Prepared by: Ms. HAZEL JADE E.
VILLAMAR
E-mail Address: [email protected]________
Central Luzon State University
Science City of Muñoz 3120
Nueva Ecija, Philippines
Instructional Module for the Course
ACCTG 2105 / Intermediate Accounting 1
Module 2
TOPIC 4 (LOANS RECEIVABLE)
Overview
This course covers the detailed discussion, appreciation, and application of
the Philippine Financial Reporting Standards (PFRS) on the assets, financial and
non-financial of a business enterprise. Emphasis is given on the interpretation and
application of the accounting standards on Financial Assets and their required
disclosures. The related internal control, ethical issues and management of assets
are also covered. Exposure to computerized system in receivables, inventory and
lapsing schedules is a requirement.
I. Objectives
At the end of the module, the following are expected:
A. Identify the proper presentation of receivables as either current or noncurrent assets.
B. State the timing of recognition and measurement of trade and other receivables.
C. Prepare amortization tables.
D. Account for impairment of receivables.
II. Learning Activities
LOANS RECEIVABLE
Loan receivable is a financial asset in the form of loan given by a bank or other
financial institutes to a borrower. The term of the loan may be classified as short-term
but usually it is long-term receivable.
Initial Measurement of Loan Receivable
At initial recognition, an entity shall measure a financial asset at Fair Value plus
transaction cost that are directly attributable to the acquisition of the financial asset.
However, if the financial asset is measured at fair value through profit or
loss the transaction cost directly attributable to the acquisition of the financial asset are
expensed outright. (PFRS 9, paragraph 5.1.1)
Loans receivable is financial asset not measured at fair value through profit or loss.
Hence it should be initially measured at fair value plus transaction cost directly attributed
to the acquisition of financial asset.
The fair value of the loan receivable at initial recognition is normally the transaction
price, which is the amount of the grated loan.
The transaction costs directly attributed to the acquisition of loan receivable include
Direct origination cost. Indirect origination costs on the other hand are treated as
outright expense.
Subsequent Measurement of Loan Receivable
After the initial measurement, the financial asset shall be measured at:
a. Fair value through profit or loss (FVPL)
b. Fair value through other comprehensive income (FVOCI)
c. Amortized cost
The method of measurement depends on the business model of managing the
financial asset which may be to realize fair value changes and to collect
contractual cash flows. (PFRS 9, paragraph 5.2.1)
If the business model is to hold the financial asset in order to collect contractual
cash flows on specified date and the contractual cash flows are solely payment of principal
and interest, the financial asset shall be measured at Amortized cost. (PFRS 9,
paragraph 4.1.2)
Hence, a loan receivable is subsequently measured at amortized cost using the
effective interest rate method.
Amortized cost
The amortized cost is the initial measurement of loan receivable less/minus
principal payment, plus or minus cumulative amortization of any difference of initial
carrying amount to the principal maturity amount and minus impairment loss or
uncollectibility.
If the initial amount recognized is lower than the principal amount, the amortization
of the difference is added to the carrying amount. If the initial amount is higher the
amortization is deducted to the carrying amount.
Origination Fees
The origination fees are fees charge by bank against the borrower. It’s a
compensation of the bank for the creation of the loan.
The origination fees are derived from the following activities:
1. Evaluation of collateral and security
2. Negotiation of the terms of the loan
3. Processing of the documents required
4. Evaluation of borrower’s financial condition
Treatment for origination fees
The origination cost received from the borrowers or clients are recognized as
unearned interest income and will be amortized over the term of the loan.
There are origination fees that are not chargeable against the borrower. These
fees are defined as “direct origination costs”. Direct origination costs are cost incurred by
the bank and not received from the borrower. Direct origination costs are also amortized
over the term of the loan.
The origination fee received and the direct origination costs incurred are included
in the measurement of the loan receivable’s carrying amount.
If the direct origination cost exceeds the origination fees received, the difference is
charged to “direct origination cost, the amortization will decrease the interest income.
However, if the origination fee is higher than the direct origination costs, the
interest income will increase and the difference of the two is recorded as unearned interest
income.
Illustration
Smart Bank granted a 3-year loan to a borrower on January 1, 2020.
The interest of the loan is 10% and payable annually starting December
21, 2020. The loan matures on December 31, 2022.
Principal amount 4,000,000
Origination fee received 302,100
Direct origination costs incurred 104,000
Indirect origination costs incurred 30,000
Initial measurement of the loan
Principal amount 4,000,000
Direct origination costs 110,000
Origination cost 302,100
Carrying amount 3,807,900
Note: The indirect origination costs are expense outright.
Journal entries on January 1, 2020
1. Recording of the loan
Loan receivable 4,000,000
Cash 4,000,000
2. To record origination fee received
Cash 302,100
Unearned interest income 302,100
3. To record the direct origination costs
Unearned Interest income 110,000
Cash 110,000
The origination fee exceeds the amount of direct origination cost. Thus, there
is an unearned interest income of P192,100 (P302,100 – 110,000). A new effective
interest rate must be computed, because of origination fees received and the direct
origination costs incurred.
After consideration of the direct origination costs and origination fees received,
the effective rate is 12%. Since the initial carrying amount of the loan is lower than
the principal amount the effective rate should be higher than the nominal rate because
of discount of the loan.
Amortization table effective interest method
Interest Interest Carrying
Date Receivable Income Amortization Amount
1-Jan 2020 3,807,900
31-Dec 2020 400,000 456,948 56,948 3,864,848
31-Dec 2021 400,000 463,782 63,782 3,928,630
31-Dec 2022 400,000 471,370 71,370 4,000,000
Note: There is a difference of P65 because of rounding the PV.
Interest received = Principal x nominal interest rate Interest income = Carrying
amount x effective interest rate Amortization = Interest received – interest income
Carrying amount = Beginning carrying amount (prior year) + amortization
Note: Since the carrying amount is lower than the principal amount, the amortization
should be added.
Journal entries – December 31, 2020
Cash 400,000
Interest income 400,000
Unearned interest income 56,948
Interest income 56,948
December 31, 2021
Cash 400,000
Interest income 400,000
Unearned interest income 63,782
Interest income 63,782
December 31 ,2022
Cash 400,000
Interest income 400,000
Unearned interest income 71,370
Interest income 71,370
On December 31, 2020’s statement of financial position, the loan receivable
is presented at amortized cost.
Loan Receivable 4,000,000
Unearned interest income (192,100 - 56,948) 135,152
Carrying amount- December 31, 2020 3,864,848
Impairment loss
There is a possibility that the issuer of the loan will not be able to collect some
or even all the amount of loan receivable due to borrower’s incapacity to pay (credit
risk). If this happens, the loan receivable is impaired.
According to the standards, an entity shall measure the loss allowance for a
financial instrument at an amount equal to the lifetime expected credit losses if the
credit risk on the financial instrument has increased significantly since initial
recognition. (PFRS 9, 5.5.3)
Credit losses occur because of the credit risk. It is the loss on the uncollectible
payments of the borrower.
In measuring the credit loss, the entity should consider the probability-weighted
outcome, the time value of money and reasonable information . Any information,
internally or externally are can be used on measuring the expected credit losses.
The impairment loss amount is the difference of the carrying amount to the
present value of estimated future cash flows discounted at original effective interest
rate. The loans receivable’s carrying amount shall be deducted using either direct
method or with allowance account.
Illustration
Sugar bank granted five year loan of P10,000,000 to Pepper company on
January 1, 2020. The terms require principal payment of P2,000,000 every year
with interest of 10%, starting on December 31, 2020.
On December 31, 2020 and December 31, 2021, Pepper Company made
the required payments.
Unfortunately, Pepper Company was unable to make the required payments
on December 31, 2022 because of weak financial condition of the company due
to low revenue during year 2022.
After sugar bank assessed the collectability of the loan on December 31,
2022, the bank determined that the remaining principal will be collected; however,
the interest payments will not be collected.
On December 31, 2022, the loan receivable has a P6,600,000 carrying
amount including the accrued interest of P 600,000.
The projected cash flow from the loan on December 31, 2022
December 31, 2023 1,000,000
December 31, 2024 2,000,000
December 31, 2025 3,000,000
Present value of 1 at 10% For one period
.91
For two periods .83
For three periods .75
Computation of present value cash flow
December 31, 2023 (1,000,000 x .91) 910,000
December 31, 2024 (2,000,000 x .83) 1,660,000
December 31, 2025 (3,000,000 x .75) 2,250,000
Total present value of cash flow 4,820,000
Computation of impairment loss
Carrying amount of the loan 6,600,000
Present value of cash flow 4,820,000
Impairment loss 1,780,000
Journal entry on December 31, 2022
Loan impairment loss 1,780,000
Accrued interest receivable 600,000
Allowance for loan impairment 1,180,000
Note: Since the interest is uncollectible, the accrued interest receivable should be
credited directly.
Computation of carrying amount-December 31, 2022
Loan receivable 6,000,000
Allowance for loan impairment (1,180,000)
Carrying amount – December 31, 2022 4,820,000
December 31, 2023
* To record the collection of cash
Cash 1,000,000
Loan receivable 1,000,000
*To record the interest
Allowance for loan impairment 482,000
Interest income 482,000
Interest income (4,820,000 x 10%) = 482,000
Note: The interest income is charge against the allowance of impairment.
December 31, 2024
* To record the collection of cash
Cash 2,000,000
Loan receivable 2,000,000
*To record the interest
Allowance for loan impairment 430,200
Interest income 430,200
Computation of interest income:
Loan receivable – December 31, 2023 5,000,000
Allowance for loan impairment (1,180,000 – 482,000) (698,000)
Carrying amount – December 31, 2023 4,302,000
Original Effective interest rate x10%
Interest income 430.200
December 31, 2025
* To record the collection of cash
Cash 3,000,000
Loan receivable 3,000,000
*To record the interest
Allowance for loan impairment 267,800
Interest income 267,800
Computation of interest income:
Loan receivable – December 31, 2023 3,000,000
Allowance for loan impairment (698,000 – 430,200) (267,800)
Carrying amount – December 31, 2023 2,732,200
Original Effective interest rate x10%
Interest income 273.220
Note: there is a difference in interest income due to rounding of the PV factor.
Three stage impairment approach
Stage 1 – It covers debt instrument that have low credit risk. Under this stage 12-
month expected credit loss is recognized. It is the portion of the lifetime expected
credit loss from default event within 12 months after reporting period.
Stage 2 – It covers debt instrument that have declined significantly but do not have
evidence of impairment. Lifetime expected credit loss is recognized under this
stage.
Lifetime expected credit loss is the expected credit loss resulting from all
default events over the expected life of the debt instrument. It is measured for trade
receivable using aging method, percentage of receivable and percentage of sales.
Stage 3 – It covers debt instrument with evidence of impairment. Lifetime expected
credit loss is recognized.
Computation of interest income
Under stages 1 and 2 the interest income is based on face amount.
Interest income = Face amount x interest rate
Under stage 3 the interest income is based on net carrying amount.
Net carrying amount = Face amount – allowance for credit loss
Interest income = Net carrying amount x interest rate
Reference
Intermediate Accounting Volume 1, 2019 by Valix, Peralta & Valix
