DISCOUNTING OF NOTE RECEIVABLE: MASTERY QUIZZER
I. TRUE OR FALSE (10 Items)
Instructions: Write TRUE if the statement is correct. If FALSE, write the correct term or phrase that would make the statement true.
1. In a promissory note, the payee is the one liable to pay on the date of maturity.
Answer: FALSE. (The maker is the one liable; the payee is the one entitled to payment).
2. When a payee endorses a note and writes “without recourse,” they avoid future liability even if the maker refuses to pay the endorsee on maturity.
Answer: TRUE.
3. In accounting, the secondary liability of an endorser in a with-recourse endorsement is classified as a current liability.
Answer: FALSE. (It is classified as a contingent liability).
4. The discount period is computed as the full term of the note minus the expired portion up to the date of discounting.
Answer: TRUE.
5. If a note is discounted with recourse and accounted for as a secured borrowing, the note receivable is derecognized immediately, and a liability is recorded.
Answer: FALSE. (The note receivable is not derecognized; a liability is recorded for the face amount).
6. The net proceeds from discounting are computed as the maturity value plus the discount.
Answer: FALSE. (Net proceeds = Maturity Value minus Discount).
7. In the absence of any evidence to the contrary, endorsement is assumed to be with recourse.
Answer: TRUE.
8. Under the conditional sale approach, the “Note Receivable Discounted” account is presented as a liability in the statement of financial position.
Answer: FALSE. (It is deducted from the total notes receivable in the statement of financial position, with disclosure of the contingent liability).
9. If the note is paid by the maker on maturity under the conditional sale approach, the contingent liability is simply extinguished.
Answer: TRUE.
10. The main justification for treating with-recourse discounting as a secured borrowing is that the transferor has lost control over the note.
Answer: FALSE. (The main justification for treating it as a conditional sale is the loss of control).
II. MULTIPLE CHOICE – THEORY (10 Items)
Instructions: Choose the letter of the best answer.
11. What is the legal effect of endorsing a note “with recourse”?
- A. The endorser becomes the primary obligor.
- B. The endorser avoids all future liability.
- C. The endorser shall pay the endorsee if the maker dishonors the note.
- D. The endorser transfers ownership but retains the right to collect.
Answer: C. (With recourse means the endorser must pay the endorsee if the maker dishonors).
12. Based on the principle of ‘control’ over transferred financial assets, what happens to the transferor’s ability to control a note receivable upon discounting?
- A. The transferor retains full legal control.
- B. The transferor has lost control over the note.
- C. The transferor retains control only if the discounting is without recourse.
- D. The transferor shares control equally with the transferee.
Answer: B. (The transferor/endorser has lost control over the note receivable; the transferee has complete control).
13. Which of the following best describes the “carrying amount” of a note receivable on the date of discounting?
- A. Principal plus interest for the full term
- B. Principal plus accrued interest from the note date to the discounting date
- C. Maturity value minus the discount
- D. Principal minus the allowance for bad debts
Answer: B. (Carrying amount = Principal + Accrued interest earned up to the date of discounting).
14. Under the secured borrowing treatment of a with-recourse discounting, what account is credited upon initial recognition?
- A. Note Receivable
- B. Note Receivable Discounted
- C. Liability for Note Receivable Discounted
- D. Interest Income
Answer: C. (The liability is credited instead of the note receivable account).
15. When counting the discount period for a note whose term is expressed in “months,” how should the count be handled?
- A. Count exact days, excluding the first and including the last.
- B. Count by months regardless of the number of days in a month.
- C. Count exact days, including the first and excluding the last.
- D. Count by weeks regardless of the start date.
Answer: B. (When the term is in months, counting is strictly by months).
16. Which of the following is NOT a component in the computation of the discount amount?
- A. Maturity value
- B. Discount rate
- C. Principal amount
- D. Discount period
Answer: C. (Discount = Maturity Value × Discount Rate × Discount Period. Principal alone is not a direct factor).
17. If a note discounted with recourse under the conditional sale approach is dishonored by the maker, and the endorser pays the bank the maturity value plus protest fees, what account is debited for the total payment?
- A. Loss on note discounting
- B. Interest expense
- C. Accounts receivable
- D. Note receivable discounted
Answer: C. (The total payment is charged to Accounts Receivable).
18. What is the default assumption regarding endorsement if there is no evidence to the contrary?
- A. Endorsement is without recourse.
- B. Endorsement is with recourse.
- C. Endorsement is a secured borrowing.
- D. Endorsement is null and void.
Answer: B. (Endorsement is assumed to be with recourse by default).
19. How does the “Note Receivable Discounted” account function under the conditional sale approach?
- A. It is a contra-liability account.
- B. It is an expense account.
- C. It is deducted from total notes receivable on the balance sheet.
- D. It is added to total notes receivable on the balance sheet.
Answer: C. (It is presented as a deduction from total notes receivable).
20. If the discounting is without recourse, what is the nature of the transaction?
- A. Conditional sale with contingent liability.
- B. Absolute sale with no contingent liability.
- C. Secured borrowing.
- D. Assignment of accounts receivable.
Answer: B. (Without recourse = absolute sale; no contingent liability arises).
II. MATCHING TYPE (6 Items)
Instructions: Match the term in Column A with its correct definition or description in Column B. Write the letter of your answer.
(Column B is randomized).
| Column A | Column B | |
|---|---|---|
| 21. Maturity Value | A. The rate used by the bank in computing the discount. | |
| 22. Discount Period | B. The endorser must pay the endorsee if the maker dishonors. | |
| 23. Discount Rate | C. Principal plus interest for the full term of the note. | |
| 24. Carrying Amount | D. The unexpired term of the note from the date of discounting. | |
| 25. With Recourse | E. The period from the date of note to maturity date. | |
| 26. Time (Full Term) | F. Principal plus interest earned up to the date of discounting. |
Answer Key:
- C
- D
- A
- F
- B
- E
IV. MULTIPLE CHOICE – COMPUTATIONAL (12 Items)
Instructions: Solve the following problems. Round to the nearest peso.
Use the following scenario for Items 27-32:
On March 1, 2024, ABC Manufacturing received a P1,500,000, 120-day, 10% note from a customer. On April 15, 2024, ABC discounted the note with XYZ Bank at an 18% discount rate without recourse.
27. What is the maturity value of the note?
- A. P1,500,000
- B. P1,550,000
- C. P1,575,000
- D. P1,650,000
Answer: B.
Solution: Principal (P1,500,000) + Interest (P1,500,000 × 10% × 120/360 = P50,000) = P1,550,000.
28. What is the discount period used by the bank?
- A. 45 days
- B. 60 days
- C. 75 days
- D. 120 days
Answer: C.
Solution: Term (120) – Days expired (March 1 to April 15: Exclude March 1, include April 15 = 45 days). 120 – 45 = 75 days.
29. What is the amount of the discount deducted by the bank?
- A. P54,000
- B. P56,250
- C. P58,125
- D. P67,500
Answer: C.
Solution: P1,550,000 × 18% × 75/360 = P58,125.
30. What are the net proceeds from discounting?
- A. P1,491,875
- B. P1,493,750
- C. P1,500,000
- D. P1,516,875
Answer: A.
Solution: P1,550,000 – P58,125 = P1,491,875.
31. What is the accrued interest receivable on the date of discounting (April 15)?
- A. P0
- B. P12,500
- C. P18,750
- D. P50,000
Answer: C.
Solution: P1,500,000 × 10% × 45/360 = P18,750.
32. What is the loss on note discounting?
- A. P6,250
- B. P18,750
- C. P26,875
- D. P50,000
Answer: C.
Solution: Carrying Amt (P1,500,000 + P18,750 = P1,518,750). Net Proceeds (P1,491,875). Loss = P1,518,750 – P1,491,875 = P26,875.
Use the following scenario for Items 33-36:
DEF Retail received a P3,000,000, 9-month, 15% note dated April 1, 2024. On July 1, 2024, DEF discounted the note with recourse at a 20% discount rate.
33. What is the maturity value of the note?
- A. P3,000,000
- B. P3,337,500
- C. P3,450,000
- D. P3,600,000
Answer: B.
Solution: P3,000,000 + (P3,000,000 × 15% × 9/12 = P337,500) = P3,337,500.
34. What is the carrying amount of the note on the date of discounting (July 1)?
- A. P3,000,000
- B. P3,112,500
- C. P3,337,500
- D. P3,450,000
Answer: B.
Solution: P3,000,000 + (P3,000,000 × 15% × 3/12 = P112,500) = P3,112,500.
35. If the transaction is treated as a conditional sale, what is the loss on note receivable discounting?
- A. P0
- B. P22,500
- C. P108,750
- D. P112,500
Answer: C.
Solution: Discount Period = 9 – 3 = 6 months. Discount = P3,337,500 × 20% × 6/12 = P333,750. Net Proceeds = P3,337,500 – P333,750 = P3,003,750. Carrying Amt = P3,112,500. Loss = P3,112,500 – P3,003,750 = P108,750.
36. If the transaction is treated as a secured borrowing, what is the amount of interest expense to be recorded on July 1?
- A. P0
- B. P22,500
- C. P108,750
- D. P333,750
Answer: D.
Solution: Under secured borrowing, the total discount (P333,750) is debited directly to Interest Expense.
37. (New Scenario): GHI Corp discounted a P500,000, 90-day, 12% note without recourse after 30 days at a 15% discount rate. What are the net proceeds?
- A. P501,000
- B. P502,125
- C. P503,750
- D. P515,000
Answer: B.
Solution: MV = 500,000 + (500,000 * 0.12 * 90/360 = 15,000) = 515,000. DP = 90 – 30 = 60 days. Disc = 515,000 * 0.15 * 60/360 = 12,875. Net Proceeds = 515,000 – 12,875 = 502,125.
V. PROBLEM SOLVING & JOURNAL ENTRIES (12 Items)
Instructions: Provide journal entries or written answers. Show your solutions.
Use the following scenario for Items 38-42:
JKL Trading received a P2,000,000, 6-month, 12% note dated May 1, 2024. On June 1, 2024, JKL discounted the note with MNO Bank at a 16% discount rate. Assume the discounting is with recourse and is accounted for as a conditional sale.
38. Compute the net proceeds from the discounting. Provide your solution.
Answer:
- MV: P2,000,000 + (P2,000,000 × 12% × 6/12) = P2,120,000.
- Expired: May 1 to June 1 = 1 month.
- Discount Period: 6 – 1 = 5 months.
- Discount: P2,120,000 × 16% × 5/12 = P141,333.
- Net Proceeds: P2,120,000 – P141,333 = P1,978,667.
39. Prepare the journal entry on the date of discounting (June 1, 2024).
Answer:
- Accrued Interest: P2,000,000 × 12% × 1/12 = P20,000.
- Carrying Amount: P2,020,000.
- Loss: P1,978,667 – P2,020,000 = (P41,333).
- Entry:
- Dr. Cash — P1,978,667
- Dr. Loss on note receivable discounting — P41,333
- Cr. Note Receivable Discounted — P2,000,000
- Cr. Interest Income — P20,000
40. If the maker pays the bank on the maturity date, provide the entry to cancel the contingent liability.
Answer:
- Dr. Note Receivable Discounted — P2,000,000
- Cr. Note Receivable — P2,000,000
41. If the maker dishonors the note on maturity and JKL pays the bank the maturity value of P2,120,000 plus a protest fee of P5,000, provide the journal entry to record JKL’s payment to the bank.
Answer:
- Dr. Accounts Receivable — P2,125,000
- Cr. Cash — P2,125,000
42. After the dishonor in Item 41, what is the entry to cancel the contingent liability?
Answer:
- Dr. Note Receivable Discounted — P2,000,000
- Cr. Note Receivable — P2,000,000
Use the following scenario for Items 43-46:
Use the same data as Items 38-42 (P2,000,000 note, discounted with recourse), but assume JKL accounts for the discounting as a secured borrowing.
43. Prepare the journal entry on the date of discounting (June 1, 2024) under this approach.
Answer:
- Discount: P141,333.
- Interest Income: P20,000.
- Entry:
- Dr. Cash — P1,978,667
- Dr. Interest Expense — P141,333
- Cr. Liability for Note Receivable Discounted — P2,000,000
- Cr. Interest Income — P20,000
44. If the note is paid by the maker to MNO Bank on maturity, provide the entry to derecognize the related accounts.
Answer:
- Dr. Liability for Note Receivable Discounted — P2,000,000
- Cr. Note Receivable — P2,000,000
45. If the maker dishonors and JKL pays the bank P2,125,000 (MV + fees), provide the entry to record the payment to the bank.
Answer:
- Dr. Accounts Receivable — P2,125,000
- Cr. Cash — P2,125,000
46. Following the dishonor in Item 45, provide the entry to derecognize the liability for the note receivable discounted and the note receivable itself.
Answer:
- Dr. Liability for Note Receivable Discounted — P2,000,000
- Cr. Note Receivable — P2,000,000
VI. DIFFICULT / CASE-BASED ANALYSIS (2 Items)
Instructions: Apply critical analysis to the following scenarios.
47. (Error Correction): PQR Company discounted a note with recourse and recorded the transaction as follows:
Dr. Cash, Dr. Loss on discounting, Cr. Note Receivable, Cr. Interest Income.
Is this journal entry correct under the preferred accounting treatment for discounting with recourse? If not, explain the error and provide the correct entry.
Answer:
The entry is INCORRECT.
- Reason: For discounting with recourse under the conditional sale approach (the preferred treatment), the note receivable account should not be credited directly.
- Error: They credited Note Receivable directly.
- Correction: The credit should be made to Note Receivable Discounted. Correct entry: Dr. Cash, Dr. Loss, Cr. Note Receivable Discounted, Cr. Interest Income.
- Justification: Because the transferor loses control, it is a conditional sale. The “Note Receivable Discounted” account is used as a contra-asset deducted from Notes Receivable, with disclosure of the contingent liability.
48. (Complex Analysis – Control Principle): STU Inc. discounted a P5,000,000 note with recourse. The bank immediately sold the note to an external investor without informing STU or asking for permission. The accounting manager argues that since STU still has the “secondary liability,” it should be treated as a Secured Borrowing to avoid reporting a loss.
Applying the principle of ‘loss of control’ over transferred assets, how should this be accounted for, and what is the primary justification to refute the manager’s argument?
Answer:
- Proper Treatment: It must be accounted for as a Conditional Sale with recognition of a contingent liability.
- Refutation: The manager’s argument is flawed because the decisive test is control, not the existence of secondary liability. Upon discounting, the endorser loses control over the note. The transferee (bank) gains complete control and has the practical ability to sell the asset to a third party without attaching any restrictions. Therefore, it is a sale (Conditional Sale), not a secured borrowing, regardless of the manager’s preference to avoid reporting a loss.
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