026):

PV Factor for 1st installment 0.892857

PV Factor for 2nd installment 0.797194
PV Factor for 3rd installment 0.711780
PV Factor for 4th installment 0.635518
Total PV Factor 3.037349
Multiplied by: Annual collection 250,000
Present value of notes 759,337.25

*Note: This is only applicable on installment notes receivable with uniform periodic payments.

Using this data, let’s compute create an amortization table for the notes receivable:

Carrying
Interest Income (a) Amortization (c) Unearned Interest Income (d)
Date Collection (b) Amount (e)
= Prev (c) x EIR (12%) = (b) - (a) = prev bal - (a)
= Prev bal - (c)

January 1, 2022 240,662.75 759,337.25

January 1, 2023 91,120.47 250,000.00 158,879.53 149,542.28 600,457.72

January 1, 2024 72,054.93 250,000.00 177,945.07 77,487.35 422,512.65

January 1, 2025 50,701.52 250,000.00 199,298.48 26,785.84 223,214.16

January 1, 2026 26,785.70 250,000.00 223,214.30 0.14 (0.14)

*Note: The 0.14 difference on the January 1, 2026 Unearned Interest Income resulted from rounding off difference but it
should equate to 0. The carrying amount by the end of the term of the notes receivable will be 0 if paid in installment.

In determining the current portion of the notes for a specific date, we just need to take note on the amount of
amortization to be settled within a year. For example, if asked on a problem on how much the current portion of the
notes for the following dates, it will be as follows:

As of:
Current Portion Non-current Portion
January 1, 2022 = 158,879.53 600,457.72
January 1, 2023 = 177,945.07 422,512.65
January 1, 2024 = 199,298.48 223,214.16
January 1, 2025 = 223,214.16 0
With this in mind, we can summarize the steps as follows:

1. Determine the amount of future cash flow.

2. Identify if the notes is to be settled in lump-sum or installment.
3. Determine the present value factor to be used.
4. Follow and repeat the process in computing interest income and amortization.

But what if the notes receivable is to be settled in unequal installments and 1 st payment is due on the date the note is
received? Using these data, let’s compute for the present value of the notes:

Effective Interest Rate = 12%

Face Value = 1,000,000
Payment method = Installment Payment
Date of Note received : January 1, 2022
Date of 1st payment : January 1, 2022
Payment method:
January 1, 2022 = 100,000
January 1, 2023 = 200,000
January 1, 2024 = 300,000
January 1, 2025 = 400,000

Present Value
Description Date Collection Present value
Factor
Payment of 1st
1-Jan-22 1 100,000.00 100,000.00
installment
Payment of 2nd
1-Jan-23 0.892857 200,000.00 178,571.40
installment
Payment of 3rd
1-Jan-24 0.797194 300,000.00 239,158.20
installment
Payment of 4th
1-Jan-25 0.71178 400,000.00 284,712.00
installment
Present Value of the
802,441.60
Notes

Face amount P1,000,000

Less: PV (802,441.60)
Unearned Interest Income 197,558.40
Using this data, let’s compute create an amortization table for the given example:

Interest Income (a) Unearned Interest

Amortization (c) Carrying Amount (e)
Date = Prev (c) x EIR Collection (b) Income (d)
= (b) - (a) = Prev bal - (c)
(12%) = prev bal - (a)
Present value of
802,441.60
Notes

January 1, 2022 - 100,000.00 100,000.00 197,558.40 702,441.60

January 1, 2023 84,292.99 200,000.00 115,707.01 113,265.41 586,734.59

January 1, 2024 70,408.15 300,000.00 229,591.85 42,857.26 357,142.74

January 1, 2025 42,857.13 400,000.00 357,142.87 0.13 (0.13)

*Notice that on the 1st collection, January 1, 2022, there is not interest income because it was also the date the note is
received. Interest only arises from passage of time and since the date the note is received and the date of the 1 st
collection coincides, it is only right to not recognize interest income during that period.

Other forms of payment method or scheme may arise from different situations, but bear in mind that it is easy to
compute for the present value of the notes as long as you match the PV factor to the date of the future cash flows.

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