Notes Receivables (INTACC1), Lecture notes of Accounting

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Notes Receivable

Notes Receivables

A formal claim against another that is evidenced by a written promise, called promissory note, or a written order to pay at a later date, called time draft.

• Promissory note is an unconditional written agreement to pay to bearer or to the order of the payee a certain sum of money on a specific or determinable date.
• Time draft is a written order (made by the drawer), addressed to the drawee to pay a certain sum of money on a specific or determinable date.

Types of Notes Receivable

• (^) Interest bearing - The fair value of an interest-bearing note is generally its face value, unless it is clear that the interest rate stated in the note does not reflect a realistic interest rate. a. With Realistic interest rates – When a note has a stated rate the approximates the prevailing market rate for similar notes. b. With Unrealistic interest rates – When a note bears an interest rate that is significantly different from prevailing interest rate for similar notes, or when the face value of the note is significantly different from the market value of the consideration given up in exchange for the note.
• (^) Non-interest bearing or zero-interest bearing

Key takeaways:

• (^) The computations of interest is based on 360-day year.
• (^) To qualify for reporting as Notes Receivable, the note must be negotiable; it must be payable to the bearer and must not yet due. Dishonored note receivable does not qualify to be reported as Notes Receivable in the statement of financial position.
• Overdue notes from customers, together with accrued interest thereon, are generally reclassified as accounts receivable.
• (^) When a note makes no provision for interest, it is said to be non-interest bearing note or zero-interest bearing.
• (^) A non-interest bearing note does not necessarily mean that there is no interest accruing on the receivable. The promissory note simply written in a form where the face value already includes an imputed interest for the term of the note.

• (^) The difference between the face amount of the note and its present value is recorded as discount or premium.
• (^) The excess of the face value of the note over its present value is credited to Discount on Notes Receivable. Face value > Present value = Discount on Notes Receivable.
• (^) The excess of the present value of the note over its face value is debited to Premium on Notes Receivable. Face value < Present value = Premium on Notes Receivable.
• (^) The discount or premium is amortized to interest revenue over the term of the note using effective interest method.
• (^) Any unamortized discount is deducted from the ledger balance of the Notes Receivable, and any unamortized premium is added to the balance of the Notes Receivable, to arrive at the amortized cost to be presented in the Statement of financial position.

Illustrative Problem: Short-term Interest

Bearing Notes

Feb. 5 Received a 60-day, 10%, P30,000 promissory note from A Company from merchandise sold. Apr. 4 Collected from A Company in settlement of its note dated January 5. Apr. 10 Received a 30-day, 12%, P25,000 promissory note from B Company in settlement of an overdue account. May 6 Received a 120-day, 12%, P45,000 promissory note from C Company in settlement of an account. May 9 B company dishonored its note on maturity date May 30 Collected the amount due from B Company on account of its overdue note. An additional charge for interest at 12% on maturity value from maturity date is also collected. June 30 Fiscal year-end adjustments are made.

May 9 Accounts Receivable 25, Notes Receivable 25, Interest Revenue 250 (25,000 x 12% x 30/360 = 250) May 30 Cash 25,426. Accounts Receivable 25, Interest Revenue 176. (25,250 x 12% x 21/360 = 176.75) June 30 Interest Receivable 825 Interest Revenue 825 (45,000 x 12% x 55/360)

Illustrative Problem: Long-term Interest-Bearing Note with Realistic Interest Rate, one-time payment of Principal On January 1,2020, Toshiba Corp sells a machinery costing P500,000 and with accumulated depreciation of P350,000 as of January 1,2020. The company receives 4-year, P100,000, 10% note. The 10% interest rate is a realistic rate of interest for a note of this type. Journal entries: Jan. 1, 2020 Notes Receivable 100, Accumulated Depreciation 350, Loss on Sale 50, Machinery 500, To record the sale transaction

(100,000 x 10% = 10,000)

• Feb. 5 Notes Receivable 30,
  • Sales 30,
• Apr. 4 Cash 30,
  • Notes Receivable 30,
  • Interest Revenue
• Apr. 10 Notes Receivable 25, (30,000 x 10% x 60/360 = 500)
  • Accounts Receivable 25,
• May 6 Notes Receivable 35,
  • Accounts Receivable 35,
• Dec. 31, 2022 Cash 10, - Interest Revenue 10,
  • To record the interest due in
• Dec. 31, 2023 Cash 10, - Notes Receivable 100, - Interest Revenue 10,
  • To record the collection of note and interest due in

Statement of Financial Position are presented below as follows at the end of each year: Notes Receivable is treated as current asset if the Notes Receivable becomes collectible within one year from the reporting date. Thus, on December 31, 2022 Notes Receivable is treated as current assets.

Journal entries: Jan. 1, 2020 Notes Receivable 100, Accumulated Depreciation 350, Loss on Sale 66, Machinery 500, Discount on Notes Receivable 16, To record the sale transaction Dec. 31, 2020 Cash 10, Discount on Notes Receivable 3, Interest Revenue 13, To record the interest due in 2020 and amortization of discount on notes receivable

Statement of Financial Position are presented below as follows at the end of each year: Notes Receivable is treated as current asset if the Notes Receivable becomes collectible within one year from the reporting date. Thus, on December 31, 2022 Notes Receivable is treated as current assets net of Discount on Notes Payable.

Illustrative example: Long-term Interest-Bearing Note with Unrealistic Interest Rate (Stated rate is higher than Market rate of interest), one-time payment of Principal

• (^) On January 1,2020, Toshiba Corp sells a machinery costing P500,000 and with accumulated depreciation of P350,000 as of January 1,2020. The company receives 4-year, P100,000, 10% note. The prevailing rate of interest for a note of this type is 8%. To compute present value of the note and the gain or loss on sale: Net selling price (Present value of the note): Present value of principal (100,000 x .7350) 73, Add: Present value of interest (100,000 x 10% x 3.3121) 33,121 106, Less: Carrying amount of machinery Cost500, Less: Accum. Depn 350,000 150, Loss on sale (43,379)