NOTES

PAYABLE
Intermediate Accounting 2
 NOTES PAYABLE

▪ These are obligations supported by debtor

promissory notes.
▪ The accounting for notes payable is
similar to the accounting for notes
receivable.
 Initial Measurement

▪ Notes payable are initially recognized at

fair value minus transaction costs.
 Initial Measurement

▪ Fair value is the price that would be

received to sell an asset or paid to
transfer a liability in an orderly
transaction between market
participants at the measurement date
(PFRS 13, Appendix A).
 Classification of Notes Payable
▪ Short-term payable
▪ Long-term payable that bears a reasonable
interest rate
▪ Long-term payable that bears no interest
(non-interest bearing)
▪ Long-term payable that bears an
unreasonable interest rate (below-market
interest rate)
 Short-term Payable

▪ A short-term payable matures in 1 year or

less, while a “long-term” payable matures
beyond 1 year.
▪ The fair value of a short-term payable may
be equal to its face amount.
 Short-term Payable

▪ However, if its clear that the arrangement

effectively constitutes a financing transaction
and the imputed rate of interest can be
determine without undue cost or effort, the
fair value of the short-term payable is equal
to its present value.
 Long-term Payable

▪ The fair value of a long-term payable that

bears a reasonable interest rate is equal to
the face amount .
▪ An interest rate is deemed reasonable if it
approximates the market rate at the
transaction date.
 Long-term Payable

▪ The fair value of a long-term payable that

bears no interest (long-term noninterest
bearing payable) is equal to the present
value of the future cash flows on the
instrument discounted using an imputed
interest rate.
 Long-term Payable

▪ The fair value of a long-term payable that

bears an unreasonable interest rate is also
equal to the present value of the future cash
flow on the instrument discounted using an
imputed interest rate.
 Long-term Payable

▪ Imputed interest rate include effective

interest rate, market rate and yield rate.
▪ Effective interest rate is the rate that exactly
discounts the future cash payments over the
life of the financial liability equal to its
carrying amount.
 Cash price equivalent

▪ The fair value of a payable may be measured

in relation to the cash price equivalent of the
non-cash asset (noncash consideration)
received in exchange for the payable.
 Cash price equivalent

▪ Cash price equivalent is the amount that

would have been paid if the transaction was
settled outright on cash basis, as opposed to
installment basis or other deferred
settlement.
 Cash price equivalent

▪ Example 1:
An entity purchases a TV set on 6-month
installment basis. The installment price is
P120,000. However, if the TV set is purchased
outright in cash, the cash price would have
been P100,000.
 Cash price equivalent

▪ The payable is initially recognized at

P100,000, the cash prize equivalent of the
TV set. The P20,000 difference (P120,000)
installment price less P100,000 cash price)
will be amortized over the credit term as
interest expense using the effective interest
method.
 Cash price equivalent

▪ Example 2:
An entity purchases goods for P250,000
under a special credit period of 1 year. The
seller normally sells the goods for P220,000
with a credit period of 1 month or with a P5,000
discount for cash basis (i.e., outright payment in
cash)
 Cash price equivalent

▪ The initial measurement of the payable is

computed as follows:
Normal purchase price
with credit period of 1 month P220,000
Discount for outright payment (5,000)
Cash price equivalent
to the goods purchased P215,000
 Cash price equivalent
▪ Both the purchase price of P250,000 (special
credit) and P220,000 (normal credit)
constitute a financing transaction, i.e., they
include consideration for the credit period. To
compute for the cash prize equivalent of the
goods, the P5,000 discount for outright
payment is deducted from the normal selling
price of P220,000.
 Subsequent measurement

▪ Notes payable that are initially measured at

face amount are subsequently measured at
face amount or expected settlement amount.
▪ Notes payable that are initially measured at
present value are subsequently measured at
amortized cost.
 Subsequent measurement
▪ Amortized cost is the amount at which the
financial asset or financial liability is
measured at initial recognition minus
principal repayments, plus or minus the
cumulative amortization using the effective
interest method of any difference between
the initial amount and the maturity amount
and, for financial assets adjusted for any loss
allowance.
 Subsequent measurement

▪ The amortized cost is determined using the

effective interest method.
▪ When a note payable is initially measured at
present value or cash price equivalent, the
difference between that amount and the face
amount is initially recognized as a discount (or
premium, in the case of bonds payable) and
subsequently amortized as interest expense using
the effective interest method.
 Subsequent measurement

▪ Effective interest method is a method of

calculating the amortized cost of a financial asset
or a financial liability and of allocating the interest
income or interest expense over the relevant
period.
 Short-term Note

▪ On July 1, 2021, ABC Co. borrowed P1,000,000

and issued a one-year note payable. The lender
discounted the note at 12%.

• The term discounted as used in this context

means the lender deducted the 12% interest in
advance. ABC Co.’s proceeds from the note
are net of the advanced interest.
 Case 1: Lump Sum

▪ The note is due in lump sum on June 30, 2022.

The effect of discounting is immaterial.

• Analysis: The note is short-term and the effect of

discounting is immaterial. Therefore, the note is
initially measured at face amount (net of the
advanced interest).
 Case 1: Lump Sum
Journal entries:
 Case 1: Lump Sum
The carrying amounts of the note are
determined as follows:
 Case 2: Installment
The note is due in equal quarterly installments starting
September 30, 2021. The effect of discounting is
immaterial.

Analysis: The note is also measured at face amount.

However, because the note is due in installments, the
P120,000 advanced interest is allocated over the
installment periods based on, for example, the outstanding
principal balance of the note or some other arbitrary
apportionment.
 Case 2: Installment
Journal entries:
 Case 2: Installment

The fractions used in the allocation are derived from

outstanding balance of the note.
 Case 2: Installment
Carrying amount of the note:
 reasonable interest – simple
interest
On October 1, 2021, ABC Co. issued a two-year, 12%,
P1,000,000 note payable in exchange for a piece of land.
Principal is due on October 1, 2023 but interest is due
annually.
 reasonable interest – simple
interest
Analysis:
✔ Type of payable: Long-term with reasonable
interest rate – the 12% nominal rate is assumed to
be equal to the current rate on initial recognition
because no additional information is given.
✔ Initial measurement : Face amount
✔ Subsequent measurement: Face amount or
expected settlement amount
✔ Type of interest: Simple interest – interest is
computed only on the outstanding principal
balance.
Illustration 2: Long-term note with
reasonable interest – simple interest
 reasonable interest – compounded
interest
On January 1, 2021, ABC Co. issued a three-year, 12%,
P1,000,000 note payable in exchange for a piece of land.
Principal and interest are due on Dec. 31, 2023.

Analysis:
✔ Type of payable and measurement – same as illustration
2 above
✔ Type of interest: Compounded interest – interest is
computed on both the outstanding balances of principal
and accrued interest.
reasonable interest – compounded
interest