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Notes Receivable When a promissory note matures and is not paid, it is

Question 1: said to be dishonored.


Define notes receivable.
Theoretically, dishonored notes shall be removed from
Answer: the notes receivable account and transferred to
Notes receivable are claims supported by formal accounts receivable at an amount to include, if any,
promises to pay usually in the form of notes. interest and other charges.

A negotiable promissory note is an unconditional The journal entry to recorded dishonored notes is:
promise in writing made by one person to another, Accounts receivable xx
signed by the maker, engaging to pay on demand or at Notes receivable xx
a fixed determinable future time a sum certain in Interest income xx
money to order or to bearer.
Such approach is defended on the ground that the
Simply stated, a promissory note is a written contract overdue note has lost part of its status as a negotiable
in which one person, known as the maker, promises to instrument and really represents only an ordinary
pay another person, known as the payee, a definite claim against the maker.
sum of money.
Question 3:
The note may be payable on demand or at a definite Explain the initial measurement of notes receivable.
future date.
Answer:
Standing alone, the term note receivable represents Conceptually, notes receivable shall be measured
only claims arising from sale of merchandise or service initially at present value.
in the ordinary course of business.
The present value is the sum of all future cash flows
Thus, notes received from officers, employees, discounted using the prevailing market rate of interest
shareholders and affiliates shall be designated for similar notes.
separately.
The prevailing market rate of interest is actually the
Question 2: effective interest rate.
Explain the treatment of dishonored notes.
However, short-term notes receivable are measured
Answer: at face value.
The amortized cost is the amount at which the note
Cash flows relating to short-term notes receivable are receivable is measured initially minus principal
not discounted because the effect of discounting is repayment, plus or minus the cumulative amortization
usually not material. of any difference between the initial carrying amount
and the principal maturity amount minus reduction for
The initial measurement of long-term notes depends impairment or uncollectibility.
on whether the notes are interest-bearing or
noninterest-bearing. For long-term noninterest-bearing notes receivable,
the amortized cost is the present value minus the
Interest bearing long-term notes are measured at face unamortized unearned interest income.
value which is actually the present value upon Question 5:
issuance. 1. On October 1 of the current year, an entity received
a one-year note receivable bearing interest at the
Noninterest-bearing long-term notes are measured at market rate. The face amount of the note
present value which is the discounted value of the receivable and the entire amount of the interest are
future cash flows using the effective interest rate. due on September 30 of next year. The interest
receivable on December 31 of the current year
Actually, the term noninterest-bearing is a misnomer would consist of an amount representing
because all notes implicitly contain interest. a. Three months of accrued interest income
b. Nine months of accrued interest income
It is simply a case of the interest being included in the c. Twelve months of accrued interest income
face amount rather than being stated as a separated d. The excess on October 1 of the present value of
rate. the note receivable over its face amount
2. On July 1 of the current year, an entity obtained a
Question 4: two-year 8% note receivable for services rendered.
Explain the subsequent measurement of notes At that time, the market rate of interest was 10%.
receivable. The face amount of the note and the entire amount
of interest are due on the date of maturity. Interest
Answer: receivable on December 31 of the current year is
Subsequent to initial recognition, long-term notes a. 5% of the face amount of the note
b. 4% of the face amount of the note
receivable shall be measured at amortized cost using
c. 5% of the present value of the note
the effective interest method.
d. 4% of the present value of the note
3. An entity uses the installment sales method to market rate. The face amount of the note
recognize revenue. Customers pay the installment receivable and the entire amount of the interest are
notes in 24 equal monthly amounts which include due in one year. When the note receivable was
12% interest. What is the installment notes recorded on July 1, which of the following was
receivable balance six months after the sale? debited?
a. 75% of the original sales price. I. Interest receivable
b. Less than 75% of the original sales price. II. Unearned discount on note receivable
c. The present value of the remaining monthly a. I only
payments discounted at 12%. b. Both I and II
d. Less than the present value of the remaining c. Neither I nor II
monthly payments discounted at 12%. d. II only
4. What is imputed interest? 8. On August 15, an entity sold goods for which it
a. Interest based on the stated interest rate received a note bearing the market rate of interest
b. Interest based on the implicit interest rate on that date. The four-month note was dated July
c. Interest based on the average interest rate 15. When the note was recorded on August 15,
d. Interest based on the bank prime interest rate which of the following accounts increased?
5. Accounting for the interest in a noninterest bearing a. Unearned discount
note receivable is an example of what aspect of b. Interest receivable
accounting theory? c. Prepaid interest
a. Matching d. Interest revenue
b. Verifiability 9. On July 1 of the current year, an entity received a
c. Substance over form one-year note receivable bearing interest at the
d. Form over substance market rate. The face amount of the note
6. On July 1 of the current year, an entity received a receivable and the entire amount of the interest are
one-year note receivable bearing interest at the due on June 30 of next year. On December 31 of
market rate. The face amount of the note the current year, the entity should report in the
receivable and the entire amount of the interest are statement of financial position
due in one year. The interest receivable account a. A deferred credit for interest applicable to next
would show a balance on year
a. July 1 but not December 31 b. No interest receivable
b. December 31 but not July 1 c. Interest receivable for the entire amount of the
c. July 1 and December 31 interest due on June 30 of next year
d. Neither July 1 nor December 31 d. Interest receivable for the interest accruing in
7. On July 1 of the current year, an entity received a the current year
one-year note receivable bearing interest at the
10. An entity received a seven-year zero interest- 9. D
bearing note on February 1, 2013 in exchange for There is an accrued interest receivable from July 1
property sold. There was no established price for to December 31 of the current year.
the property and the note has no ready market. The 10. B
prevailing rate of interest for a note of this type was The interest revenue should be computed based
7% on February 1, 2013, 6% on December 31, the prevailing rate of interest on the date of issue,
2013, 8% on February 1, 2014, and 9% on February 1, 2013.
December 31, 2014. What interest rate should be
used to calculate the interest revenue from the
transaction for the years ended December 31, 2013
and 2014, respectively?
a. 0% and 0%
b. 7% and 7%
c. 7% and 9%
d. 6% and 9%

Answer 16-5: Loan Receivable


1. a Question 1:
2. b Define loan receivable.
3. c
4. b Answer:
5. c A loan receivable is a financial asset arising from a
6. b loan granted by a bank or other financial institution to
The accrued interest receivable on December 31 is
a borrower or client.
for the period July 1 to December 31 of the current
year.
The term of the loan may be short-term but in most
7. C
cases, the repayment periods cover several years.
On July 1, when the note was received, there is no
accrued interest receivable as yet. Also, there is no
Question 2:
unearned discount because the note receivable is
Explain the initial measurement of loan receivable.
interest bearing.
8. B
Since the note was dated July 15 and it was Anwer:
received on August 15, there is an accrued interest At initial recognition, an entity shall measure a loan
receivable for one month from July 15 to August 15. receivable at fair value plus transaction costs that are
directly attributable to the acquisition of the financial recognized and the principal maturity amount, minus
asset. reduction for impairment or uncollectibility.

The fair value of the loan receivable at initial Question 4:


recognition is normally the transaction price, meaning, Explain origination fees in relation to a loan
the amount of the loan granted. receivable.

Transaction costs that are directly attributable to the Answer:


receivable include origination fees. Lending activities usually precede the actual
disbursement of funds and generally include efforts to
Direct origination costs should be included in the identify and attact potential borrowers and to
initial measurement of the loan receivable. originate a loan.

Question 3: The fees charged by the bank against the


Explain the subsequent measurement of loan borrower for the creation of the loan are known as
receivable. origination fees.

Answer: Origination fees include compensation for activities


PFRS 9, paragraph 4.1.2, provides that if the business such as evaluating the borrowers financial condition,
model in managing financial asset is to collect evaluating guarantees, collateral and other security,
contractual cash flows on specified dates and the negotiating the terms of the loan transaction.
contractual cash flows are solely payments of principal
and interest, the financial asset shall be measured at Question 5:
amortized cost. What is the treatment of origination fees?

Accordingly, a loan receivable is subsequently Answer:


measured at amortized cost using the effective The origination fees received from borrower are
interest method. recognized as unearned interest income and amortized
over the term of the loan.
The amortized cost is the amount at which the
receivable is measured initially minus principal If the origination fees are not chargeable against the
repayment, plus or minus the cumulative amortization borrower, the fees are known as direct origination
of any difference between the initial amount costs.
The direct origination costs are deferred and also Objective evidence of impairment may result from the
amortized over the term of the loan. following loss events occurring after the initial
recognition of the financial asset:
Preferably, the direct origination costs are offset 1. Significant financial difficulty of the issuer or obligor.
directly againsts any origination fees received. 2. Breach of contract, such as default or delinquency in
interest or principal payment.
If the origination fees received exceed the direct 3. Debt restricting
origination costs, the difference is unearned interest The lender, for economic or legal reason relating
income and the amortization will increase interest to the borrowers financial difficulty, grants to the
income. borrower a concession that the lender would not
otherwise consider.
If the direct origination costs exceed the origination 4. Probability that the borrower will enter
fees received, the difference is charged to direct bankruptcy or other financial reorganization.
origination costs and the amortization will decrease 5. The disappearance of an active market for the
interest income. financial asset because of financial difficulty.
Measurable decrease in the estimated future cash
Accordingly, the origination fees received and the flows from a group of financial assets.
direct origination costs are included in the
measurement of the loan receivable. Question 7:
Explain the measurement of impairment loss on loan
Question 6: receivable.
Explain impairment of loan receivable.
Answer:
Answer: PFRS 9, paragraph 5.2.2, provides the measurement of
PFRS 9, paragraph 5.2.2, in conjunction with PAS 39, impairment loss on loan receivable carried at
paragraph 58, provides that an entity shall assess at amortized cost.
every end of reporting period whether there is
objective evidence that a financial asset or group of The amount of the loss is measured as the
financial assets is impaired. difference between the carrying amount of the loan
receivable and the present value of estimated future
If such evidence exists, the entity shall determine and cash flows discounted at the original effective rate
recognize the amount of any impairment loss. of the loan.
The carrying amount of the loan receivable shall be a. Significant financial difficulty of the issuer.
reduced either directly or through the use of an b. A decline in the fair value of the financial asset
allowance account. below the previous carrying amount.
c. A breach of contract, such as a default or
The amount of the impairment loss shall be recognized delinquency in interest or principal payment.
in profit or loss. d. The lender, for economic or legal reason relating
to the borrowers financial difficulty, grants to
Question 8: the borrower a concession that the lender would
1. A loan receivable is initially measured at not otherwise consider.
a. Fair value
b. Fair value plus transaction cost 5. If there is evidence that an impairment loss on loan
c. Fair value minus transaction cost receivable has been incurred, the loss is equal to
d. Present value the
a. Excess of the carrying amount of the loan
2. In calculating the carrying amount of a loan receivable over the present value of the cash
receivable, the lender adds to the principal flows related to the loan.
a. Direct loan origination cost incurred by the b. Excess of the present value of cash flows related
lender to the loan over the carrying amount of the loan
b. Indirect loan origination cost incurred by the receivable.
lender c. Excess of the carrying amount of the loan over
c. Loan origination fee charged to the borrower the principal amount of the loan.
d. Interest incurred by the borrower d. Excess of the principal amount of the loan over
the carrying amount.
3. Subsequent to initial recognition, a loan
receivable shall be measured at Answer:
a. Cost 1. b
b. Amortized cost using the straight line method 2. a
c. Amortized cost using the effective interest 3. c
method 4. b
d. Fair value 5. a

4. Which of the following is not an objective evidence ooooooo8(2)


of impairment of a financial asset?