48948151 Notes Payable

NOTE PAYABLE AND DEBT RESTRUCTURING Note Payable: Written promises to pay a certain sum of money on a specified future date. Arise from purchases, financing, or other transactions. Classified as either “Short-term” or “Long-term” depending on the payment due date. Also classified as “Interest bearing” or “Zero-Interest bearing”. Measurement of Notes Payable  

Initially, notes payable shall be measured at fair value which is equal to the present value or discounted value. Subsequently, the note payable shall be measured at amortized cost.

Note Issued Solely for Cash 

When a note is issued solely for cahs, the present value is equal to the cash proceeds. The entry to record the issuance of the note is: Cash xx Discount on Note Payable xx Notes Payable xx

Note: The discount debited, is the discount on notes payable for the whole year, the interest. So, if it is needed, the discount could be amortized as interest expense. Interest Expense Discount on Notes Payable

xx xx

Straight line method is used in amortizing the discount on note payable. The discount on notes payable is a direct deduction from the note payable. Note Payable xx Less: Discount on Note payable (xx) Book Value xx Note: The book value is actually the amortized cost of the note payable. Two Types of Notes Payable Interest Bearing Note Journal entries Issuance of an interest bearing note: Cash Notes Payable

xx xx

Payment of the note including interest: Notes Payable Interest Payable Cash

xx xx xx

Zero-Interest- Bearing Not Does not explicitly state an interest rate on the face of the note but Interest is still charged. At maturity the borrower must pay back an amount greater than the cash received. Journal entries Issuance of a zero-interest-bearing note: Cash Discount on Notes Payable Notes Payable

xx xx xx

Interest Bearing Note Issued for Property  

When a property or noncash asset is acquired by issuing a note which is interest-bearing, the property or asset is recorded at purchase price The purchase price is the present value of the and therefore the fair value of the property because the note issued is interestbearing.

Noninterest Bearing Note issued for Property  

When a noninterest bearing note is issued for property, the property is recorded at the cash price of the property. The cash price is assumed to be the present value of the note issued. The difference between the cash price and the fce value of the note issued represents the imputed interest. The imputed interest is based on the sound philosophy that no lender would part away with his money or property interest-free.

Dacion en pago Accounting: or can be considered as payment in kind. It arises when a mortgaged property is offered by the debtor in full settlement of the debt.this transaction shall be accounted for as an “Asset Swap” for of debt restructuring. This requires recognition of gain or loss based on the balance of the obligation including accrued interest and other charges. If the balance of the obligation including accrued interest and other charges is more than the cost or book value of the property mortgaged, there is a gain on extinguishment of debt. Otherwise, there is a loss on extinguishment. Debt Restructuring: is a situation where the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants to the debtor concession that would not be granted in a normal business relationship. The concession either stems from an agreement between the credtor and debtor, or is imposed by law or a court. Types of Debt Restructuring 1.

Asset Swap: is a transfer by the debtor to the creditor of any asset such as real estate, inventory, receivables and investment, in full payment of an obligation. Asset swap is recorded as follows: Note payable xx Accrued Interest Payable xx Asset (transferred) xx Gain on Extinguishment xx

2.

Equity Swap: the issuance of share capital by the debtor to the creditor in full or partial payment of an obligation. Equity swap is recorded as follows: Bonds Payable xx Accrued interest Payable xx Share capital xx Share Premium xx Gain on extinguishment of debt xx

3.

Modification of Terms: may involve either the interest, maturity value or both. PAS 39, that a substantial modification of terms of an existing financial liability shall be accounted for as an extinguishment of the old financial liability and the recognition of a new financial liability.

PROBLEMS Problem 1 Samson Corporation issued a 4-year, $75,000, zero-interest-bearing note to Brown Company on January 1, 2011, and received a cash of $47,664. The implicit interest rate is 12%. Prepare Samson’s journal entries for (a) the January 1 issuance and (b) the December 31 recognition of interest. Problem 2 McCormick Corporation issued a 4-year, $40,000, 5% note to Greenbush Company on January 1, 2011m and received a computer that normally sells for $31,495. The note requires annual interest payments each December 31. The market rate of interest for a note of similar risk is 12%. Prepare McCormick’s journal entries for (a) the January 1 issuance and (b) the December 31 interest. Problem 3 On January 1, 2010, East Company acquired an equipment for P850,000 payable in two annual equal instalments every December 31 of each year. East Company signed an interest bearing note for P850,000. Interest of 14% is payable annually on the unpaid balance. Prepare all indicated entries for 2010 and 2011. Problem 4 On January 1, 2010, James Company borrowed P4,800,000 from a major customer evidenced by a noninterest bearing note due in three years. James agreed to supply the customer’s inventory needs for the loan period at lower than market price. At the 11% imputed interest rate for this type of loan, the present value of the note is P3,530,000 at January 1, 2010. What amount of interest expense should be included in James’ 2010 income statement? Problem 5 1.On December 31, 2010, CFord Company purchased a machine from Liss Company in exchange for a noninterest bearing note requiring 10 payments of P250,000. The first payment was made on December 31, 2010 and the others are due annually on December 31. At date of issuance, the prevailing rate of interest for this type of note was 9%. On December 31, 2010, the note payable should be reported at

Problem 6 On August 31, Jenks Co. partially refunded $180,000 of its outstanding 10% note payable made one year ago to Arma State Bank by paying $180,000 plus $18,000 interest, having obtained the $198,000 by using $52,400 cash and signing a new one-year $160,000 note discounted at 9% by the bank. (1)

Make the entry to record the partial refunding. Assume Jenks Co. makes reversing entries when appropriate.

(2)

Prepare the adjusting entry at December 31, assuming straight-line amortization of the discount.

Problem 7 Hiroshima Corporation borrowed P60,000 on November 1, 2010, by signing a P61,350, 3-month, zero-interest bearing note. Prepare Hiroshima’s November 1, 2010, entry; the December 31, 2010, annual adjusting entry and the February 1, 2011, entry. Problem 8 Joshua Company bought a new machine on January 1, 2010 and agreed to pay in equal annual installments of 600,000 at the end of the next five years. The prevailing interest rate for this type of transaction is 12%. a.How much should Joshua report as note payable in the statement of financial position if financial statements were prepared on January 1, 2010. b.What is the interest expense on the note payable? Problem 9 On January 1, 2010, Pares Company borrowed P3,600,000 from a major customer evidenced by a non-interest bearing note due in three years. Pares agreed to supply the customer’s inventory needs for the loan period at lower than market price. At the 12% imputed interest rate for this type of loan, the present value of the note is P2,550,000 at January 1, 2010. a.What interest expense should be reported in the 2010 income statement? b.How much is the discount on the notes payable? Problem 10 On December 31, 2010 , Boston Company purchased a machine from Helix Company in exchange for a non-interest bearing note requiring eight payments of 200,000. The first payment was made on December 31, 2010 and the others are due annually on December 31. At the date of issuance the prevailing rate of interest for this type of note was 11%. On December 31, 2010, what should be reported as carrying amount of the note payable? Problem 11 Coldwell, Inc. issued a $100, 000, 4-year, 10% note at face value to Flint Hills Bank on January 1, 2011, and received $100, 000 cash. The note requires annual interest payments each December 31. Prepare Coldwell’s journal entries to record (a) the issuance of the note and (b) the December 31 interest payment. Problem 12 Samson Corporation issued a 4-year, $75, 000, zero-interest-bearing note to Brown Company on January 1, 2011, and received cash of $47, 664. The implicit interest rate is 12%. Prepare Samson’s journal entries for (a) the January 1 issuance and (b) the December 31 recognition of interest. Problem 13 McCormick Corporation issued a 4-year, $40, 000, 5% note to Greenbush Company on January 1, 2011, and received a computer that normally sells for $31, 495. The note requires annual interest payments each December 31. The market rate of interest for a note of similar risk is 12%. Prepare McCormick’s journal entries for (a) the January 1 issuance and (b) the December 31 interest. Problem 14 Shlee Corporation issued a 4-year, $60, 000, zero-interest-bearing note to Garcia Company on January 1, 2011, and received cash of $60, 000. In addition, Shlee agreed to sell merchandise to Garcia at an amount less than regular selling price over the 4-year period. The market rate of interest for similar notes is 12%. Prepare Shlee Corporation’s January 1 journal entry. Problem 15 On December 31, 2009, Roth Company issued a P1,000,000 face value note payable to Wake Company is exchange for services rendered to Roth. The note, made at usual trade terms, is due in nine months and bears interest, payable at maturity, at the annual rate of 3%. The market interest rate is 8%. At what amount should the note payable be reported in Roth’s December 31, 2009 statement of financial position? Problem 16 On January 1, 2009, Pares Company borrowed P3,600,000 from a major customer evidenced by a noninterest bearing note due in three years. Pares agreed to supply the customer’s inventory needs for the load period at lower than market price. At the 12% imputed interest rate for this type of loan, the present value of the note is P2,550,000 at January 1, 2009. What amount of interest expense should be included in Pares’ 2009 income statement?

Problem 17 On July 1, 2009, Cody Company obtained a P2,000,000, 180-day bank loan at an annual rate of 12%. The loan agreement requires Cody to maintain a P400,000 compensating balance in its checking account at the lending bank. Cody would otherwise maintain a balance of only P200,000 in this account. The checking account earns interest at an annual rate of 6%. Based on a 360-day year, the effective interest rate on the borrowing is: Loan Less: Compensating balance in excess of the Normal checking account balance

2,000,000 ( 200,000) 1,800,000

Effective amount (1,800,000 x 180/360) Effective interest rate (114,000/900,000)

900,000 12.67%

Problem 18 On March 1, 2008, Fine 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, 2009. What amount should Fine report as a liability for accrued interest at December 31, 2009? Problem 19 Joshua Company bought a new machine on January 1, 2009 and agreed to pay in equal annual installment of P600,000 at the end of each of the next five years. The prevailing interest rate for this type of transaction is 12%. How much should Joshua report as note payable in the statement of financial position if financial statements were prepared on January 1, 2009? Problem 20 On December 31, 2009, Largo Company had a P750,000 note payable outstanding, due July 31, 2010. Largo borrowed the money to finance construction of a new plant. Largo planned to refinance the note by issuing long-term bonds. Because Largo temporarily had excess cash, it prepaid P250,000 of the note on January 15, 2010. In February 2010, Largo completed a P1,500,000 bond offering. Largo will use the bond offering proceeds to repay the note payable at its maturity and to pay construction cost during 2010. On March 31, 2010, Largo issued its 2009 Financial Statements. What amount of the note payable should Largo include in current liabilities on December 31, 2009? Problem 21 Versatile Company after having experienced financial difficulties in 2010 negotiated with a major creditor and arrived at an agreement to restructure its notes payable on December 31, 2010. The creditor was owed principal of 3,600,000 and interest of 400,000 but agree d to accept equipment worth 700,000 and note receivable from a Versatile Company’s customer with carrying amount of 2,700,000. The equipment had an original cost of 900,000 and depreciation of 300,000. How much should be recognized as gain from debt extinguishment on December 31, 2010? Problem 22 On December 31, 2008, Nolte Co. is in financial difficulty and cannot pay a note due that day. It is a $600,000 note with $60,000 accrued interest payable to Piper, Inc. Piper agrees to accept from Nolte equipment that has a fair value of $290,000, an original cost of $480,000, and accumulated depreciation of $230,000. Piper also forgives the accrued interest, extends the maturity date to December 31, 2011, reduces the face amount of the note to $250,000, and reduces the interest rate to 6%, with interest payable at the end of each year. a.Nolte should recognize a gain or loss on the transfer of the equipment of_____________ b.Nolte should recognize a gain on the partial settlement and restructure of the debt of__________ c.Nolte should record interest expense for 2011 of____________

SOLUTIONS TO PROBLEMS Solution to Problem 1 (a) January 1, 2011

(b) December 31, 2011

Cash Discount on Notes Notes Payable

47,664 27,336

Interest Expense

5719.68

Discount on Notes

75,000

5719.68

Solution to Problem 2 Schedule of Note Discount Amortization Effective Interest Method

Date

Interest Expense

Discount Amortized

December 31, 2011

5,719.68

5,719.68

December 31, 2012

6,406.04

6,406.04

December 31, 2013

7,174.77

7,174.77

December 31, 2014

8,035.74

8,035.74

January 1,2011

(a)

(b)

January 1, 2011

Equipment Discount on Notes Notes Payable

31, 495 8, 505 40,000

December 31, 2011 Interest Expense Cash Discount on Notes

5,779.4 2,000 3,774.9

Solution to Problem 3 Schedule of Note Discount Amortization Effective Interest Method Date

Interest Expense

Interest Paid

Discount Amortized

January 1,2011 December 31, 2011

3779.4

2000

1779.4

December 31, 2012

3,992.93

2000

1992.93

December 31, 2013

4,232.08

2000

2232.08

December 31, 2014

4,499.93

2000

2499.93

January 1, 2010

Equipment Discount on Notes Notes Payable

699,831 150,169 850,000

*Present Value 850,000/2 = 425,000 x 1.6467 = 699,831 December 31, 2010

December 31, 2010

Interest Expense (850,000 x .14) Notes Payable Cash

119,000 425,000

Interest Expense (425,000 x .14) Notes Payable Cash

59,500 425,000

Solution to Problem 4 P388,300 P3530,000 x 11% = 388,300 Solution to Problem 5 P1498,800 P250,000 x 6.9952 = 1748,800 (250,000) 1498,800

544,000

484,500

Solution to Problem 6 (1)

(2)

Notes Payable................................................................................................................... Interest Expense............................................................................................................... Discount on Notes Payable (9% × $160,000)................................................................... Notes Payable................................................................................................... Cash..................................................................................................................

180,000 18,000 14,400

Interest Expense (1/3 × $14,400)...................................................................................... Discount on Notes Payable..............................................................................

4,800

160,000 52,400 4,800

Solution to Problem 7 Nov 1.

Cash ………………………………………………………….. Discount on Note Payable ………………………………… Notes Payable ………………………………………….

60,000 1,350 61,350

Dec 1. Interest Expense ………………………………………………. Discount on Notes Payable ………………………….. ( 1, 350 x 2/3 )

900

Feb. 1 Interest Expense ……………………………………………….. Discount on Notes Payable ………………………... ( 1,350 x 1/3 )

450

Notes Payable ………………………………………………… Cash …………………………………………………..

900

450 61,350 61,350

Solution to Problem 8 a.PV of note payable on 1/1/2010 (600,000 x 3.60*) Note: PV of Ordinary annuity of 1 at 12% for 5 periods is 3.60* b.Interest expense for 2010 ( 2,160,000 x 12% )

2,160,000

259, 200

Solution to Problem 9 a.Interest expense for 2010 ( 2,550,000 x 12% ) b.Face value of Note Present value Discount on Note Payable

306,000 3,600,000 2,550,000 1,050,000

Solution to Problem 10 PV of Note payable ( 200,000 x 5.712 ) Payment on December 31, 2010 PV of note payable – December 31, 2010

1,142,400 ( 200, 000) 942,400

Note: PV of annuity of 1 in advance, 5.712, is used because the date of purchase is December 31, 2010 and the first payment is made on the same date, December 31, 2010. Solution to Problem 11 (a) Cash.................................................................................... 100,000 Notes Payable....................................................... 100,000 (b) Interest Expense............................................................. 11,000 Cash ($100,000 X 11% = $11,000)................... 11,000 Solution to Problem 12 (a) Cash.................................................................................... 47,664 Discount on Notes Payable ........................................ 27,336 Notes Payable.......................................................75,000 (b) Interest Expense............................................................ 5,720 Discount on Notes Payable ............................. 5,720 Solution to Problem 13 (a) Computer.......................................................................... 31,495 Discount on Notes Payable........................................ 8,505 Notes Payable ...................................................... 40,000 (b) Interest Expense............................................................ 3,779 Cash ......................................................................2,000 Discount on Notes Payable ............................. 1,779

Solution to Problem 14 Cash ............................................................................................... 60,000 Discount on Notes Payable .................................................... 21,869 Notes Payable................................................................... 60,000 Unearned Revenue ......................................................... 21,869 Solution to Problem 15 Answer: P1,000,000 Solution: The note payable is shown at face value because it is short-term and made in the usual terms. Solution to Problem 16 Answer: P306,000 Solution: Interest expense for 2009 (2,550,000 x 12%)

306,000

Interest expense is computed by multiplying the present value (PV) by the imputed interest rate (effective rate). Solution to Problem 17 Answer: 12.67% Solution: Interest Expense (2,000,000 x 12% x 180/360) Interest income on compensating balance In excess of the normal checking account Balance (200,000 x 6% x 180/360)

120,000 ( 6,000) 114,000

Solution to Problem 18 Answer: 232,000 Solution: Accrued interest from March 1, 2008 to February 28, 2009 (1,000,000 x 12%) Accrued interest from March 1 to December 31,2009 (1,000,000 + 120,000 x 12% x 10/12) Accrued interest payable, December 31, 2009

120,000 112,000 232,000

Solution to Problem 19 Answer: 2,160,000 Solution PV of Note payable on 1/1/2009

600,000 ((1-1/(1.12)^5 )/(.12))

2,160,000

Solution to Problem 20 Answer: 750,000 Solution/Explanation: The entire amount of 750,000 is shown as current liability because the note payable is due to be settled within one year regardless of the issuance of bonds payable. Solution to Problem 21 Note payable Accrued interest payable Total Liability Asset transferred: Note receivable Equipment at CA Gain on extinguishment

3,600,000 400,000 4,000,000 2,700,000 600,000

3,300,000 700,000

Solution to Problem 22 a. B.

c

$290,000 – ($480,000 – $230,000) = $40,000. ($600,000 + $60,000) – [$290,000 + $250,000 + ($250,000 × 06 × 3)] = $75,000. 0. The effective-interest rate is 0%.