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

Question 1: said to be dishonored.

Define notes receivable.
Answer:
Notes receivable are claims supported by formal
promises to pay usually in the form of notes.
Theoretically, dishonored notes shall be removed from
the notes receivable account and transferred to
accounts receivable at an amount to include, if any,
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.

Cash flows relating to short-term notes receivable are
not discounted because the effect of discounting is
usually not material.
The initial measurement of long-term notes depends
on whether the notes are interest-bearing or
noninterest-bearing.
Interest bearing long-term notes are measured at face
value which is actually the present value upon
issuance.
Noninterest-bearing long-term notes are measured at
present value which is the discounted value of the
future cash flows using the effective interest rate.
Actually, the term noninterest-bearing is a misnomer
because all notes implicitly contain interest.
It is simply a case of the interest being included in the
face amount rather than being stated as a separated
rate.
Question 4:
Explain the subsequent measurement of notes
receivable.
Answer:
Subsequent to initial recognition, long-term notes
receivable shall be measured at amortized cost using
the effective interest method.
The amortized cost is the amount at which the note
receivable is measured initially minus principal
repayment, plus or minus the cumulative amortization
of any difference between the initial carrying amount
and the principal maturity amount minus reduction for
impairment or uncollectibility.
For long-term noninterest-bearing notes receivable,
the amortized cost is the present value minus the
unamortized unearned interest income.
Question 5:
1. On October 1 of the current year, an entity received
a one-year note receivable bearing interest at the
market rate. The face amount of the note
receivable and the entire amount of the interest are
due on September 30 of next year. The interest
receivable on December 31 of the current year
would consist of an amount representing
a. Three months of accrued interest income
b. Nine months of accrued interest income
c. Twelve months of accrued interest income
d. The excess on October 1 of the present value of
the note receivable over its face amount
2. On July 1 of the current year, an entity obtained a
two-year 8% note receivable for services rendered.
At that time, the market rate of interest was 10%.
The face amount of the note and the entire amount
of interest are due on the date of maturity. Interest
receivable on December 31 of the current year is
a. 5% of the face amount of the note
b. 4% of the face amount of the note
c. 5% of the present value of the note
d. 4% of the present value of the note
3. An entity uses the installment sales method to
recognize revenue. Customers pay the installment
notes in 24 equal monthly amounts which include
12% interest. What is the installment notes
receivable balance six months after the sale?
a. 75% of the original sales price.
b. Less than 75% of the original sales price.
c. The present value of the remaining monthly
payments discounted at 12%.
d. Less than the present value of the remaining
monthly payments discounted at 12%.
4. What is imputed interest?
a. Interest based on the stated interest rate
b. Interest based on the implicit interest rate
c. Interest based on the average interest rate
d. Interest based on the bank prime interest rate
5. Accounting for the interest in a noninterest bearing
note receivable is an example of what aspect of
accounting theory?
a. Matching
b. Verifiability
c. Substance over form
d. Form over substance
6. On July 1 of the current year, an entity received a
one-year note receivable bearing interest at the
market rate. The face amount of the note
receivable and the entire amount of the interest are
due in one year. The interest receivable account
would show a balance on
a. July 1 but not December 31
b. December 31 but not July 1
c. July 1 and December 31
d. Neither July 1 nor December 31
7. On July 1 of the current year, an entity received a
one-year note receivable bearing interest at the
market rate. The face amount of the note
receivable and the entire amount of the interest are
due in one year. When the note receivable was
recorded on July 1, which of the following was
debited?
I. Interest receivable
II. Unearned discount on note receivable
a. I only
b. Both I and II
c. Neither I nor II
d. II only
8. On August 15, an entity sold goods for which it
received a note bearing the market rate of interest
on that date. The four-month note was dated July
15. When the note was recorded on August 15,
which of the following accounts increased?
a. Unearned discount
b. Interest receivable
c. Prepaid interest
d. Interest revenue
9. On July 1 of the current year, an entity received a
one-year note receivable bearing interest at the
market rate. The face amount of the note
receivable and the entire amount of the interest are
due on June 30 of next year. On December 31 of
the current year, the entity should report in the
statement of financial position
a. A deferred credit for interest applicable to next
year
b. No interest receivable
c. Interest receivable for the entire amount of the
interest due on June 30 of next year
d. Interest receivable for the interest accruing in
the current year
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
asset.
The fair value of the loan receivable at initial
recognition is normally the transaction price, meaning,
the amount of the loan granted.
Transaction costs that are directly attributable to the
receivable include origination fees.
Direct origination costs should be included in the
initial measurement of the loan receivable.
Question 3:
Explain the subsequent measurement of loan
receivable.
Answer:
PFRS 9, paragraph 4.1.2, provides that if the business
model in managing financial asset is to collect
contractual cash flows on specified dates and the
contractual cash flows are solely payments of principal
and interest, the financial asset shall be measured at
amortized cost.
Accordingly, a loan receivable is subsequently
measured at amortized cost using the effective
interest method.
The amortized cost is the amount at which the
receivable is measured initially minus principal
repayment, plus or minus the cumulative amortization
of any difference between the initial amount
recognized and the principal maturity amount, minus
reduction for impairment or uncollectibility.
Question 4:
Explain origination fees in relation to a loan
receivable.
Answer:
Lending activities usually precede the actual
disbursement of funds and generally include efforts to
identify and attact potential borrowers and to
originate a loan.
The fees charged by the bank against the
borrower for the creation of the loan are known as
origination fees.
Origination fees include compensation for activities
such as evaluating the borrowers financial condition,
evaluating guarantees, collateral and other security,
negotiating the terms of the loan transaction.
Question 5:
What is the treatment of origination fees?
Answer:
The origination fees received from borrower are
recognized as unearned interest income and amortized
over the term of the loan.
If the origination fees are not chargeable against the
borrower, the fees are known as direct origination
costs.
The direct origination costs are deferred and also
amortized over the term of the loan.
Preferably, the direct origination costs are offset
directly againsts any origination fees received.
If the origination fees received exceed the direct
origination costs, the difference is unearned interest
income and the amortization will increase interest
income.
If the direct origination costs exceed the origination
fees received, the difference is charged to direct
origination costs and the amortization will decrease
interest income.
Accordingly, the origination fees received and the
direct origination costs are included in the
measurement of the loan receivable.
Question 6:
Explain impairment of loan receivable.
Answer:
PFRS 9, paragraph 5.2.2, in conjunction with PAS 39,
paragraph 58, provides that an entity shall assess at
every end of reporting period whether there is
objective evidence that a financial asset or group of
financial assets is impaired.
If such evidence exists, the entity shall determine and
recognize the amount of any impairment loss.
Objective evidence of impairment may result from the
following loss events occurring after the initial
recognition of the financial asset:
1. Significant financial difficulty of the issuer or obligor.
2. Breach of contract, such as default or delinquency in
interest or principal payment.
3. Debt restricting
The lender, for economic or legal reason relating
to the borrowers financial difficulty, grants to the
borrower a concession that the lender would not
otherwise consider.
4. Probability that the borrower will enter
bankruptcy or other financial reorganization.
5. The disappearance of an active market for the
financial asset because of financial difficulty.
Measurable decrease in the estimated future cash
flows from a group of financial assets.
Question 7:
Explain the measurement of impairment loss on loan
receivable.
Answer:
PFRS 9, paragraph 5.2.2, provides the measurement of
impairment loss on loan receivable carried at
amortized cost.
The amount of the loss is measured as the
difference between the carrying amount of the loan
receivable and the present value of estimated future
cash flows discounted at the original effective rate
of the loan.
The carrying amount of the loan receivable shall be
reduced either directly or through the use of an
allowance account.
The amount of the impairment loss shall be recognized
in profit or loss.
Question 8:
1. A loan receivable is initially measured at
a. Fair value
b. Fair value plus transaction cost
c. Fair value minus transaction cost
d. Present value
2. In calculating the carrying amount of a loan
receivable, the lender adds to the principal
a. Direct loan origination cost incurred by the
lender
b. Indirect loan origination cost incurred by the
lender
c. Loan origination fee charged to the borrower
d. Interest incurred by the borrower
3. Subsequent to initial recognition, a loan
receivable shall be measured at
a. Cost
b. Amortized cost using the straight line method
c. Amortized cost using the effective interest
method
d. Fair value
4. Which of the following is not an objective evidence
of impairment of a financial asset?
a. Significant financial difficulty of the issuer.
b. A decline in the fair value of the financial asset
below the previous carrying amount.
c. A breach of contract, such as a default or
delinquency in interest or principal payment.
d. The lender, for economic or legal reason relating
to the borrowers financial difficulty, grants to
the borrower a concession that the lender would
not otherwise consider.
5. If there is evidence that an impairment loss on loan
receivable has been incurred, the loss is equal to
the
a. Excess of the carrying amount of the loan
receivable over the present value of the cash
flows related to the loan.
b. Excess of the present value of cash flows related
to the loan over the carrying amount of the loan
receivable.
c. Excess of the carrying amount of the loan over
the principal amount of the loan.
d. Excess of the principal amount of the loan over
the carrying amount.
Answer:
1. b
2. a
3. c
4. b
5. a
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