Notes Receivable

For UC Berkeley Extension Berkeley, CA By Anna N. Lee Notes Receivable Interest Bearing Notes

Interest Bearing Notes Notes Receivable Rights to receive a specified amount of cash, either on demand or at a definite future date. A negotiable instrument; signed by maker, received by payee. Interest-bearing (has a stated rate of interest), OR Zero-interest-bearing (interest included in face amount).

Notes Receivable Reasons for Accepting a Note: • to extend payment period of an outstanding receivable (from an overdue customer). • to sell products or services to High-risk or new customers. • to make a loan to employees and subsidiaries. • to sell property, plant, and equipment. • to lend money to borrowers (the majority of notes).

Present Value Table $1,000 x 3.16986 = $3,170 Present Value Interest Received Factor .90909 .82645 .75132 .68301 3.16986 $10,000 x .68301 = $6,830 Principal Factor Present Value

Note Not Issued at Face Value Interest-Bearing Note Illustration: January 1, 2012, Good Neighbor Corp. makes a loan to Needy Co. and receives in exchange a four-year, $10,000 note at stated interest of 10 percent annually. The market rate of interest for a note of similar risk is 12 percent. How does Good Neighbor record the receipt of the note? $10,000 Principal N (period) = 4 i = 12% 1,000 Interest 1,000 $1,000 1,000 1 2 3 4

Note Not Issued at Face Value Interest-Bearing Notes (continued) $1,000 x 3.03735 = $3,037 Interest Received Factor Present Value $10,000 x .63552 = $6,355 Principal Factor Present Value 9,392 = 3,037 + 6,355 PV or Note Carrying Amount

Note Not Issued at Face Value Interest-Bearing Note (continued) b c a a $1,000 = $10,000 x 10% b $9,392 x 12% = $1,127 c $9,392 + $127 = $9,519

Note Not Issued at Face ValueInterest-Bearing Note (continued) Illustration: Calculation Presentation

Note Not Issued at Face Value Interest-Bearing Note (continued) Journal Entries for Interest-Bearing note Present value of the note: $9,392 (see slides 5 & 6)

Recognizing Notes Receivable Short-Term Long-Term Record at Face Value, less allowance (similar to Accounts Receivable) Record at Present Value of expected cash flows (loss is treated the same with short-term receivables Interest Rates Stated rate = Market rate Stated rate > Market rate Stated rate < Market rate Note Issued at Face Value Premium Discount

Recognizing Notes Receivable (continuation) Illustration (Cost basis): 9/30/12 Notes Receivable (Loans) 800,000 Allowance for Note (Loan) Losses 100,000 Net Notes Receivable (carrying amount) 700,000

Valuation of Notes Receivable(continued) Illustration (using fair value option): At December 31, 2012, Gracious Lady Company has notes receivable that have a fair value of $500,000 and a carrying amount of $700,000, Gracious Lady decides to use the fair value option for these receivables. This is the first valuation (the original year the instrument is recognized) of these recently acquired receivables. At December 31, 2012, Gracious Lady makes an adjusting entry to record the decrease in value of Notes Receivable and to record the unrealized holding loss, as follows: Notes Receivable (or Fair Value Adjustment) 200,000 (If your holding is less than 20%, and if it is a trading security, UHGL is reported in Income Statement; if it is available for sale security, UHGL is reported in Balance Sheet as Other Comprehensive Income, a separate component). Unrealized Holding Gain or Loss (UHGL) - Income 200,000

Valuating Notes Receivable • Short-Term reported at Net Realizable Value (same as accounting for accounts receivable). • Long-Term- FASB requires companies disclose not only their cost but also their fair value in the notes to the financial statements. • Fair Value Option.Recently, the FASB has given companies the option to use fair value as the basis of measurement for financial instruments including receivables, in the financial statements.

Notes Receivable