Chapter 7 Loans Receivable PDF

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Chapter 13LOAN RECEIVABLEA loan receivable is a financial asset arising from a loan granted by a bank or other financial institution to a borrower or client. The term of the loan may be short-term but in most cases, the repayment periods cover several years.Initial measurement of loan receivable At ...

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Chapter 13 LOAN RECEIVABLE

A loan receivable is a financial asset arising from a loan granted by a bank or other financial institution to a borrower or client. The term of the loan may be short-term but in most cases, the repayment periods cover several years.

Initial measurement of loan receivable At initial recognition, an entity shall measure a loan receivable at fair value plus transaction costs that are directly attributable to the acquisition of the financial asset. The fair value of the loan receivable at initial recognition is normally the transaction price, meaning, the amount of the loan granted. Transaction costs that are directly attributable to the loan receivable include direct origination costs. Direct origination costs should be included in the initial measurement of the loan receivable. However, indirect origination costs should be treated as outright expense.

Subsequent measurement of loan receivable If the business model in managing financial asset is to collect contractual cash flows on specified dates and the contractual cash flows are solely payments of principal and interest, the financial asset shall be measured at amortized cost. Meaning of amortized cost The “amortized cost” is the amount at which the loan receivable is measured initially: a. Minus principal repayment b. Plus or minus cumulative amortization of any diffenrence between the initial carrying amount and the principal maturity amount c. Minus reduction for impairment or uncollectibility

Origination fees The fees charged by the back against the borrower for the creation of the loan are known as “origination fees”. a. Evaluating the borrower’s financial condition b. Evaluating guarantees, collateral and other security

c. Negotiating the terms of the loan d. Preparing and processing the documents related to the loan e. Closing and approving the loan transaction

Accounting for origination fees The origination fees received from borrower are recognized as unearned interest income and amortized over the term of the loan. If the origination fees are not chargeable against the borrower, the fees are known as “direct origination costs”.

Example: On January 1, 2020 Capontel Bank granted a loan to a borrower. The interest on the loan is 10% payable annually starting December 31, 2020. On December 31, 2022 in three years the loan will matures.

January 1, 2008 Loan Receivable

4,000,000

Cash Cash

4,000,000 342,100

Unearned interest income Unearned interest income

341,200 150,000

Cash

150,000

December 31, 2018 Cash

400,000 Interest income

Unearned interest income Interest income

400,000 56,948 56,948

Amortization Table – effective interest method

Date 1/1/2020 12/31/202 0 12/31/202 1 12/31/202 2

Interest Received

Interest income

Amortizatio n

Carrying amount 3,807,900

400,000

456,948

56,948

3,864,848

400,000

463,782

63,782

3,928,630

400,000

471,370

71,370

4,000,000

Formulas

The carrying amount on January 01, 2020 times the effective rate of 12% is equal to interest income of 456,948Php on december 31, 2020 (3,807,900x.12=456,948) minus interest income of 400,000Php is equal to amortization of 56,948Php (456,948-400,000=56,948) plus the carrying amount on January 01, 2020 (3,807,900+56,948=3,864,848) is equal to carrying amount of 3,864,848Php on December 31, 2020.

December 31, 2021 Cash

400,000 Interest income

Unearned interest income

400,000 63,782

Interest income

63,782

December 31, 2022 Cash

400,000 Interest income

Unearned interest income Interest income Cash

400,000 71,370 71,370 4,000,000

Loan receivable

4,000,000

Problems 1. Nasty Bank granted a loan to a borrower on January 1,2016. The interest on the loan is 10% payable annually starting December 31, 2016. The loan matures in three years on December 31, 2018.

Principal amount

4,000,000

Direct origination cost incurred

150,000

Origination fee charged against the borrower

342,100

After considering the origination fee charged against the borrower and the direct origination cost incurred, the effective rate on the loan is 12%. Required: 1. Prepare journal entries for 2016, 2017 and 2018.

Answer: Requirement 2016 Jan.1 Loan receivable Cash Cash

4,000,000 4,000,000 342,100

Unearned interest income Unearned interest income

342,100 150,000

Interest income

150,000

Dec.31 Cash

400,000 Interest income

Unearned interest income Interest income

400,000 56,948 56,948

Amortization table Date

Interest Received (10%)

Interest Income (12%)

Amortization

01/01/2016 12/31/2016 12/31/2017 12/31/2018

400,000 400,000 400,000

456,948 463,782 471,370

56,948 63,782 71,370

Carrying Amount 3,807,900 3,864,848 3,928,630 4,000,000

*12% x 3,928,630 equals 471,435, or a difference of P65 due to rounding.

2017 Dec. 31 Cash

400,000 Interest income

400,000

Unearned interest income

63,782

Interest income

63,782

2018 Dec 31 Cash

400,000 Interest income

400,000

Unearned interest income

71,370

Interest income

71,370

31 Cash

4,000,000 Loan receivable

4,000,000

Impairment of loan An entity shall recognizea a loss allowance for expected credit losses on financial asset measured at amortized cost.

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 that financial instrument has increased significantly since initial recognition. Credit losses are the present vaue of all cash shortfalls Expected credit losses are an estimate of credit losses over the life of the financial instrument.

Measurement of impairment When measuring expected credit losses, an entity should consider: a. The probability-weighted outcome The estimate should reflect the possibility that a credit loss occurs and the possibility the no credit loss occurs. b. The time value of money The expected credit losses should be discounted. c. Reasonable and supportable information that is available without undue cost or effort.

Meaning of credit risk Credit risk is the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation.

Example:

Let’s assume that on December 31, 2006, the Lie Dharma Company issued a $1,000,000, five-year, non-interest-bearing note to the Putra Security Bank, yielding 10% per year. At the date of the issuance the Lie Dharma Company paid $620,920 = (1,000,000 x 0.62092). The following entries were made:

1. By the creditor, the Putra Security Bank: Notes Receivable

1,000,000

Discount on Notes Receivable

379,080

Cash

620,920

2. By the debtor, the Lie Dharma Company Cash

620,920

Discount on Notes Payable Notes

379,080 1,000,000

The following table shows the note discount amortization using the effective interest method:

First Loan Amortization Schedule

Now, let’s assume that because of bad economic conditions for the Lie Dharma Company, the Putra Security Bank estimates on December 31, 2008, that only $800,000 is collectable at the end of the five years. Therefore, it estimates its loss due to impairment as follows:

Carrying amount of the loan, 12/31/2008 =751,312.20 Present value of $800,000 due in 3 years at 10% compounded annually (800,000 x 0.75132) = 601,056.00 Loss due to impairment (751,312.20 – 601,056) =150,256.20 Therefore, the Putra Security Bank made the following entry: Bad Debt Expense

150,256.20

Allowance for Doubtful Accounts

150,256.20

The Lie Dharma Company does not make an entry. The Putra Security Bank prepares a new schedule of discount amortization based on the new carrying amount of $601,056. It is shown in the next table:

Second Loan Amortization Schedule The following entries are made on Dec. 31, 2009: 1. By the Putra Security Bank Discount on Notes Receivable

75,131.32

Interest Revenue

60,105.60

Allowance for Doubtful Accounts

15,025.72

2. By the Lie Dharma Company Interest Expense Discount on Notes Payable

75,131.32 75,131.32

At the maturity date, on January 1, 2000, the Lie Dharma Company pays $800,000 and the following entries are made: 1. By the Putra Security Bank Cash

800,000

Allowance for Doubtful Accounts

200,000

Notes Receivable

1,000,000

2. By the Lie Dharma Company Notes Payable

1,000,000

Cash

800,000

Gain on Extinguishment

200,000

Problems 1. Solvent bank loaned P10,000,000 to a borrower on January 1, 2014. The terms of the loan require principal payments of P2,000,000 each year for 5 years plus interest at 8%. The first principal and interest payment is due on december 31, 2014. The borrower made the required payments on December 31, 2014 and December 31, 2015. However, during 2016 the borrower began to experience financial difficulties, requiring the bank to reassess the collectibility of the loan. On December 31, 2016, the bank has determined that the remaining principal payments will be collected but the collection of the interest in unlikely. The bank has accrued the interest for 2016. Expected principal payments December 31, 2017 December 31, 2018 December 31, 2019

1,000,000 2,000,000 3,000,000

Present value of 1 at 8% For one period For two periods For three periods Required: 1. Compute the impairment loss on the loan receivable. 2. Prepare journal entries for 2016, 2017 and 2018.

.93 .86 .79

Answer: Requirement 1 December 31, 2017 (1,000,000 x .93)

900,000

December 31, 2018 (2,000,000 x .86)

1,720,000

December 31, 2019 (3,000,000 x .79)

2,370,000

Total present value of loan

5,020,000

Loan receivable – 12/31/2016

6,000,000

Accrued interest (6,000,000 x 8%)

480,000

Total carrying amount

6,480,000

Present value of loan

5,020,000

Impairment loss

1,460,000

Requirement 2 2016 Impairment loss

1,460,000

Accrued interest receivable

480,000

Allowance for loan impairment

980,000

2017 Cash

1,000,000 Loan receivable

1,000,000

Allowance for loan impairment

401,600

Interest income (8% x 5,020,000)

401,600

2018 Cash

2,000,000 Loan receivable

Allowance for loan impairment

2,000,000 353,728

Interest income

353,728

Loan receivable – 12/31/2017

5,000,000

Allowance for loan impairment (980,000-401,600)

(578,400)

Carrying amount – 12/31/2017

4,421,600

Interest income for 2018 (8% x 4,421,600)

353,728

2019 Cash

3,000,000 Loan receivable

Allowance for loan impairment

3,000,000 224,672

Interest income

224,672

Loan receivable – 12/31/2018

3,000,000

Allowance for loan impairment (578,400 – 353,672)

(224,672)

Carrying amount – 12/31/2018

2,775,328

Interest income for 2019 (8% x 2,775,328)

222,026

Allowance per book

224,672

Difference due in rounding

2,646

2. Cozy Bank loaned a borrower P7,500,000 on January 1, 2014. The terms of the loan were payment in full on January 1, 2019, plus annual interest payment at 12%. The interest payment was made as scheduled on January 1, 2015. However, due to financial setbacks, the borrower was unable to make the 2016 interest paymeny. The bank considered the loan impaired and projected the cash flows from the loan on December 31, 2016. The bank accrued the interest on December 31, 2015, but did not continue to accrue interest for 2016 due to the impairment of the loan. Projected cash flows

Amout projected Date of cash flow December 31, 2017 December 31, 2018 December 31, 2019 December 31, 2020

On December 31, 2016 5,00,000 1,000,000 2,000,000 4,000,000

Present value of 1 at 12% For one period For two periods For three periods For four periods Required:

.89 .80 .71 .64

1. Compute the present value of the loan receivable on december 31, 2016 2. Compute the impairment loss on the loan receivable. 3. Prepare journal entries for 2016, 2017 and 2018.

Answer : Requirement 1 December 31, 2017 (500,000 x .89)

445,000

December 31, 2018 (1,000,000 x .80)

800,000

December 31, 2019 (2,000,000 x .71)

1,420,000

December 31, 2020 (4,000,000 x .64)

2,560,000

Total present value of loan

5,225,000

Requirement 2 Loan receivable Accrued interest receivable (12% x 7,500,000)

7,500,000 900,000

Total carrying amount

8,400,000

Present value of loan

5,225,000

Impairment loss

3,175,000

Requirement 3 2016 Impairment loss

3,175,000

Accrued interest receivable

900,000

Allowance for loan impairment

2,275,000

2017 Cash

500,000 Loan receivable

Allowance for loan impairment

500,000 627,000

Interest income

627,000

2018 Cash

1,000,000 Loan receivable

1,000,000

Loan receivable – 12/31/2017

7,000,000

Allowance for loan impairment (2,275,000-627,000)

(1,648,000)

Carrying amount – 12/31/2017

5,352,000

Interest income for 2018 (12% x 5,352,000)

642,240...