COLLEGE OF BUSINESS AND ACCOUNTANCY

Topic: Loans Receivable and Impairment of Receivables

Learning Objectives:
1. State the initial and subsequent measurements of loans receivable.
2. Explain the accounting for origination costs and fees.
3. Account for the impairment of receivables.

Core Value/Biblical Principles:

Ecclesiastes 3: 1-8
1 There is a time for everything, and a season for every activity under the heavens: 2 a time to be born and a time
to die, a time to plant and a time to uproot, 3 a time to kill and a time to heal, a time to tear down and a time to
build, 4 a time to weep and a time to laugh, a time to mourn and a time to dance, 5 a time to scatter stones and a
time to gather them, a time to embrace and a time to refrain from embracing, 6 a time to search and a time to
give up, a time to keep and a time to throw away, 7 a time to tear and a time to mend, a time to be silent and a
time to speak, 8 a time to love and a time to hate, a time for war and a time for peace.

Learning Activity:
In today's world, credit is integrated into everyday life. From renting a car to reserving an airline ticket or
hotel room, credit cards have become a necessary convenience. However, using credit wisely is critical to
building a solid credit history and maintaining fiscal fitness. While most students have a general idea about
the advantages and disadvantages of credit, this lesson provides an opportunity to discuss these issues in
more detail.

Introduction:
The term loan refers to a type of credit vehicle in which a sum of money is lent to another party in exchange
for future repayment of the value or principal amount. In many cases, the lender also adds interest and/or
finance charges to the principal value which the borrower must repay in addition to the principal balance.

Body:

LOANS RECEIVABLE
Loans receivable are obligations supported by a formal promise to pay a certain amount of money at
a specific future date(s). It is similar to note receivable, however, the term “loans payable” is more
appropriately used by entities whose main operations involve lending of money, such as banks, financing
companies, pawnshops, non-bank intermediaries like savings and loans associations, credit cooperative, and
the like.

MEASUREMENT
Receivables are initially recognized at fair value plus transaction costs.
Loans transactions usually involve transaction costs compare to notes. Transaction costs include
fees and commissions paid to agents, advisers, brokers and dealers, levies by regulatory agencies and security
exchanges, and transfer taxes and duties.

Origination Costs and Fees

Lenders usually incur costs in originating loans. These costs are either direct origination costs
(transaction costs) or indirect origination costs. The lenders recover these costs from borrowers by charging
them origination fees.

 Direct origination costs are added to the carrying amount of a loan receivable.
 Origination fees are deducted from the carrying amount of a loan receivable.
 Indirect origination costs are not included in measurement of receivables they are expensed
when incurred.

Direct origination costs and origination fees are included in the calculation of the effective interest
rate over the expected term of the loan receivable, meaning, on transaction date, the direct origination costs
and origination fees are treated as adjustment to the effective interest rate.
ILLUSTRATION 1: Origination Costs and Fees

On January 1, 20x1, ABC Bank extended a 10%, P1,000,000 to XYZ Co. The principal is due on January 1, 20x4
but interests are due annually starting on January 1. ABC Bank incurred direct loan origination costs of
P12,000 and indirect loan origination costs of P8,000. In addition, ABC Bank charged XYZ a 6-point
nonrefundable loan origination fee.

Requirements:
1. Initial Carrying amount of loan receivable
2. Interest income in 20x1

Requirement 1: Initial Carrying amount of loan receivable

Initial Measurement:
Principal Amount 1,000,000
Direct origination costs 12,000
Origination Fee (1M x 6%) (60,000)
Carrying Amount of Loan, 01/01/20x1 952,000

01/01/20x1 Loans receivable 1,000,000

Cash 940,000
Unearned interest income 60,000

Unearned interest income 12,000

Cash 12,000

Administrative expense 8,000

Cash 8,000

Requirement 2: Interest income in 20x1

TRIAL AND ERROR APPROACH

First Trial: (using random rate of 11%)

Future Cash flows PV Factors Present value

Principal 1,000,000 PV of 1 @11%, n=3 731,191
Interest 100,000 PVOA of 1 @11%, n=3 244,371
TOTAL 975,562

Second Trial: (using random rate of 12%)

Future Cash flows PV Factors Present value

Principal 1,000,000 PV of 1 @12%, n=3 711,780
Interest 100,000 PVOA of 1 @12%, n=3 240,183
TOTAL 951,963

The effective interest rate is 11.985489% or 12%.

Subsequent Measurement
Date Interest Payments Interest Expense Amortization Present value
01/01/x1 952,000
12/31/x1 100,000 114,240 14,240 966,240
12/31/x2 100,000 115,949 15,949 982,189
12/31/x3 100,000 117,863 17,812** 1,000,000
**squeezed

12/31/20x1 Interest receivable 100,000

Unearned interest income 14,240
Interest income 114,240

Comparison between Discount and Premium

DISCOUNT PREMIUM
 Carrying Amount < Face Amount Carrying Amount > Face Amount
Effective Interest Rate > Nominal Rate Effective Interest Rate < Nominal Rate

ILLUSTRATION 2: Day 1 Difference

On January 1, 20x1, ABC Co. extended a P1,000,000, zero-interest loan to one of its directors. The loan
matures in lump sum on January 1, 20x4. The prevailing interest rate for this type of loan is 10%.

Case 1: Loan proceeds equal to present value

Assume that the loan proceeds extended to the director is equal to the present value of the loan receivable.

Future cash flow 1,000,000

PV of P1 @10%, n=3 0.751315
Present value of loan receivable 751,315

Face amount 1,000,000

Present value of loan receivable 751,315
Unearned interest income 248,685

01/01/20x1 Loan receivable 1,000,000

Cash 751,315
Unearned interest 249,685

Present value of loan receivable 751,315

Transaction price (cash paid) 751,315
Difference 0

There is no accounting problem in this case because the transaction price (price paid) is equal to the
fair value at initial recognition (present value).

Case 2: Loan proceeds equal to face amount

Assume that the loan proceeds extended to the director is equal to the face amount of the loan receivable.

01/01/20x1 Loan receivable 1,000,000

Unrealized loss - “day 1 difference” 248,665
Cash 1,000,000
Unearned interest income 248,665

Present value of loan receivable 751,315

Transaction price (cash paid) 1,000,000
Difference - Unrealized loss (248,665)

The “day 1 difference” is recognized immediately in profit/loss on initial recognition. The

“Unearned interest income” is amortized using the effective interest method.

IMPAIRMENT OF RECEIVABLES

Under old model, an entity recognizes impairment only when there is objective evidence of a loss
event. Under the new model, an entity will always estimate expected credit losses using “multi-factor” and
“holistic” analysis of credit risk that considers only past events but also forward-looking information on
current conditions and forecasts of future economic conditions. Which means that impairment loss is
recognized before the occurrence of any credit event. These impairment losses are referred to as expected
credit losses (‘ECL’).
The expected credit losses (ECL) shall be applied to all debt instruments that are not classified as
Fair Value through Profit/Loss (FVPL).

Definition of terms:
 • Loss allowance – is the allowance for expected credit losses on financial assets that are within the
scope of the impairment requirements of PFRS 9.
• Expected credit losses – is the weighted average of credit losses with the respective risks of a default
occurring as the weights.
• Credit loss – is the difference between all contractual cash flows that are due to an entity in
accordance with the contract and all the cash flows that the entity expects to receive (i.e., all cash
shortfalls), discounted at the original effective interest rate (or credit-adjusted effective interest rate
for purchased or originated credit-impaired financial assets).
• 12-month expected credit losses – The portion of lifetime expected credit losses that represent the
expected credit losses that result from default events on a financial instrument that are possible
within the 12 months after the reporting date.
• Credit risk – The risk that one party to a financial instrument will cause a financial loss for the other
party by failing to discharge an obligation.
• Lifetime expected credit losses – The expected credit losses that result from all possible default
events over the expected life of a financial instrument.

Three approaches to impairment

Type of asset/exposure Approach

Trade receivables, contract assets and lease
Simplified approach
receivables
Originated or purchased credit-impaired financial
Changes in lifetime expected credit losses approach
assets
Other assets/ exposures General approach

Simplified Approach

To assist entities that have less sophisticated credit risk management systems, IFRS 9 introduced a
simplified approach under which entities do not have to track changes in credit risk of financial assets (IFRS
9.BC5.104).
Instead, lifetime expected credit losses (ECL) are recognized from the date of initial recognition of a
financial asset.
The simplified approach is required for trade receivables or contract assets that result from
transactions that are within the scope of IFRS 15 and do not contain a significant financing component. For
trade receivables or contract assets that do contain a significant financing component, it is the entity’s choice
to apply simplified approach. Similarly, the entity can choose to apply simplified approach to lease
receivables accounted for under IFRS 16 (IFRS 9.5.5.15).
PFRS 9 does not require specific procedures in estimating lifetime expected credit losses under
simplified approach. Instead, PFRS 9 allows practical expedients and refers to the example of a provision
matrix (e.g., the aging method, singles loss rate approach).

Changes in Lifetime Expected Credit Losses Approach (Specific approach for purchased or originated credit-impaired financial assets)

IFRS 9 sets out a specific approach for purchased or originated credit-impaired financial assets (‘POCI’
assets). Originated or purchased credit impaired financial assets are those that are credit-impaired on initial
recognition.
For these financial assets, the loss allowance recognizes only the cumulative changes in lifetime
expected credit losses (ECL) since initial recognition of such an asset.
When discounting cash flow for purposes of measuring expected credit losses, the entity shall use a
credit-adjusted interest rate.
Credit-adjusted effective interest rate is the rate that exactly discounts the estimated future cash
payments or receipts through the expected life of the financial asset to the amortized cost of a financial asset
that is purchased or originated credit-impaired financial asset.

General Approach (Three-stage or three-bucket approach)

Stage 1 Stage 2 Stage 3

Credit risk has not increased Credit risk has increased Credit risk has increased
significantly since initial significantly since initial significantly since initial recognition
recognition. recognition. plus there is objective evidence of
Low credit risk expediency impairment.
Recognize 12-month expected Recognize Lifetime expected Recognize Lifetime expected
credit losses. credit losses. credit losses.
Interest revenue is computed on the Interest revenue is computed on the Interest revenue is computed on the
 gross carrying amount of the asset gross carrying amount of the asset net carrying amount of the asset.
*Gross CA less Loss allowance
Change in credit risk since initial recognition
IMPROVEMENT DETERIORATION
ILLUSTRATION 3: 12-month vs. Lifetime expected credit losses

ABC Co. issues a 3-year, interest bearing loan of P1,000,000 on August 1, 20x1. ABC Co. makes the following
estimates of risks and default losses:

Risk of default in:

Date Loss from Default
Next 12 months Remaining mos.
08/01/x1 2.00% 5.00% 400,000
12/31/x1 3.00% 12.00% 350,000
12/31/x2 1.00% 3.00% 250,000

Requirements: Compute for the amount of loss allowance on the following dates:
a. August 1, 20x1
b. December 31, 20x1
c. December 31, 20x2

Requirement a: Initial recognition

08/01/20x1 Impairment loss 8,000
Loss Allowance 8,000

On initial recognition, ABC Co. shall recognize 12-month expected credit losses of P8,000.
*400,000 x 2% = P8,000

Requirement a: December 31, 20x1

At each reporting period, ABC Co. shall determine whether there has been a significant increase in
credit risk since initial recognition. This assessment is made as follows:

Risk of default in:

Loss from Default
Date Next 12 months Remaining mos.
(a) (b) (c) = (a) + (b)
08/01/x1 2.00% 5.00% 7.00%
12/31/x1 3.00% 12.00% 15.00%

12/31/20x1 Impairment loss 44,500

Loss Allowance (52,500 – 8,000) 44,500

The total risk increases from 7% to 15%. Accordingly, ABC Co. shall measure the loss allowance equal to the
lifetime expected credit losses of P52,500.
*350,000 x 15% = P52,500

Requirement a: December 31, 20x2

Risk of default in:

Loss from Default
Date Next 12 months Remaining mos.
(a) (b) (c) = (a) + (b)
08/01/x1 2.00% 5.00% 7.00%
12/31/x1 3.00% 12.00% 15.00%
12/31/x2 1.00% 3.00% 4.00%

12/31/20x1 Loss Allowance (52,500 – 2,500) 50,000

Impairment loss 50,000

The total risk decreased to 4% which is lower than 7% total risk in initial recognition. Therefore, ABC Co.
shall revert to measuring the loss allowance from the lifetime expected credit losses to 12-month
expected credit losses. ABC shall measure the loss allowance equal to 12-month expected credit losses of
P2,500.
*250,000 x 1% = P2,500
Measurement of Expected Credit Losses
Expected credit losses shall be measured in a manner that reflects:
1. Unbiased and probability weighted amount that is determined by evaluating a range of possible
outcomes.
2. The time value of money.
3. Reasonable and supportable information that is available without undue cost or effort at the
reporting date about past events, current conditions, and forecasts of future economic conditions.

Stage Nature of instrument Measurement of credit losses

Present value of the difference between:
Financial asset that is not a. The contractual cash flows due under the
Stages 1 & 2
credit-impaired contract, and
b. The cash flows expected to be received
The difference between:
Financial asset that is credit- a. The asset’s gross carrying amount, and
Stage 3
impaired (but not POCI) b. The present value of estimated cash flows
discounted at the original effective interest rate.

Credit-impaired financial assets

A financial asset is credit-impaired when one or more events that have a detrimental impact on the
estimated future cash flows of that financial asset have occurred.

Evidence that a financial asset is credit-impaired includes observable data about the following events:
a. Significant Financial Difficulty of the issuer or the borrower
b. A Breach of Contract, such as a Default or Past Due event
c. The Lender(s) of the Borrower, for economic or contractual reasons relating to the borrower’s
financial difficulty, have granted to the borrower a concession(s) that the lender(s) would not
otherwise consider
d. It is becoming probable that the borrower will enter Bankruptcy or other financial reorganization
e. The disappearance of an Active Market for that financial asset because of financial difficulties
f. The purchase or origination of a financial asset at a deep Discount that reflects the incurred Credit
Loss

The impairment loss is computed as the difference between:

a. The asset’s gross carrying amount, and
b. The present value of estimated cash flows discounted at the original effective interest rate

ILLUSTRATION 4: Stage 3 - Credit-impaired financial assets

On January 1, 20x1, ABC Bank extended a P1,000,000 loan to XYZ, Inc. principal is due on December 31, 20x5
but 10% interest is due annually starting December 31, 20x1.

On December 31, 20x3, XYZ, Inc. was delinquent, and it was ascertained that the loan is credit impaired. ABC
Bank assessed those interests accruing on loan will not be collected; however, the principal is expected to be
received in two equal annual installments starting on December 31, 20x4. The carrying amount of the loan,
together with the accrued interest, as of December 31, 20x3 is as follows:

Loan receivable 1,000,000

Interest Receivable 0 100,000
Total carrying amount of receivables before impairment 1,100,000

The current market rate on December 31, 20x3 is 14%.

Requirement: Compute for the impairment loss on the loan receivable

Estimated FCF (1M/2) 500,000

PV of OA @ 10%, n=2 1.735537
Present value of estimated cash flows 867,769
The impairment loss is computed as follows:
Present value of estimated FCF 867,769
Carrying amount before impairment (1,100,000)
Impairment loss 232,231

Direct Allowance
12/31/x3 Impairment loss 232,231 12/31/x3 Impairment loss 232,231
Interest receivable 100,000 Interest receivable 100,000
Loans receivable 132,231 Loss allowance 132,231

Loan Receivable (before) 1,000,000 Loan Receivable 1,000,000

Credit to loan receivable (132,231) Loss allowance (132,231)
Loan receivable (after) 867,769 Loan receivable – net 867,769

A new amortization table is prepared after the impairment:

Date Collections Interest Income Amortization Present value
12/31/x3 867,769
12/31/x4 500,000 86,777 413,223 454,546
12/31/x5 500,000 45,455 454,545 0

Direct Allowance
12/31/x4 Cash 500,000
12/31/x4 Cash 500,000
Loss allowance 86,777
Interest income 86,777
Interest income 86,777
Loans receivable 413,223
Loss receivable 500,000

ILLUSTRATION 5: Interest not accrued because of loss event

On January 1, 20x1, ABC Co. received a P10,000,000 note receivable from XYZ, Inc. Principal payments of
P2,000,0000 and interest at 12% are due annually at the end of each year for 5 years. The first payment starts
on December 31, 20x1.

XYZ, Inc. made the required payments during 20x1 and 20x2. However, during 20x3, XYZ, Inc. began to
experience financial difficulties, requiring ABC Co. to reassess the collectability of the note. Because of the loss
event, ABC Co. did not accrue the interest on December 31, 20x3.

Date of expected receipt Amount of cash flows

January 1, 20x4 1,000,000
January 1, 20x5 2,000,000
January 1, 20x6 3,000,000

Requirement: Compute for the impairment loss on the note receivable.

The present value of the estimated future cash flows is computed as follows:
Date Future Cash Flows PV @12%, n= 0,1,2 Present value
01/01/20x4 1,000,000 1 1,000,000
01/01/20x5 2,000,000 0.892857 1,785,714
01/01/20x6 3,000,000 0.797194 2,391,582
    5,177,296

The carrying amount of the receivable is computed as follows

Principal amount, 01/01/20x1 10,000,000
Payment in 20x1 (2,000,000)
Payment in 20x2 (2,000,000)
Outstanding balance, 12/31/20x3 6,000,000
Interest receivable, 12/31/20x3 0
Carrying amount before impairment 6,000,000

The impairment loss is computed as follows

Present value of the estimated future cash flows 5,177,296
Carrying amount before impairment (6,000,000)
Impairment loss (822,704)
Amortization table – installment:
Date Collections Interest Income Amortization Present value
12/31/20x3 5,177,296
01/01/20x4 1,000,000 0 1,000,000 4,177,296
01/01/20x5 2,000,000 501,276 1,498,724 2,678,571
01/01/20x6 3,000,000 321,429 2,678,571 0

12/31/20x3 Impairment loss 822,704

Allowance for impairment loss 822,704

01/01/20x4 Cash 1,000,000

Notes receivable 1,000,000

12/31/20x4 Impairment loss 501,276

Allowance for impairment loss 501,276

01/01/20x5 Cash 2,000,000

Notes receivable 2,000,000

12/31/20x5 Impairment loss 321,429

Allowance for impairment loss 321,429

01/01/20x6 Cash 3,000,000

Notes receivable 3,000,000

ILLUSTRATION 6: Origination costs and fees (page 358)

On Jan. 1, 20x1, Sore Bank extended a P5,000,000, 10% loan to a borrower. The principal is due in 4 years'
time, but interest is due annually every Dec. 31. Sore Bank incurred direct loan origination costs of P261,986
and charged the borrower origination fee of 2%.

Requirement: Compute for the carrying amounts of the loan on Jan. 1, 20x1 and Dec. 31, 20x1, respectively.

Initial measurement:
Face amount 5,000,000
Direct loan origination costs 261,986
Origination fees (5M x 2%) (100,000)
Carrying amount - 1/1/x1 5,161,986

First trial (using 9%): Future cash flows x PV factor @ x% = Present value of note
Future Cash Flows PV @9%, n=4 Present value
Principal 5,000,000 0.708425 3,542,126
Interest 500,000 3.239719 1,619,860

 The effective interest rate is 9%.

Subsequent measurement:
Date Collections Interest income Amortization Present value
1/1/x1 5,161,986
12/31/x1 500,000 464,579 35,421 5,126,565
12/31/x2 500,000 461,391 38,609 5,087,956
12/31/x3 500,000 457,916 42,084 5,045,872
12/31/x4 500,000 454,128 45,872 5,000,000

ILLUSTRATION 7: Day-1 difference (page 359)

On Jan. 1, 20x1, Chromatic Bank extended a P2,000,000, zero-interest loan to one of its officers. The loan
matures in lump sum in 4 years' time. The officer received loan proceeds of P2,000,000. The effective interest
rate is 10%.

Requirements: Provide the journal entry on Jan. 1, 20x1.

Initial measurement: 2M x PV of 1 @ 10%, n=4 = 1,366,027

Jan. 1, Loan receivable 2,000,000
20x1
Unrealized loss (“Day 1” difference) 633,973
Cash 2,000,000
Unearned interest 633,973

ILLUSTRATION 8: Impairment: '3-bucket' approach (page 359)

On July 1, 20x1, Sunny Day Corporation recognizes a 3-year, 10%, P2,000,000 loan receivable in exchange for
cash. The principal is due at maturity, but interest is due annually every July 1. The effective interest rate on
the loan is 10%. Sunny Day makes the following estimates of risks of defaults and losses.

Risk of default in next Risk of default in 13 to Loss that would

12 months 36 months result from default
07/01/20x1 2.5% 5.0% 800,000
12/31/20x1 3.0% 10.0% 700,000
12/31/20x2 1.0% 2.0% 500,000

At initial recognition, Sunny determines that the loan is not a purchased or originated credit-impaired
financial asset. On December 31, 20x1, Sunny determines that the increase in credit risk since initial
recognition is significant, but the loan is not creditimpaired.

Requirements: Provide the entries on the following dates: July 1, 20x1, December 31, 20x1 and December
31, 20x2

Requirement 1: July 1, 20x1

July 1, 20x1 Loan receivable 2,000,000
Cash 2,000,000
July 1, 20x1 Impairment loss* 20,000
Loss allowance 20,000
* Equal to 12-month expected credit losses (2.5% x 800,000)

Requirement 2: December 31, 20x1

Dec. 31, 20x1 Impairment loss 71,000
Loss allowance (91K – 20K) 71,000
Lifetime expected credit losses = (3.0% + 10%) x 700,000 = 91,000

Dec. 31, 20x1 Interest receivable 100,000

Interest income (2M x 10% x 6/12)** 100,000
** Interest revenue is computed on the gross carrying amount because the loan is not credit-impaired (i.e., Stage 2 rather
than Stage 3).

Requirement 3: December 31, 20x2

Dec. 31, 20x2 Loss allowance (91K – 5K) 86,000
Impairment gain 86,000
12-month expected credit losses = (1% x 500,000) = 5,000

Sunny Day Corp. reverts back to measuring expected credit losses equal to 12-month expected credit losses
because the credit risk has significantly decreased since initial recognition. This is evidenced by the fact that
the 12-month default risk of 1% on 12/31/20x2 is lower than the 12-month default risk of 2.5% on 7/1/20x1

Dec. 31, 20x2 Interest receivable 100,000

Interest income (2M x 10% x 6/12) 100,000
ILLUSTRATION 9: Credit-impaired financial asset (page 360)

On Dec. 31, 20x1, an entity determines that a P3,000,000, 10% loan receivable is credit impaired. A P400,000
interest receivable has been accrued on the loan. The entity determines that it can only collect a total of
P3,000,000 on the loan, inclusive of both principal and interest, and that the cash flows will be collected in
installments of P1,000,000 per year starting Dec. 31, 20x2. The current market rate on Dec. 31, 20x1 is 12%.

Requirements: Provide the journal entry on Dec. 31, 20x1 and compute for the interest income in 20x2.

PV of future cash flows (1M x PV ord. ann. @10%, n=3) 2,486,852

Carrying amount (3M principal + .4M int. receivable) (3,400,000)
Impairment loss (913,148)

Direct Allowance
Dec. 31, 20x1 Dec. 31, 20x1
Impairment loss 913,148 Impairment loss 913,148
Interest receivable 400,000 Interest receivable 400,000
Loan receivable 513,148 Loss allowance 513,148

Date Collections Interest income Amortization Present value

Dec. 31, 20x1 2,486,852
Dec. 31, 20x2 1,000,000 248,685 751,315 1,735,537
Dec. 31, 20x3 1,000,000 173,554 826,446 909,091
Dec. 31, 20x4 1,000,000 90,909 909,091 -

Life Application:
Here's how the loan process works. When someone needs money, they apply for a loan from a bank,
corporation, government, or other entity. The borrower may be required to provide specific details such as
the reason for the loan, their financial history, Social Security Number (SSN), and other information. The
lender reviews the information including a person's debt-to-income (DTI) ratio to see if the loan can be paid
back. Based on the applicant's creditworthiness, the lender either denies or approves the application. The
lender must provide a reason should the loan application be denied. If the application is approved, both
parties sign a contract that outlines the details of the agreement. The lender advances the proceeds of the
loan, after which the borrower must repay the amount including any additional charges such as interest.

Conclusion:
 A loan is when money is given to another party in exchange for repayment of the loan principal
amount plus interest.
 Loan terms are agreed to by each party before any money is advanced.
 A general approach that applies to all loans and receivables not eligible for the other approaches.
 A simplified approach that is required for certain trade receivables and so called “IFRS 15 contract
assets” and otherwise optional for these assets and lease receivables.
 A “credit adjusted approach” that applies to loans that are credit impaired at initial recognition
(e.g., loans acquired at a deep discount due to their credit risk).