Loans
Receivable
INTERMEDIATE ACCOUNTING 3
TODAY'S PRESENTATION
∙ Definition
∙ Initial Recognition
∙ Fair Value
∙ Transaction Costs
∙ Subsequent Measurement
∙ Effective Interest Rate (EIR)
∙ Origination Fees
∙ Impairment of Financial Assets
LOAN RECEIVABLE
A financial asset arising from
a loan granted by a bank or
other financial institution to
a borrower or a client.
LOAN RECEIVABLE
Loan receivable represents the amounts
lent to the borrowers, either:
Ø as part of ordinary course of business
(i.e., banks and other financial
institutions); or
Ø casually (e.g., lending of excess cash
by a manufacturing entity).
Loans receivable and investment in bonds
are both considered as securities.
Bonds Loans
Traded in an
Yes (in bond markets) No
exchange market?
Contract disclosure Public contract Private contract
A lender or group of
Counterparty/ies General public
lenders
Determination of Based on prevailing
Privately agreed-upon
interest rate market rates
Stable and well-
Issuers (borrowers) known entities. Also, Not so known entities
the government
INITIAL RECOGNITION
GENERAL REQUIREMENT
PFRS 9 provides that an entity must recognize
a financial asset or a financial liability in its
statement of financial position when, and
only when, the entity becomes a party to the
contractual provisions of the instrument.
EXCEPTION
PFRS 9 provides a practical exception to the
application of this general principle for “regular
way” purchases and sales.
GENERAL RULE
On initial recognition, loans receivable
shall be recognized at their fair value
plus transaction costs that are
directly attributable to the acquisition
of the loan. EXCEPTION
Short–term loans receivables with no
stated interest rate may be measured at
invoice amounts, without discounting,
when the effect of not discounting is
INITIAL immaterial.
MEASUREMENT
TRANSACTION PRICE
The best evidence of the fair value of a
financial instrument on initial recognition is
normally the transaction price (i.e., the fair
value of the consideration given or received).
INTEREST-FREE AND LOW-INTEREST
LONG-TERM LOANS
The fair value of a long–term loan
receivable that carries no interest
could be estimated as the
present value of all future cash
receipts, discounted using the
prevailing market rate(s) of
FAIR VALUE
interest.
TRANSACTION COSTS
Incremental costs that are directly
attributable to the acquisition, issue
or disposal of a financial asset or
financial liability. An incremental cost
is one that would not have been
incurred if the entity had not
acquired, issued or disposed of the
financial instrument.
For loans receivable subsequently
measured at amortized cost, transaction
costs are included in the calculation of
the amortized cost using the effective
interest method, in effect reducing the
amount of interest income recognized over
the life of the loan.
MEASUREMENT
Subsequent to initial
recognition, long-term
loans receivable shall
SUBSEQUENT
be measured at
amortized cost using
MEASUREMENT
the effective interest
method.
AMORTIZED COST
The amortized cost is the amount at which the loan receivable is
measured at initial recognition minus any principal
repayments, plus or minus the cumulative amortization using
the effective interest method of any difference between the
initial carrying amount and the principal maturity amount and
minus for any loss allowance (impairment or uncollectibility).
EFFECTIVE INTEREST METHOD
The effective interest method is the method that is
used in the calculation of the amortized cost of the
loans receivable and in the allocation and recognition
of the interest revenue in profit or loss over the
relevant period.
EFFECTIVE INTEREST RATE (EIR)
The effective interest rate (EIR)
is the rate that exactly
discounts estimated future
EFFECTIVE
cash payments or receipts
through the expected life of the
INTEREST RATE loan to the amortized cost of
the loans receivable.
The calculation of EIR includes:
ESTIMATE THE Øall fees and points paid or
EXPECTED received between parties to the
contract that are an integral part
CASH FLOWS of the EIR;
Øtransaction costs; and
Øall other premiums or discounts.
CALCULATION
OF EIR
When applying the effective
interest method, an entity
generally amortizes any
fees, points paid or APPLYING THE
received, transaction costs EFFECTIVE
and other premiums or INTEREST
discounts that are included
in the calculation of the EIR METHOD
over the expected life of the
loan.
FEES THAT ARE
INTEGRAL PART OF EIR
Fees that are an integral part of the effective interest
rate of a financial instrument include:
a) origination fees received by the entity relating to
the creation or acquisition of a financial asset.
b) commitment fees received by the entity to
originate a loan (financial liabilities measured at
fair value through profit or loss)
c) origination fees paid on issuing financial liabilities
measured at amortized cost.
Origination Costs Origination Fees
Amounts actually incurred by an
entity in relation to checking of
creditworthiness of a prospective
borrower. Amounts charged by a lender
entity to the borrower to
These may include legal costs, compensate the former for the
documentation costs, background origination activities that it had
checking costs and other agency undertaken prior to the granting
costs. of the loan. These fees are
normally stated as a
In accounting, origination costs are percentage of the loan amount.
classified as either direct
origination costs and indirect
origination costs.
PFRS 9 identifies that the origination
costs and origination fees are integral
parts of the determination of the
effective interest rate of a financial
instrument.
These are integral because they will
not be incurred (for origination costs)
or received (for origination fees)
unless there is a loan receivable.
ORIGINATION FEES RECEIVED
FROM BORROWER
The origination fees received from
borrower are recognized as unearned
interest income and amortized over
the term of the loan.
DIRECT ORIGINATION COSTS
Origination fees that are not chargeable
against the borrower. The direct
origination costs are deferred and
amortized over the term of the loan.
PREFERABLY, the direct
origination costs are
offset directly against any
unearned origination fees
received.
Consequences
Scenarios Initial CA vs. Face Premium or
Amount Discount?
Direct origination costs Initial CA > Face
Premium
> origination fees Amount
Direct origination costs Initial CA < Face
Discount
< origination fees Amount
Premium on Loans Discount on Loans
Normal balance Debit Credit
Relation to loan Added Deducted (contra-
receivable account (adjunct account) asset account)
EIR vs Stated Rate EIR < Stated Rate EIR > Stated Rate
Interest income vs. Interest income < Interest income >
interest received interest received interest received
Unearned interest
Other names Direct origination fees
income
INDIRECT ORIGINATION COSTS
Indirect origination costs shall be expensed
outright (not included in the initial carrying
amount of the loan receivable).
LOANS WITH EQUAL
PERIODIC PAYMENTS
Some loans are structured so that the
borrowers will pay equal amounts
each period. Each periodic payment is
already composed of the interest and
principal components.
In connection with this, the following
formula is relevant:
Equal PV of
Periodic = Principal
÷ Ordinary
Payment Amount
Annuity
At the beginning of 2023, Leah Isabelle
Company granted a four-year, 8% interest-
bearing loan receivable with face amount of
P6,000,000. Based on the loan agreement, the
borrower shall pay the loan in equal
amounts, which already include the payment
for the principal and the payment for interest.
These loan payments are made at the end of
each year.
Calculate the amount of periodic payment.
IMPAIRMENT OF
FINANCIAL ASSETS
Despite the rigorous credit evaluation, some
of the counterparties will still fail to pay the
amounts due from them.
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.
Credit losses on financial assets
are measured and recognized
using the expected credit loss
(ECL) approach.
EXPECTED CREDIT
LOSSES (ECLs)
Credit losses are the difference between
the present value of all contractual
cash flows and the present value of
expected future cash flows.
EXPECTED CREDIT
LOSSES (ECLs)
CREDIT LOSS
Credit loss is the present value of the difference
(i.., cash shortfalls) between the cash flows below
discounted using the original effective interest
rate:
a. All contractual cash flows that are due to an
entity in accordance with the contract; and
b. All the cash flows that the entity expects to
receive.
In other words, credit losses are
recognized even if there are no actual
defaults or inability of the
counterparties in paying their owed
amounts to the entity.
The goal of the expected credit loss
model is to recognize the credit losses to
coincide with the events indicative of the
counterparty’s possible failure to pay its
obligation to the entity (i.e., changes in
credit risk) instead of recognizing the
credit losses only when there is an actual
failure. This will result to a more timely
financial information about the financial
asset's credit risk.
ECLs are an estimate of credit losses over the next 12
months or the life of a financial instrument and,
when measuring ECLs, an entity needs to take into
account:
Probability– Time Value
Weighted of Money
Outcome
Reasonable and
Supportable Information
that is Available Without
Undue Cost or Effort
SCOPE
Financial assets
that are debt
instruments
measured at Financial assets that
amortized cost. are debt instruments
measured at fair
value through other
Finance lease comprehensive
and operating income.
lease receivables
under PFRS 16
Contract assets
under PFRS 15
Loan commitments
that are not
measured at fair
value through Financial guarantee contracts
profit or loss under that are not measured at fair
PFRS 9 value through profit or loss
under IFRS 9
In applying the PFRS 9 impairment
requirements, an entity needs to follow
one of the approaches below:
PURCHASE OR
ORIGINATED
THE GENERAL THE SIMPLIFIED CREDIT-
APPROACH APPROACH IMPAIRED
APPROACH
Under the general approach, at each
reporting date, an entity recognizes a loss
allowance based on either 12–month ECLs
or lifetime ECLs, depending on whether
there has been a significant increase in
credit risk on the financial instrument since
initial recognition.
The changes in the loss
allowance balance are
recognized in profit or loss GENERAL
as an impairment gain or
loss. APPROACH
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.
The guiding principle of the ECL
model is to reflect the general
pattern of deterioration, or
improvement, in the credit quality
of financial instruments.
On December 31, 20X1, Bank A originates a 10 year loan
with a gross carrying amount of P1,000,000, with
interest being due at the end of each year and the
principal due on maturity. There are no transaction
costs and the loan contracts include no options,
premiums or discounts, points paid, or other fees.
At origination, the loan is in stage 1 and a
corresponding 12–month ECL allowance is recognized
in the year ending December 31, 20X1.
On December 31, 20X4, the loan has shown signs of
significant deterioration in credit quality and Bank A
moves the loan to stage 2. A corresponding lifetime
ECL allowance is recognized. In the following year, the
loan defaults and is moved to stage 3.
Stage 2:
Stage 1: Lifetime Stage 3:
12-month Expected Credit Lifetime
Expected Credit Losses Expected
Losses Credit Losses
On December 31,
On December 31, 20X4, the loan has On December 31,
20X1, the loan is shown signs of a 20X5, the loan
originated. significant increase defaults.
in credit risk.
Is there a significant increase
in credit risk since the initial
recognition? YES
NO
Measure the ECL equal to Measure the ECL equal to
12-month ECL Lifetime ECL
12-month ECL
It is 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.
Lifetime ECL
Lifetime ECL is the expected credit losses that
result from all possible default events over
the expected life of a financial instrument.
Based on these definitions, the amount
of lifetime ECL is always higher than
the amount of 12-month ECL.
This is because the longer the period
to the maturity date, the higher the
credit risk of a financial asset.
SIGNIFICANT INCREASE
IN CREDIT RISK
The following is a portion of the non-exhaustive list
that PFRS 9 mentioned that are relevant in assessing
whether there is a significant increase in credit risk
from the initial recognition:
a) existing or forecast adverse changes in business,
financial or economic conditions
b) an actual or expected significant change in the
operating results of the borrower that results in a
significant change in the borrower’s ability to
meet its debt obligations.
SIGNIFICANT INCREASE
IN CREDIT RISK
c) Significant increases in credit risk on other
financial instruments of the same borrower.
d) an actual or expected significant adverse change
in the regulatory, economic, or technological
environment of the borrower.
e) significant changes, such as reductions in
financial support from a parent entity or other
affiliate.
COMPUTING ECL
In computing for the amount of ECL, an entity
may apply either of the following:
Ø PD X LGD Approach – a complicated one; or
Ø Loss Rate Approach – a simpler one.
By analogy, this has already been applied under
the aging method of estimating allowance for
bad debts.
ECL = PD x LGD x EAD
PD (probability of default) – indicates
how likely that a counterparty will
default. This is stated as a percentage.
PD X LGD APPROACH
ECL = PD x LGD x EAD
LGD (loss given default) – the credit
loss that an entity will incur assuming a
counterparty defaults. This is stated as
a percentage and complement to the
recovery rate (RR), where LGD = 1 - RR.
PD X LGD APPROACH
ECL = PD x LGD x EAD
EAD (exposure at default) – the
amount recognized in the records of
an entity during the expected timing of
default.
PD X LGD APPROACH
The computed ECL amount is the
required ending balance of the
“allowance for ECL” account and will
be a deduction from the financial
asset's gross carrying amount to get
its net carrying amount.
Any changes in the required balance of the
allowance for ECL from one reporting date
to another are recognized in the profit or
loss as follows:
Ø Any increase in the allowance is recognized
as impairment loss.
Ø Any decrease in the allowance is recognized
as gain on reversal of impairment.
For bonds and other debt securities
issued by governments and private
corporations, PD and LGD
percentages are normally available
publicly as part of credit rating
agencies’ publications (e.g.,
Moody's, Standard & Poor's, etc.).
For loans receivables, the banks
internally estimate PD and LGD
percentages based on its past data,
which is then adjusted by forward-
looking information. These
estimations use statistical analyses
like regression and correlation, which
are beyond the scope of this topic.
As of December 31, 2023, RAIL COFFEE Company has an
investment in 10% interest-bearing government bonds
with a carrying amount of P10,000,000 as of date. The
investment is accounted for at amortized cost. Based
on a credit agency's publications, the relevant PD within
12 months is 2%, lifetime PD is 30% and recovery rate
(RR) is 80%. The balance of allowance for ECL as of
December 31, 2022 is P21,000.
Required: Determine the amounts of allowance for ECL,
impairment loss, net carrying amount of the bonds,
and interest income under each of the following
independent scenarios:
1. No significant increase in credit risk
2. Significant increase in credit risk.
GENERALIZATION – SCENARIOS 1 AND 2
The difference in the computation of
allowance for ECL arises from the different
PDs used. The amount of ECL is higher in
Scenario 2 to coincide with the significant
increase in credit risk. As a result,
recognition of impairment losses will now
be more timely.
Continuing with Scenario 2, as of December 31, 2024,
assume that the significant increase in credit risk last
December 31, 2023 has been reverted back to credit risk
levels as of December 31, 2022 (i.e., no significant
increase in credit risk since the initial recognition). The
relevant PD within 12 months is 1.5%, lifetime PD is 35%,
and LGD is 25%.
Required: Compute for the ending balance of
allowance for impairment and impairment loss/gain
for 2024.
1. First, discount using the original effective
interest rate the expected total cash
flows to be recovered from the financial
asset assuming the counterparty will
default.
Ø The period to be used in computing for the
PV factor is not necessarily the remaining
period until maturity date but should reflect
the expected timing of the cash flows.
COMPUTATION OF LGD
1. First, discount using the original effective
interest rate the expected total cash
flows to be recovered from the financial
asset assuming the counterparty will
default.
Ø Nevertheless, when there is no expected
timing of cash flow indicated, the period to
maturity can be used instead.
COMPUTATION OF LGD
2. The amount computed in Step 1 is
considered as the present value of
expected recoveries from which we can
compute for the recovery rate as follows:
Recovery PV of Expected Recovery
Rate (RR) =
Carrying Amount
COMPUTATION OF LGD
On January 1, 2023, BOONA Company entered into a
loan agreement with a borrower by lending P5,000,000.
The Loan bears interest of 9% that is payable every
December 31. Maturity date is December 31, 2028. If the
borrower defaults, the Company expects to receive
P4,000,000 of the principal on the maturity date. No
amounts of interest are expected to be received if the
borrower defaults.
Required: Compute for the estimated rate of LGD as of
December 31, 2023.
FINANCIAL ASSET IS
CREDIT-IMPAIRED
When a financial asset is credit-
impaired, there is there is either
an actual failure to pay (default),
or it is virtually certain that the
counterparty will fail to pay.
Evidence that a financial asset is credit-impaired
include 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, having granted to the borrower
a concession(s) that the lender(s) would not
otherwise consider;
Evidence that a financial asset is credit-impaired
include observable data about the following events:
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; or
f) the purchase or origination of a financial asset at
a deep discount that reflects the incurred credit
losses.
In these cases, an entity shall measure the financial
asset at the present value of the modified cash
flows discounted at original EIR. Using this present
value amount, impairment loss to be recognized in
profit or loss can be determined as:
Gross carrying amount Pxx
Add: Accrued interest receivable (if any ) xx
Less: Allowance for ECL (if any) xx
Net carrying amount Pxx
Less: New present value (xx)
Impairment loss Pxx
Interest income shall now be based on
the net carrying amount of the financial
asset (after deducting the amount of
allowance for impairment).
On January 1, 2023, HARMONIOUS Bank lent P8,000,000 to
a borrower. The loan has interest of 10% payable every
December 31 of each year and maturity date of
December 31, 2025. Starting 2024, the borrower
experienced financial difficulties which forced it to enter
into agreement with the bank for the modification of
the loan as of December 31, 2024:
1. Interest will continue to be paid but to a reduced
rate of 5% starting December 31, 2025. Accrued
interest for 2024 is to be waived.
2. Principal amount will be reduced to P7,000,000 (i.e.,
P1,000,000 will be waived) and will be paid on
December 31, 2027.
Allowance for impairment as of December 31, 2023,
computed using PD x LGD approach, amounted to
P12,000.
Required: Determine the amount of impairment loss to
be recognized in 2024 and the subsequent accounting
for the loan starting 2025.
Events which gave rise to credit-
impairment of a financial asset
may cease to happen
completely or partially.
REVERSAL OF
IMPAIRMENT LOSS
In these cases, gain on reversal of
impairment shall be recognized in profit
or loss equal to the difference of the
following:
Net carrying amount before reversal Pxx
Less: New present value (xx)
Gain on reversal of impairment Pxx
Continuing with HARMONIOUS Bank, except that as of
December 31, 2025, the borrower has partially
recovered and agreed to pay 8% interest for 2026
and 2027.
What is the amount of Gain on Reversal of
Impairment in 2025?
COMPREHENSIVE PROBLEM
On January 1, 2023, DAZZLING Bank lent P9,000,000 to a
borrower. The loan has interest of 10%, payable every
December 31 of each year and has maturity date of
December 31, 2028.
As of December 31, 2023, no major events have
happened and as a result, there is no significant
increase in credit risk. On December 31, 2024, events
happened which led to the deterioration of the
borrower's financial performance, hence causing a
significant increase in credit risk. Nevertheless, interest
amounts for 2023 and 2024 were received.
PD Within 12 months Lifetime
December 31, 2023 2% 40%
December 31, 2024 3% 45%
Amounts to be Estimated years
Recovery Amounts received if there before it can be
is a default* received
December 31, 2023 8,000,000 2 years
December 31, 2024 7,000,000 3 years
*no amount of interest is expected to be received in case of
default.
The events of 2024 became worse in 2025 and as a
result, the loan is considered as credit-impaired. The
Bank estimates that it will receive P2,000,000 on
December 31, 2026, P2,500,000 on December 31, 2027,
and P2,500,000 on December 31, 2028. Interest for 2025
has been paid, but no amounts of interest are to be
received moving forward.
Required: Determine the journal entries related to
impairment over the term of the loan.
This approach is primarily applicable to trade
receivables (e.g., accounts receivables).
Under this approach, the amount of ECL is
always based on the lifetime ECL due to the
short-term nature of the related receivables
(i.e., maturity of less than one year).
SIMPLIFIED
APPROACH
THE END
Loans Receivable
