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Chapter 2
Notes Payable
PROBLEM 1: TRUE OR FALSE
1. FALSE – interest payable = face amount x nominal rate

2. TRUE
⮚ (1,241,843 x 110% x 110%) = 1,502,630 carrying amount on Dec.
31, 20x2
⮚ 2M face amount - 1,502,630 = 497,370

3. TRUE

4. FALSE (1M x PV of ordinary annuity of 1 @10%, n=3)

5. TRUE

6. FALSE 40,000 (400,000 cash price equivalent x 10%)

7. TRUE (100,000 x .90) = 90,000 x 10% = 9,000

8. TRUE (100,000 x .90 x 110% x 10%) = 9,900 OR (90,000 + 9,000)

x 10% = 9,900

9. FALSE 850,000 (the note is payable in installments)

10. TRUE
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PROBLEM 2: MULTIPLE CHOICE – THEORY

1. D – a note with below-market interest rate is discounted
2. A
3. C
4. A
5. D
Choice (a) is incorrect because this refers to the income statement
rather than the statement of financial position.

6. C
7. C
8. D
9. B
1st note: 6,000 x 18% = 1,080 interest expense;
2nd note: (7,080 ÷ 118%) x 18% = 1,080 interest expense

10. B
Concept: Pre-acquisition accrued interest
When interest has accrued before the issuance of an
interest-bearing payable, the subsequent payment of interest is
allocated between the pre-acquisition and post-acquisition
periods. Only the portion pertaining to the post-acquisition period
is recognized as interest expense.

Mar. Accounts payable 6,000

1,
Loss on derecognition of liability 120
20x1
(squeeze) 6,000
Notes payable 120
Interest payable (6,000 x 12% x 2/12)
July. Notes payable 6,000
1,
Interest expense (6,000 x 12% x 4/12) 240
20x1
Interest payable (from Mar. 1, 20x1) 120
Cash [6,000 + (6,000 x 12% x 6/12)] 6,360
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PROBLEM 3: EXERCISES

1. Solution:

Cash flows
2,000,000

PV of 1 @16%, n=3
0.64066
Present value -
1/1/x1 1,281,320

Interest
Date expense Discount Present value
1/1/x1 718,680 1,281,320
12/31/x1 205,011 513,669 1,486,331
12/31/x2 237,813 275,856 1,724,144
12/31/x3 275,856* 0 2,000,000
* Squeezed to eliminate difference due to rounding-off

1/1/x1
Equipment 1,281,320
Discount on notes payable 718,680
Notes payable 2,000,000

12/31/x1
Interest expense 205,011
Discount on notes payable 205,011

12/31/x2
Interest expense 237,813
Discount on notes payable 237,813

12/31/x3
Interest expense 275,856
Discount on notes payable 275,856
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Note payable 2,000,000

Cash 2,000,000

2. Solutions:

Requirement (a):

Cash flows
1,000,000
PV ord. annuity @18%,
n=3 2.17427
Present value - 1/1/x1 2,174,270

Payment Interest Amortizatio Present

Date s expense n value
1/1/x1 2,174,270
12/31/x
391,369 608,631 1,565,639
1 1,000,000
12/31/x
281,815 718,185 847,454
2 1,000,000
12/31/x
152,546* 847,454 0
3 1,000,000
* Squeezed to eliminate difference due to rounding-off

Current portion = 718,185

Noncurrent portion = 847,454

Requirement (b):
Future cash payments (1M x 2 yrs.) 2,000,000
Carrying amount, 12/31/x1 1,565,639
Discount on note payable, 12/31/x1 434,361

Current portion:  
Notes payable (1,000,000 due in 20x2) ₱1,000,000
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Discount on notes payable (1M – 718,185 current portion) (281,815)

Notes payable, net (presented in current liabilities) 718,185
Noncurrent portion:  
Notes payable (1,000,000 due in 20x3) 1,000,000

Discount on notes payable (1M – 847,454 noncurrent portion) (152,546)

Notes payable - net (presented in noncurrent liabilities) 847,454
Total notes payable, net - Dec. 31, 20x1 ₱1,565,639

Requirement (c):
1/1/x1
Equipment 2,174,270
Discount on notes payable 825,730
Notes payable 3,000,000

12/31/x1
Notes payable 1,000,000
Interest expense 391,369
Discount on notes payable 391,369
Cash 1,000,000

12/31/x2
Notes payable 1,000,000
Interest expense 281,815
Discount on notes payable 281,815
Cash 1,000,000

12/31/x3
Notes payable 1,000,000
Interest expense 152,546
Discount on notes payable 152,546
Cash 1,000,000

3. Solutions:
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⮚ PV of note = (2M ÷ 4) x PV of an annuity due of P1 @12%, n=4

⮚ PV of note = 1,700,916

Interest Present
Date Payments expense Amortization value
Jan. 1, 20x1 1,700,916
Jan. 1, 20x1 500,000 - 500,000 1,200,916
Jan. 1, 20x2 500,000 144,110 355,890 845,026
Jan. 1, 20x3 500,000 101,403 398,597 446,429
Jan. 1, 20x4 500,000 53,571 446,429 -

Requirement (a):
Jan. 1, Vehicle 1,900,91
20x1
Discount on notes payable 6
Cash 299,084 200,000
Notes payable 2,000,00
0
Jan. 1, Notes payable 500,000
20x1
Cash 500,000
Dec. 31, Interest expense 144,110
20x1
Discount on notes payable 144,110
Jan. 1, Notes payable 500,000
20x2
Cash 500,000
Dec. 31, Interest expense 101,403
20x2
Discount on notes payable 101,403
Jan. 1, Notes payable 500,000
20x3
Cash 500,000
Dec. 31, Interest expense 53,571
20x3
Discount on notes payable 53,571
Jan. 1, Notes payable 500,000
20x4
Cash 500,000

Requirement (b):
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Interest expense in 20x2 = 101,403

Requirement (c):
Carrying amt. on 1/1/x2 845,026
Add back: Payment on 1/1/x2 500,000

Carrying amt. on 12/31/x1

1,345,026

4. Solution:
Face amount (1) (400,000 x 4) = 1,600,000
Discount on N/P on initial recognition (2) (1.6M – 1,119,272) = 480,728
Effective interest rate (3) (179,084 ÷ 1,119,272) = 16%
Term of the note (in years) (4) 4 years

Interest Amortizatio Present

Date Payments expense n value
1/1/x1 1,119,272
12/31/x1 400,000 179,084 (5) 220,916 898,356
(7)
12/31/x2 400,000 (6) 143,737 256,263 642,093
(8)
12/31/x3 400,000 102,735 297,265 344,828
(9)
12/31/x4 400,000 (10) 55,172 344,828 0

5. Solution:
First step: Place the given information on the amortization table:
Amortizatio
Date Payments Interest expense n Present value
1/1/x1 911,205
12/31/x1 300,000
12/31/x2 300,000 86,466 213,534 507,016
12/31/x3 300,000
12/31/x4 300,000

Second step: Squeeze for the carrying amount of the note on

December 31, 20x1.
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Amortizatio
Date Payments Interest expense n Present value
1/1/x1 911,205
12/31/x1 300,000 720,550*
12/31/x2 300,000 86,466 213,534 507,016
12/31/x3 300,000
12/31/x4 300,000

* (213,534 + 507,016) = 720,550

Third step: Compute for the effective interest rate

EIR = 86,466 ÷ 720,549 = 12%

Fourth step: Squeeze for the other missing information

Amortizatio
Date Payments Interest expense n Present value
1/1/x1 911,205
12/31/x1 300,000 109,345 190,655 720,550
12/31/x2 300,000 86,466 213,534 507,016
12/31/x3 300,000 60,842 239,158 267,858
12/31/x4 300,000 32,142* 267,858 -

* Squeezed to eliminate difference due to rounding-offs.

PROBLEM 4: MULTIPLE CHOICE – COMPUTATIONAL

1. D
Interest expense in 20x4 (10,000 x 12% x 10/12) 1,000
Interest expense in 20x5 [(10,000 + 1,000) x 12%] 1,320
Interest payable (compounded) - 12/31/x5 2,320

2. B
Date Interest expense Discount Present value
1/1/x1 2,141,234 2,858,766
12/31/x1 428,815 1,712,419 3,287,581
12/31/x2 493,137 1,219,282 3,780,718
12/31/x3 567,108 652,174 4,347,826
12/31/x4 652,174 (0) 5,000,000
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Shortcut:
☞ (5M x PV of 1 @15%, n=4) = 2,858,766;

☞ 2,858,766 x 115% x 115% = 3,780,718;

☞ 5M – 3,708,718 = 1,219,282

3. B
⮚ Shortcut: 418,250 - the cost of the annuity purchased.
⮚ Longcut: Reconciliation for the shortcut above

12/31/2000
Investment (annuity product) 418,250
Cash 418,250

Contest prize expense (a) 468,250

Discount on notes payable (1M – 468,250) 531,750
Notes payable 1,000,000

Note payable 1,000,000

Discount on note payable (531,750)
Carrying amount - 12/31/2000 468,250
Current portion of note (due on 1/2/2001) (50,000)
Noncurrent portion 12/31/2000 (equal to cost of
418,250
annuity)

(a)
Payment due on 1/2/2001 50,000
Cost of annuity purchased 418,250
Contest prize expense (equal to carrying amount of
468,250
note)

1/2/2001
Notes payable 50,000
Cash 50,000

4. C
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⮚ Shortcut: 468,250 the total carrying amount of the note or

(418,250 annuity + 50,000 payment = 468,250)
⮚ Longcut: see reconciliation above

5. A
PV factors Present
Future cash flows @ 6%, n= 6 value
4,000,00
Principal 0 0.70496 a 2,819,840
Semiannual int. (4M x 1.5%) 60,000 4.91732 b 295,039
Total 3,114,879
a
(PV of ₱1 @6%, n=6)
b
(PV of ordinary annuity of ₱1 @6%, n=6

6. A
Cash flow 20,000
PV of annuity due of 1 @11%, n=8 5.712
PV of note on Dec. 30, 20x6 114,240
Less: First installment on Dec. 31, 20x6 (20,000)
PV of note on Dec. 31, 20x6 94,240

7. D
⮚ Future cash flows x (PV of ordinary annuity of 1 @1%, n=300) =
14,000,000
⮚ Future cash flows x 94.9465512548 = 14,000,000

⮚ Future cash flows = 14,000,000 ÷ 94.9465512548

⮚ Future cash flows (monthly payment) = ₱147,451.38

Monthly amortization 147,451.38

Monthly expenditure 36,600
Minimum monthly take-home salary 184,051.38

8. A
Monthly amortization 147,451.38
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Multiply by: (25 yrs. x 12 months) 300

Total payments 44,235,414
Cash selling price (14,000,000)
Total interest expense 30,235,414

9. C
Loan payable 4,000,000
Transaction costs (4M x
11.19%) (447,600)
Carrying amount - 1/1/x1 3,552,400

Trial and error:

(Principal: 4,000,000 x PV of 1 @ x%, n=4) + (Interest: 480,000 x PV
ordinary annuity @ x%, n=4) = 3,552,400

First trial: @16%

(Principal: 4,000,000 x PV of 1 @ 16%, n=4) + (Interest: 480,000 x PV
ordinary annuity @ 16%, n=4) = 3,552,400
(4,000,000 x 0.55229) + (480,000 x 2.79818) = 3,552,400
(2,209,160 + 1,343,126) = 3,552,400
3,552,286 = 3,552,400

If the difference of ₱114 is deemed immaterial, 16% is regarded as

the effective interest rate.

10. C (194,000 x 12.4% x 1/12) = 2,005

PROBLEM 5: CLASSROOM ACTIVITY

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*********** portion deliberately not presented to save space*****

PROBLEM 6: FOR CLASSROOM DISCUSSION

1. Solution:

Cash flows
1,600,000
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PV of 1 @17%, n=3
0.62437
Present value -
1/1/x1 998,992

Interest Discount on Present

Date expense N/P value
1/1/x1 601,008 998,992
12/31/x1 169,829 431,179 1,168,821
12/31/x2 198,700 232,479 1,367,521
12/31/x3 232,479 0 1,600,000

1/1/x1
Land 998,992
Discount on notes payable 601,008
Notes payable 1,600,000

12/31/x1
Interest expense 169,829
Discount on notes payable 169,829

12/31/x2
Interest expense 198,700
Discount on notes payable 198,700

12/31/x3
Interest expense 232,479
Discount on notes payable 232,479

Notes payable 1,600,000

Cash 1,600,000

2. Solution:
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Requirement (a):
Cash flows 400,000
PV ord. annuity @17%,
n=3 2.209585
Present value - 1/1/x1 883,834

Payment Interest Amortizatio Present

Date s expense n value
1/1/x1 883,834
12/31/x1 400,000 150,252 249,748 634,086
12/31/x2 400,000 107,795 292,205 341,881
12/31/x3 400,000 58,119* 341,881 0
* Squeezed to eliminate difference due to rounding-off

1/1/x1
Land 883,834
Discount on notes payable 316,166
Notes payable 1,200,000

12/31/x1
Notes payable 400,000
Interest expense 150,252
Discount on notes payable 150,252
Cash 400,000

12/31/x2
Notes payable 400,000
Interest expense 107,795
Discount on notes payable 107,795
Cash 400,000

12/31/x3
Notes payable 400,000
Interest expense 58,119
Discount on notes payable 58,119
Cash 400,000
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Requirement (b):
Current portion:  
Notes payable (400,000 due in 20x2) ₱ 400,000

Discount on notes payable (400K – 292,205 current portion) (107,795)

Notes payable, net (presented in current liabilities) 292,205
Noncurrent portion:  
Notes payable (400,000 due in 20x3) 400,000
Discount on notes payable (400K – 341,881 noncurrent
portion) (58,119)
Notes payable - net (presented in noncurrent liabilities) 341,881
Total notes payable, net - Dec. 31, 20x1 ₱ 634,086

3. Solutions:

Initial measurement:
(1.2M ÷ 3) = 400,000;
400,000 x PV of an annuity due of ₱1 @10%, n=3 = 1,094,215

Requirement (a):
Payment Interest Amortizatio Present
Date s expense n value
1/1/x1 1,094,215
1/1/x1 400,000 - 400,000 694,215
1/1/x2 400,000 69,422 330,578 363,637
1/1/x3 400,000 36,363 363,637 (0)

Requirement (b):
69,422 – see table above.

Requirement (c):
Carrying amt. on 1/1/x2
363,637

Add back: Payment on 1/1/x2

400,000
Carrying amt. on 12/31/x1 763,637
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4. Solutions:

Requirement (a):
Loan payable 3,000,000
Transaction costs (3M x
4.8037%) (144,111)
Carrying amount - 1/1/x1 2,855,889

Requirement (b):
Trial and error:

Working formula:
(Principal: 3,000,000 x PV of 1 @ x%, n=3) + (Interest: 300,000 x PV
ordinary annuity @ x%, n=3) = 2,855,889

First trial: @12%

(Principal: 3,000,000 x PV of 1 @ 12%, n=3) + (Interest: 300,000 x PV
ordinary annuity @ 12%, n=3) = 2,855,889
(3,000,000 x 0.711780) + (300,000 x 2.401831) = 2,855,889
(2,135,340 + 720,549) = 2,855,889
2,855,889 = 2,855,889

❖ The effective interest rate is 12%.

Requirement (c):
Interest
Date Payments expense Amortization Present value
1/1/x1 2,855,889
12/31/x1 300,000 342,707 42,707 2,898,596
12/31/x2 300,000 347,832 47,832 2,946,428
12/31/x3 300,000 353,572 53,572 3,000,000
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