Note Payable

LECTURE NOTES
Promissory note - unconditional promise in writing made by one person (maker) to another (payee) payment of which
is on demand or at a determinable future time a sum certain in money to order or bearer.

Recognition - IFRS 9 requires an entity to recognize a financial liability in its statement of financial position when it
becomes party to the contractual provisions of the instrument.

Measurement
 Initial measurement
 Fair value less transaction costs;
 If irrevocably designated at fair value through profit or loss, the transaction costs are expensed
immediately
o Fair value = present value of future cash payments to settle the obligation
 Subsequent measurement
 At amortized cost using effective interest method
o Amortized cost = initial measurement minus principle repayment, plus or minus the cumulative
amortization using the effective interest method of any difference between initial carrying
amount and maturity amount
 At fair value through profit or loss if the note payable is designated irrevocably as measured at fair value
through profit or loss

Treatment for the following notes:

a. Note issued solely for cash
 Cash proceeds = present value of the note
b. Interest bearing note issued for property
 Purchase price = present value of the note
c. Non-interest bearing note issued for property
 Cash price = present value of the note

Use of PVF:
 PVF of 1 – Single payment / Unequal installments
 PV of ordinary annuity – Equal installments payable at the end of each period
 PV of annuity due – Equal installments payable at the beginning of each period

APPLICATION
Computation of Interest Expense
Problem 1: Belphegor Company frequently borrowed from the bank in order to maintain sufficient operating cash. The
loans were at a 12% interest rate, with interest payable at maturity. The entity repaid each loan on the scheduled
maturity date.
Date of loan Amount Maturity date
11/1/2019 500,000 10/31/2020
2/1/2020 1,500,000 7/31/2020
5/1/2020 800,000 1/31/2020
The entity recorded interest expense when the loans were repaid. As a result, interest expense of P150,000 was recorded
in 2020.

Required:
1) What amount should be reported as interest expense for 2020?
2) If no correction is made, by what amount would interest expense for 2020 be understated?

Solution: 12% Interest rate

Loan 1 10 months 50,000
Loan 2 6 months 90,000
Loan 3 8 months 64,000
Interest expense - Should be** 204,000
Less: interest expense - recorded 150,000
Understatement 54,000

**Explanation: Interest expense is computed only for the interest incurred during the reporting period. In this case,
the year 2020.

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Computation of Interest Payable (Simple Interest)

Problem 2: Asmodeus Company reported a 10% note payable of P3,600,000 on June 30, 2020. The note is dated
October 1, 2018 and payable in three equal annual payments of P1,200,000 plus interest. The first interest and principal
payment was made on October 1, 2019.

Required: On June 30, 2020, what amount should be reported as accrued interest payable for this note?

Solution:
Date Interest Principal payment CA
10/1/2018 3,600,000
10/1/2019 360,000 1,200,000 2,400,000
10/1/2020 240,000 1,200,000 1,200,000

Oct. 1, 2019 - June 30, 2020 180,000 (240k * 9/12 mos.)

Explanation: Interest payable is computed only from the last interest payment until the reporting period. In this case,
last payment was made October 1, 2019, the reporting period is June 30, 2020.

Computation of Interest Payable (Compounded Interest)

Problem 3: On March 1, 2019, Barthamus Company borrowed P1,000,000 and signed a 2-year note bearing interest
at 12% per annum compounded annually. Interest is payable in full at maturity on February 28, 2021.

Required: What amount should be reported as accrued interest payable on December 31, 2020?

Solution:
Date Interest CA
3/1/2019 1,000,000
2/28/2020 120,000 1,120,000
2/28/2021 134,400 1,254,400

Mar. 1, 2019 - Feb. 28, 2020 120,000

Mar. 1, 2020 - Dec. 31, 2020 112,000 (134,400 * 10/12 mos.)
Accrued interest payable 232,000

Explanation: Interest payable is computed only from the last interest payment until the reporting period. In this case,
there was no payment yet. The reporting period was December 31, 2020 plus the interest was compounded annually,
meaning the interest not paid was earning interest as well.

Noninterest-bearing note (payable in installments at the end of each period)

Problem 4: On January 1, 2020, Weimeraner Company acquired transportation equipment by paying cash of P400,000
and issuing a noninterest-bearing note payable of P4,000,000 due in 4 equal annual installments starting December 31,
2020. The prevailing rate of interest of this type of note is 12%. (PVF 4 decimal points)

Required:
1) How much is the carrying amount of the note on initial recognition?
2) How much is the interest expense in 2020?
3) How much is the carrying amount of the note on December 31, 2020?
4) How much is the current and noncurrent of the note on December 31, 2020?

Solution:
Note payable (Present Value):
Future payments 1,000,000
PV of annuity of 1 @ 12% for four periods 3.0373
Initial CA 3,037,300

Amortization table: Attributable to:

Date Payment Interest expense Principal CA
1/1/2020 3,037,300
12/31/2020 1,000,000 364,476 635,524 2,401,776
12/31/2021 1,000,000 288,213 711,787 1,689,989

**Explanation: Since the noninterest bearing note is payable in equal installments at the end of each period, the
PV of annuity of 1 is used to compute for the present value of the note payable.

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Noninterest-bearing note (payable in installments at the beginning of each period)

Problem 5: On December 31, 2020, Azazel Company purchased a machine from Fell Company in exchange for a
noninterest bearing note requiring eight payments of P200,000. The first payment was made on December 31, 2020
and the others are due annually on December 31. At date of issuance, the prevailing rate of interest for this type of
note was 11%. (PVF 4 decimal points)

Required:
1) How much is the cost of the machine?
2) What is the carrying amount of the note payable on December 31, 2020?
3) What is the interest expense for the year ended December 31, 2021?

Solution:
Note payable (Present Value):
Future Payments 200,000
PVF of Annuity Due of 1 @ 11% for 8 periods 5.7122 Face value Unamort. Disc.
Cost of the machine 1,142,440 1,600,000 457,560

Amortization table: Attributable to:

Date Payment Interest expense Principal CA
12/31/2020 200,000 - 200,000 942,440
12/31/2021 200,000 103,668 96,332 846,108

JE:
Dec. 31, 2020
Machine 1,142,440
Discount on note 457,560
Note payable 1,600,000

Note payable 200,000

Cash 200,000

Dec. 31, 2021

Interest expense 103,668
Discount 103,668

Note payable 200,000

Cash 200,000

Explanation:
1) Cost of the machine - Since the consideration given to acquire the machine was a noninterest bearing note, we
need to get the present value of the note. Such present value will be the cost of the machine.
2) Present value factor - Since the noninterest bearing note is payable in equal installments at the beginning
of each period, the PV of annuity due of 1 is used to compute for the present value of the note payable.
3) Carrying amount of Note Payable- In this case, the present value on December 31, 2020 will not be the carrying
amount on such date. Why? Because P200,000 was paid on the same date. Hence, the carrying amount on
December 31, 2020 is P942,440 (P1,142,440 less P200,000)

Noninterest-bearing note (payable in lump-sum)

Problem 6: On January 1, 2020, Anthony Company acquired a tract of land for P5,250,000. The entity paid P1,250,000
down and signed a noninterest bearing note for the balance which is due on January 1, 2023.

There was no established exchange price for the land and the note had no ready market. The prevailing interest rate
for this type of note was 12%. (PVF 4 decimal points)

Required:
1) How much is the cost of the land?
2) How much is the interest expense for 2020?
3) Prepare journal entries for 2020.

Solution:
Cash downpayment 1,250,000
Note payable (Present Value): Face value Unamortized Discount
Future payment (P5.25M - 1.25M DP) 4,000,000
PVF of 1 @ 12% for 3 periods 0.7118 2,847,200 4,000,000 1,152,800
Cost of land 4,097,200

Amortization:
Date Interest expense CA
1/1/2020 2,847,200
12/31/2020 341,664 3,188,864
12/31/2021 382,664 3,571,528
12/31/2022 428,472 4,000,000

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JE:
Jan. 1, 2020
Land 4,097,200
Discount on note 1,152,800
Cash 1,250,000
Note payable 4,000,000

Dec. 31, 2020

Interest expense 341,664
Discount on note 341,664

Explanation:
1) Cost of land - Since the consideration given to acquire the land was cash and a noninterest bearing note, we
need to get the present value of the note. Such present value plus cash down payment will be the cost of the
land.
2) Present value factor - Since the noninterest bearing note is payable in lump-sum, the PVF of 1 is used to
compute for the present value of the note payable.

Interest-bearing note (w/ unrealistic stated rate)

Problem 7: On January 1, 2020, Flames bought a machine from Blames Co. in lieu of cash payment, Flames gave
Blames a 4-year P4,000,000, 15% note payable. Principal is due on December 31, 2023 but interest is due annually
every December 31. The prevailing interest rate for this type of note is 10%. (PVF 4 Decimal)

Required:
1) How much is the cost of the machinery acquired on January 1, 2020?
2) How much is the interest expense for 2020?
3) How much is the carrying amount of the note on December 31, 2020?
4) How much is the current portion of the note on December 31, 2020?

Solution:
Present value of future payments: FCF PVF PV
Principal 4,000,000 0.6830 2,732,000
Interest 600,000 3.1699 1,901,940 Face value Premium
Initial CA of Note / Cost of Machine 4,633,940 4,000,000 633,940

Date N.I. E.I. Amortization CA

1/1/2020 4,633,940
12/31/2020 600,000 463,394 136,606 4,497,334
12/31/2021 600,000 449,733 150,267 4,347,067
Current Noncurrent

Explanation:
1) Interest-bearing note with unrealistic stated rate – Since the note bears a stated rate that is not equal to the
market rate, we need to get the present value of future payments using the effective rate.
2) Current portion of the note – As of December 31, 2020, the current portion of the note is actually next year’s
amortization. Please take note that the amortization is what actually increases or decreases the carrying amount
of the note.

Problem 8: On January 1, 2020, Cain Company received P1,000,000 on a noninterest-bearing note due in three years.
The market rate of interest on such date is 10%. The entity irrevocably elected the fair value option in measuring the
note payable. On December 31, 2020, the risk factors indicated that the rate of interest applicable to the borrowing was
9%. (PVF 3 decimal points)

Required:
1) What is the initial carrying amount of the note payable on January 1, 2020?
2) What is the carrying amount of the note payable on December 31, 2020?
3) What amount of net gain or loss from the change in fair value of the note payable should be reported for 2020?

Solution: FCF PVF

Face value - Jan. 1, 2020 1,000,000
FV - Jan. 1, 2020 1,000,000 0.751 751,000
Gain on change in FV (P/L) 249,000

FCF PVF PV
FV - Dec. 31, 2020 1,000,000 0.842 842,000
FV - Jan. 1, 2020 751,000
Loss on change in FV (P/L) 91,000

Gain on change in FV (P/L) - Initial measurement 249,000

Loss on change in FV (P/L) - Subsequent measurement 91,000
Net gain on change in FV (P/L) 158,000

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THEORIES

1. When an entity issued a note solely in exchange for cash, the present value of the note at issuance is equal to
a. Face amount
b. Face amount discounted at the prevailing interest rate
c. Proceeds received
d. Proceeds received discounted at the prevailing interest rate

2. If the present value of a note issued in exchange for a property is less than face amount, the difference should
be
a. Included in the cost of the asset
b. Amortized as interest expense over the life of the note
c. Amortized as interest expense over the life of the asset
d. Included in interest expense in the year of issuance

3. At issuance date, the present value of a promissory note is equal to the face amount if the note
a. Bears a stated rate of interest which is realistic
b. Bears a stated rate of interest which is less than the prevailing market rate for similar notes
c. Is noninterest bearing and the implicit interest rate is less than the prevailing market rate for similar
notes
d. Is noninterest bearing and the implicit interest rate is equal to the prevailing market rate for similar
notes

4. Which statement concerning discount on note payable is incorrect?

a. Discount on note payable may be debited when entity discounts its own note with the bank
b. The discount on note payable is a deduction from the face amount of the note payable
c. The discount on note payable represents interest charges applicable to future periods
d. Amortizing the discount on note payable gradually decreases the carrying amount of the liability over
the life of the note

5. A note payable with no ready market is exchanged for property whose fair value is currently indeterminable.
When such a transaction takes place
a. The present value of the note payable must be approximated using an imputed interest rate
b. The note payable should not be recorded until the fair value of the property becomes evident
c. The entity receiving the property should estimate a value for the property
d. Both entities involved in the transaction should negotiate a value to be assigned to the property

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