NOTES PAYABLE

Definition
A promissory note is an unconditional promise in writing made by one person to another, signed by the
maker, engaging to pay on demand or at a fixed or determinable future time a sum certain in money to
order or to bearer.
Initial measurement of note payable
PFRS 9, paragraph 5.1.1, provides that a note payable not designated at fair value through profit or loss
shall be measured initially at fair value minus transaction costs that are directly attributable to the issue of
the note payable.
In other words, transaction costs are included in the measurement of note payable.
However, if the note payable is irrevocably designated at fair value through profit or loss, the transaction
costs are expensed immediately.
The "fair value" of the note payable is equal to the present value of the future cash payment to settle the
note payable using market rate of interest.
Subsequent measurement of note payable
PFRS 9, paragraph 5.3.1, provides that after initial recognition, a note payable shall be measured:
a. At amortized cost using the effective interest method.
b. At fair value through profit or loss if the note payable is designated irrevocably as measured at fair
value through profit or loss.
Amortized cost of note payable
The amortized cost of note payable is the amount at which the note payable is measured initially:
a. Minus principal repayment
b. Plus or minus the cumulative amortization using the effective interest method of any difference
between the face amount and present value of the note payable.
Actually, the difference between the face amount and present value is either discount or premium
on the issue of note payable.

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Note issued solely for cash
When a note is issued solely for cash, the present value is equal to the cash proceeds.
Illustration
On November 1, 2023, an entity discounted its own note of P1,000,000 at 12% for one year.
Note payable 1,000,000
Less: Discount (12% x 1,000,000) 120,000
Net proceeds 880,000
Journal entry
Cash
Discount on note payable
Note payable

Actually, the discount on note payable of P120,000 is the total interest for one year.
Thus, on December 31, 2023, after 2 months, the discount on note payable is amortized as interest
expense.
Interest expense
Discount on note payable (120,000 x 2/12)
The straight line method is used in amortizing the discount on note payable for simplicity. Besides, the
note payable has only a term of one year.
If a statement of financial position is prepared on December 31, 2023, the note payable is classified and
reported as current liability.
Note payable
Discount on note payable
Carrying amount
Observe that the discount on note payable is a direct deduction from the note payable.
The carrying amount of P900,000 is actually the "amortized cost" of the note payable.

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Interest bearing note issued for property
When a property or noncash asset is acquired by issuing a promissory note which is interest bearing, the
property or asset is recorded at the purchase price.
The purchase price is reasonably assumed to be the present value of the note and therefore, the fair value
of the property because the note issued is interest bearing.
Illustration
On January 1, 2023, an entity acquired an equipment for P1,000,000 payable in 5 annual equal
installments every December 31 of each year. Interest is 10% on the unpaid balance.
Journal entries
2023
Jan. 1
Equipment 1,000,000
Note payable
Dec. 31
Interest expense (10% x 1,000,000)
Note payable
Cash
Payment of the first installment and the interest for 2023.
2024
Dec. 31
Interest expense (10% x 800,000)
Note payable
Cash
Payment for second installment and interest for 2018.

Noninterest bearing note issued for property

When a noninterest bearing 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 face of the note issued represents the imputed interest.
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The imputed interest is based on the sound philosophy that no lender would part away with his money or
property interest-free.
Illustration
On January 1, 2023, an entity acquired an equipment with a cash price of P350,000 for P500,000, P
100,000 down and the balance payable in 4 equal annual installments.
Journal entries for 2023
Jan. 1
Equipment 350,000
Discount on note payable 150,000
Cash 100,000
Note payable 400,000
Dec. 31
Note payable 100,000
Cash 100,000
Payment of annual installment.

Interest expense 60,000

Discount on note payable 60,000
Amortization of the discount for 2023.

Table of amortization
Year Note payable Fraction Amortization
2023 400,000 4/10
2024 300,000 3/10
2025 200,000 2/10
2026 100,000 1/10 _______
1,000,000 150,000

Note payable represents the amount outstanding every year.

The note was issued on January 1, 2023 and the first payment was made on December 31, 2023.

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Thus, for 2023, the note payable outstanding is P400,000.
Fraction is developed from the note payable outstanding every year.
Amortization is the amount of discount multiplied by the fraction developed.
Thus, for 2023, P 150,000 times 4/10 equals P60,000.

Another illustration no cash price

On January l. 2017, an entity acquired an equipment for P 1,000,000 in 5 equal annual installments on
every December 31 of each year.
Observe that, there is no agreed interest and no cash price i, available for the equipment.
In such a case, the cost of the equipment is equal to the present value of the P200,000 annual installments
in 5 yean at an appropriate rate of 10%.
The rate of 10% is assumed to be the prevailing market rate of interest.
The present value of an ordinary annuity of 1 for 5 years at is 3.7908.
Therefore, the present value of five P200,000 installments is P 758,160, computed by multiplying
P200,000 by the present value factor of 3.7908.
Journal entries for 2017
Jan. 1
Equipment 758, 160
Discount on note payable 241,840
Note payable
Dec. 31
Note payable 200,000
Cash 200,000
First installment payment.

Interest expense
Discount on note payable
Amortization of the discount 75,816 on note payable for 2017.
The "effective interest" method is followed in the amortization of the discount.

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Table of amortization
Date Payment Interest Principal Present value
Jan. 1, 2017
Dec. 31, 2017
Dec. 31, 2018
Dec. 31, 2019
Dec. 31, 2020
Dec. 31, 2021

Payment represents the annual installment.

Interest is equal to the preceding present value multiplied by the implied interest rate. Thus, for 2017,
P758, 160 times equals P75,816.
Principal is the portion of the payment after deducting interest representing principal.
Thus, on December 31, 2017, P200,000 minus the interest of equals P124, 184.
Present value is the balance of the preceding present value after deducting the principal payment.
Thus, on December 31, 2017, P758, 160 minus the principal payment of P 124, 184 equals P633,976.
Note payable 200,000
Discount on note payable ( 63,398)
Carrying amount — amortized cost 136,602

On December 31, 2017; the current portion of the note payable would be reported as current liability.
The noncurrent portion of the note payable would be reported as noncurrent liability.
Note payable 600,000
Discount on note payable ( 102,626)
Carrying amount — amortized cost 497,374

Noninterest bearing note payable lump sum

On January l, 2017, an entity acquired an equipment for P 1,000,000. The entity paid P 100,000 down and
signed a noninterest bearing note for 2020.the balance which is due after three years on January 1,

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There was no established cash price for the equipment. The prevailing interest rate for this type of note is
10%. Th present value of 1 for 3 periods is .7513.
Computation
Downpayment 100,000
Present value of note (P900,000 x .7513) 676,170
Cost of equipment 776,170
Imputed interest
Face value of note 900,000
Present value of note 676,170
Imputed interest 223,830
Journal entries
1. To record the purchase of equipment on January 1, 2017:
Equipment 776,170
Discount on note payable 223,830
Cash 100,000
Note payable 900,000
2. To record the interest expense for 2017:
Interest expense 67,617
Discount on note payable 67,617
The discount on note payable is amortized as interest expense using the "effective
interest" method.
3. To record the full payment of the note on January 1, 2020:
Note payable 900,000
Cash 900000
Table of amortization
Date Interest expense note payable Present value
1/1/2017
12/31/2017
12/31/2018
12/31/2019

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Interest expense is equal to the preceding present value multiplied by the implied interest rate.
Thus, for 2017, P676,170 times equals P67,617.
Discount on note payable is the balance minus the interest expense every year.
Thus, on December 31, 2017, P223,830 minus the interest of P67,617 equals P156,213.
Present value is the preceding balance plus the interest expense every year.
Thus, on December. 31, 2017, P676,170 plus the interest of P67,617 equals P743,787.

Fair value option of measuring note payable

PFRS 9, paragraph 4.2.2, provides that at initial recognition a note payable may be irrevocably designated
as at fair value through profit or loss.
PFRS 9, paragraph 5.7.7, provides that the gain or loss on financial liability designated at fair value
through profit or loss shall be accounted for as follows:
a. The change in fair value attributable to the credit risk is recognized in other comprehensive
income.
Credit risk is the risk that the issuer of the liability would cause a financial loss to the other party by
failing to discharge the obligation.
Credit risk does not include market risk such as interest risk, currency risk and price risk.
b. The remaining amount of the change in fair value is recognized in profit or loss.
Application Guidance B5.7.9 provides that amount recognized in other comprehensive income resulting
from change in fair value attributable to credit risk shall not be subsequently transferred to profit or loss.
However, the cumulative gain or loss recognized may be transferred within equity or retained earnings.
Under the fair value option, any transaction cost is recognized as outright expense.
There is no amortization of discount and premium on note payable.
As a matter of fact, interest expense is recognized using the nominal or stated interest rate.

Illustration
On January 1, 2017, an entity borrowed from a bank P 4,000,000 on a 12% 5-year interest bearing note.

The entity received P4,000,000 which is the fair value of the note on January 1, 2017. Transaction cost of
P 100,000 was paid by the entity.
The fair value of the note payable was P 3,500,000 on December 31, 2017.
The entity has elected irrevocably the fair value option for measuring the note payable.
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The change in fair value comprised P50,000 attributable to credit risk and P450,000 attributable to
interest risk.
Journal entries for 2017
Jan. 1

Cash
Note payable
1 Transaction cost 100,000
Cash 100,000
Dec. 31 Interest expense (12% x 4,000,000) 480,000
Cash 480,000
31 Note payable 500,000
Gain from change in fair value 450,000
Gain from credit risk — OCI 50,000

Carrying amount 4,000,000

Fair value — December 31, 2017
Decrease in fair value of liability — gain 500,000

The gain from change in fair value is recognized in profit or loss.

The gain from credit risk is recognized in other comprehensive income.