INTRODUCTION
This mini-lesson includes learning objectives, background information, discussion questions, an activity, and sources of additional information.
OBJECTIVES
Associates will learn:
How loans bookkeeping flows. What documents to require and items to look into prior to booking. How to properly classify loans accordingly. What are the acceptable mode of payments and hierarchy of payments. How interest paid or received is calculated. The difference between interest computation methods. How to calculate penalties/charges. How repaying a loan early saves you money. The life-cycle of a loan with relation to bookkeeping.
Past Due
Restructured
M AT U R I T Y o r PAY O F F
Basis of Booking
Documents Required Prior to Booking
CRAM BIS Transaction Ticket PN with Disclosure Statement
Type of Loans
COMMERCIAL LOANS AGRICULTURAL LOANS INDUSTRIAL LOANS REAL ESTATE LOANS SMALL BUSINESS LOANS CONSUMPTION LOANS AUTO/TRUCK/FLEET) SALARY LOANS TPL/PSPL/PSND CASH LOAN PVAO OTHER LOANS AND DISCOUNTS
Other Loans
Back-to-back/one-to-one/hold-out-on deposit Bills Purchased Financial Assistance Program (FAP - for employees) Letters of Credit domestic/foreign
Type of Loans
AGRICULTURAL LOANS - This represents loans to finance agricultural production and related activities, purchase of farm machinery, equipment and implements work/breeding animals, including but not limited to the establishment and operation of poultry, piggery, livestock and fishery projects.
INDUSTRIAL LOANS - This represents loans to finance the production, processing transformation, handling and/or transportation of industrial products and /or conservation, enlargement, or improvement of productive properties, or the acquisition of machinery or other fixed installation.
COMMERCIAL LOANS - This represents loans to finance the purchase of products or merchandise for resale.
Type of Loans
REAL ESTATE LOANS This represents loans to finance and/or refinance the construction, acquisition, expansion, or improvement or rural/ urban properties. CONSUMPTION LOANS This represents loans for personal and household finance, such as care, household appliances, furniture sans fixtures and/ or to pay taxes, hospital and education bills.
OTHER LOANS DISCOUNTS This account represents loans granted for purposes other than agricultural, commercial, industrial, real estate or consumption.
Type of Loans
ABOVE LOAN ACCOUNTS ARE
DEBITED FOR:
new loans granted any debits than new loans granted should be properly described.
CREDITED FOR:
Classification of loans
CURRENT LOANS AND DISCOUNTS This represents all loans with updated accounts. PAST DUE LOANS AND DISCOUNTS Past Due accounts are being classified as follows: BSP Policy Monthly installment 3 Quarterly payment 1 Semi - Annually 1 Annually 1 ACCOUNT IS DEBITED FOR: a. transfer from current to Past Due ACCOUNT IS CREDITED FOR: transfer from past due to Items in Litigation payments received applied to principal write off (direct off or against valuation reserve) renewals/restructurings
Classification of loans
RESTRUCTURED LOANS
This represents loans that were past due and whose terms and conditions of grant have been modified in accordance with a restructured agreement. The modification of terms may include, but is not limited to an extension of maturity or a change in interest rate, collateral or in the face accumulated charges. Provided, that Accrued Interest and accumulated charges on restructured are credited to Interest Earned not yet collected and treated as a deferred credit pending collection.
Classification of loans
ITEMS IN LITIGATION This represents all loans and advances refereed to the banks lawyer or sheriff for collection/foreclosure court action as the case maybe. The loan or advance shall remain in this account during the tendency of the legal proceedings until it is fully paid or the property is foreclosed. ACCOUNT IS DEBITED FOR: a. transfer from Past due to Items in Litigation ACCOUNT IS CREDITED FOR: a. payments received applied to principal b. writes offs c. renewal/restructurings d. foreclosure of property/collateral mortgaged
Loan Tenor
Term Factor/ Denominator
360 days term of loan is 360 days or less 365 days term of loan is more than 360 days
Term of Loan
Short term - one year or less Medium Term more than 1 year to 5 years Long Term more than 5 years
Mode of Payments
INSTALLMENTS
MONTHLY QUATERLY SEMI-ANNUALLY ANNUALLY
BALLOON DISCOUNTED/INTEREST COLLECTED IN ADVANCE COMBINATION OF 1 & 2 COMBINATION OF 1 & 3 COMBINATION OF 2 & 3
Hierarchy of Payments
ACCOUNTS RECEIVABLE ACCRUED INTEREST RECEIVABLE SERVICE CHARGES PENALTIES INTEREST PRINCIPAL
Laws on Rates
Laws have been passed to minimize some of the confusion consumers face when they borrow or lend money. The Truth in Lending Act, RA 3765, has made it easier for consumers to compare rates when they borrow money. Similarly, the purpose of the Disclosure of Effective Rate of Interest on Savings Deposit, BSP Cir. No. 533, is to assist consumers in comparing the rates on savings accounts offered by depository institutions.
INTEREST CALCULATIONS
Interest represents the price borrowers pay to lenders for credit over specified periods of time. The amount of interest paid depends on a number of factors: the amount lent or borrowed, the length of time involved in the transaction, the stated (or nominal) annual rate of interest, the repayment schedule, and the method used to calculate interest (Interest Rate is quoted on an annual basis unless other term is specified ).
Interest Monthly =
Principal x Interest Rate x Number of Days 360 or 365 Loan Amount 1 - Interest Rate Term Total 12 . Interest Rate 12 Loan Amount 12 _ Interest Rate
Amortization Monthly =
OR
Amortization Monthly =
REPAYMENT: Monthly payment of principal & interest in the amount of P 9,078.00 every 23 rd of the month to start on Dec. 18, 1993. --------------------------------------------------------------------------------------------------------------Date of Total Outstanding Payment Payment Interest Principal Balance ---------------------------------------------------------------------------------------------------------------50,000.00 18-Dec-93 18-Jan-94 18-Feb-94 18-Mar-94 18-Apr-94 18-May-94 9,078.00 9,078.00 1,250.00 1,089.44 7,828.00 7.988.56 42,172.00 34,183.44
9,078.00 883.07 8,194.93 25,988.52 9,078.00 606.40 8,471.60 17,516.91 9,078.00 452.52 8,625.48 8,891.43 9,113.72 222.29 8,891.43 0.00 ---------------------------------------------------------54,503.72 4,503.72 50,000.00 ==================================
INTEREST CALCULATIONS
Straight Line
Interest Total = Loan Amount x Interest Rate x 100 Interest Monthly = Interest Total Term Total Term Total 12
Amortization Monthly = Loan Amount + Interest Total Term Total Principal Monthly = Amortization Monthly Interest Total
REPAYMENT: Interest collected in advance, principal to be paid upon maturity ---------------------------------------------------------------------------------------------Amortization Date Total Payment Unearned Interest Discount Amortization of Interest Principal Payment Outstanding Balance
---------------------------------------------------------------------------------------------30-Nov-93 0.00 31-Dec- 93 0.00 31- Jan- 94 0.00 28-Feb- 94 0.00 31-Mar-94 0.00 30-Apr-94 0.00 18-May-94 50,000.00
7,541.67 0.00 500.00 0.00 1,291.67 0.00 1,291.67 0.00 1,166.67 0.00 1,291.67 0.00 1,250.00 0.00 750.00 50,000.00
INTEREST CALCULATIONS
Rule of 78
Interest Total = Loam Amount x Interest Rate 100
x Term Total
Term Total 12
SYD =
Term Total + 1 2
Interest Monthly =
Amortization Monthly = Loan Amount x Interest Rate /100 Term Total Principal Monthly = Amortization Monthly Interest Monthly
Monthly installment of P10,000.00 every 23rd of the month to start on Dec. 18, 1993. Total Payment 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 10,000.00 120,000.00 Outstanding Balance 100,000.00 93,076.92 85,897.44 78,461.54 70,769.23 62,820.51 54,615.38 46,153.85 37,435.90 28,461.54 19,230.77 9,743.59 -
Interest 3,076.92 2,820.51 2,564.10 2,307.69 2,051.28 1,794.87 1,538.46 1,282.05 1,025.64 769.23 512.82 256.41 20,000.00
Principal 6,923.08 7,179.49 7,435.90 7,692.31 7,948.72 8,205.13 8,461.54 8,717.95 8,974.36 9,230.77 9,487.18 9,743.59 100,000.00
INTEREST CALCULATIONS
Effective Interest
Interest Monthly = Principal x Interest Rate Term Total Amortization Monthly = Loan Amount 1 - Interest Rate Term Total 12 OR . Interest Rate/12 Amortization Monthly = Loan Amount . 12 / Interest Rate - ( 12 x Interest Rate Term Total) Interest Rate 12 Principal Monthly = Amortization Monthly Interest Monthly
EFFECTIVE INTEREST RATE METHOD Diminishing Balance actual no. of days , used in REL Example: AF Rate Term
= = =
0/S Bal. * Rate* no. of days 365 Computed Quarterly: Principal Interest Q1 25,000 2,958.90 100,000 Q2 25,000 2,243.84 75,000 Q2 25,000 1,512.33 50,000 Q3 25,000 756.16 25,000 -------------------7,471.23 Computed Monthly: Principal Interest O/S Balance M1 8,333.33 1,019.18 100,000.00 M2 8,333.33 843.84 91,666.57 M3 8,333.33 743.79 75,000.01 M4 8,333.33 679.45 66,666.68 M5 8,333.33 575.34 58,333.35 M6 8,333.33 509.59 50,000.02 M7 8,333.33 410.96 41,666.69 M8 8,333.33 849.32 83,333.34 M9 8,333.33 339.73 33,333.36 M10 8,333.33 246.58 25,000.03 M11 8,333.33 169.86 16,666.70 M12 8,333.37 82.19 8,333.37 ---------0.00 6,465.77
Int. R 12 24 36 48 120
Penalty Computation
P = UA x PR x T / 30
Where: P UA PR T = = = = Penalty Unpaid Amortization Penalty Rate Time (No. of Days from last payment date or due Date whichever is later)
SIMPLE INTEREST
The various methods used to calculate interest are basically variations of the simple interest calculation method. The basic concept underlying simple interest is that interest is paid only on the original amount borrowed for the length of time the borrower has use of the credit. The amount borrowed is referred to as the principal. In the simple interest calculation, interest is computed only on that portion of the original principal still owed.
Add-On Interest
When the add-on interest method is used, interest is calculated on the full amount of the original principal. The interest amount is immediately added to the original principal, and payments are determined by dividing principal plus interest by the number of payments to be made. When only one payment is involved, this method produces the same effective interest rate as the simple interest method. When two or more payments are to be made, the effective rate of interest is greater than the nominal rate.
More Facts
The interest amount is calculated by applying the nominal rate to the total amount borrowed, but the borrower does not have use of the total amount for the entire time period if two or more payments are made. Using the add-on interest method, interest of P50 (5% of P1,000 for one year) is added to the P1,000 borrowed, giving P1,050 to be repaid; half (or P525) at the end of 6 months and the other half at the end of the year.
More Facts
A one-year, two equal-payment, 5% add-on rate loan is equivalent to a one-year, two equal-payment, 6.631% declining balance loan, consider the following. When the first P525 payment is made, P33.15 in interest is due (6.631% of P1,000 for onehalf year). Deducting the P33.15 from P525 leaves P491.85 to be applied to the outstanding balance of P1,000, leaving the borrower with P508.15 to use during the second half-year. The second P525 payment covers P16.85 in interest (6.631% of P508.15 for one-half year) and the P508.15 balance due.
More Facts
In this particular example, using the add-on interest method means that no matter how many payments are to be made, the interest will always be P50. As the number of payments increases, the borrower has use of less and less credit over the year. For example, if four quarterly payments of P262.50 are made, the borrower has the use of P1,000 during the first quarter, around P750 during the second quarter, around P500 during the third quarter, and around P250 during the fourth and final quarter.
More Facts
.
Therefore, as the number of payments increases, the effective rate of interest also increases. For instance, in the current example, if four quarterly payments are made, the effective rate of interest would be 7.922%; if 12 monthly payments are made, the effective interest rate would be 9.105%. The add-on interest method is sometimes used by finance companies and some banks in determining interest on consumer loans.
Bank Discount
When the bank discount calculation method is used, interest is calculated on the amount to be paid back and the borrower receives the difference between the amount to be paid back and the interest amount. The bank discount method is also referred to as the discount basis.
Example 5
Consider the loan in Example 1 where a 5%, P1,000 loan is to be repaid at the end of one year. If the bank discount method is used, the interest amount of P50 would be deducted from the P1,000, leaving the borrower with P950 to use over the year. At the end of the year, the borrower pays P1,000. The interest amount of P50 is the same as in Example 1.
More Facts
The borrower in Example 1, however, had the use of P1,000 over the year. Thus, the effective rate of interest in Example 5 would be 5.263% (P50 divided by P950) compared to an effective rate of 5% in Example 1. Borrowing that use the bank discount method often have no intermediate payments. For example, the bank discount method is used for Treasury bills sold by the Government and commercial paper issued by businesses. In addition, bonds are sold on a discount basis, i.e., at a price below their face value.
Example 6
Suppose that a P1,000 loan is discounted at 5% and payable in 365 days. This is the situation in Example 5 where, based on a 365-day year, the effective rate of interest was 5.263%. If the bank discount calculation assumes a 360-day year, then the length of time is computed to be 365/360 instead of exactly one year; the interest deducted (the discount) equals P50.69 instead of P50; and the effective annual rate of interest is 5.34%.
COMPOUND INTEREST
When the compound interest calculation is used, interest is calculated on the original principal plus all interest accrued to that point in time. Since interest is paid on interest as well as on the amount borrowed, the effective interest rate is greater than the nominal interest rate. The compound interest rate method is often used by banks and savings institutions in determining interest they pay on savings deposits "loaned" to the institutions by the depositors.
Example 7
Suppose P1,000 is deposited in a bank that pays a 5% nominal annual rate of interest, compounded semiannually (twice a year). At the end of the first half-year, P25 in interest (5 percent of P1,000 for one-half year) is payable. At the end of the year, the interest amount is calculated on the P1,000 plus the P25 in interest already paid, so that the second interest payment is P25.63 (5% of P1,025 for onehalf year). The interest amount payable for the year, then, is P25 plus P25.63, or P50.63. The effective rate of interest is 5.063 percent, which is greater than the nominal 5% rate.
More Facts
The more often interest is compounded within a particular time period, the greater will be the effective rate of interest. In a year, a 5% nominal annual rate of interest compounded four times (quarterly) results in an effective annual rate of 5.0945%; compounded 12 times (monthly), 5.1162%; and compounded 365 times (daily), 5.1267%. The effective rate of interest is disclosed as the Effective Yield (EY).
Rule of 78s
Some loan contracts make provisions for an interest rebate if the loan is prepaid. One method used in determining the amount of the interest rebate is referred to as the "Rule of 78s". Application of the Rule of 78s yields the percentage of the total interest amount that is to be returned to the borrower in the event of prepayment. The percentage figure is arrived at by dividing the sum of the integer numbers (digits) from one to the number of payments remaining by the sum of the digits from one to the total number of payments specified in the original loan contract.
More Facts
The more often interest is compounded within a particular time period, the greater will be the effective rate of interest. In a year, a 5% nominal annual rate of interest compounded four times (quarterly) results in an effective annual rate of 5.0945%; compounded 12 times (monthly), 5.1162%; and compounded 365 times (daily), 5.1267%. The effective rate of interest is disclosed as the Effective Yield (EY).
More Facts
Application of the Rule of 78s results in the borrowers paying somewhat more interest than would have been paid with a comparable declining balance loan. How much more depends on the total number of payments specified in the original loan contract and the effective rate of interest charged. The greater the specified total number of payments and the higher the effective rate of interest charged, the more the amount of interest figured under the Rule of 78s exceeds that under the declining balance method.
More Facts
The difference between the Rule of 78s interest and the declining balance interest also varies depending upon when the prepayment occurs. This difference over the term of the loan tends to increase up to about the 1/3 point of the term and then decrease after this point. For example, with a 12-month term, the difference with prepayment occurring in the second month would be greater than the difference that would occur with prepayment in the first month; the third-month difference would be greater than the second-month difference; etc. After the fifth month, each succeeding month's difference would be less than the previous month's difference.
Example 8
Suppose that there are two P1,000 loans that are to be repaid over 12 months. Interest on the first loan is calculated using a 5% add-on method, which results in equal payments ofP87.50 due at the end of each month (P1,000 plus P50 interest divided by 12 months). The effective annual rate of interest for this loan is 9.105%. Any interest rebate due because of prepayment is to be determined by the Rule of 78s.
Example 8
Interest on the second loan is calculated using a declining balance method where the annual rate of interest is the effective annual rate of interest from the first loan, or 9.105%. Equal payments of P87.50 are also due at the end of each month for the second loan. Suppose that repayment on both loans occurs after one-sixth of the term of the loan has passed, i.e., at the end of the second month, with the regular first month's payment being made for both loans.
Example 8
The interest paid on the first loan will be P14.74, while the interest paid on the second loan will be P14.57, a difference of 17 centavos. If the prepayment occurs at the end of the fourth month (regular payments having been made), interest of P26.92 is paid on the first loan and interest of P26.69 on the second loan, a difference of 23 centavos. If the prepayment occurs later at the end of the ninth month (regular payments having been made), P46.16 in interest is paid on the first loan and P46.07 in interest is paid on the second loan, a difference of but 9 cents.
Mortgage Points
Mortgage lenders will sometimes require the borrower to pay a charge in addition to the interest. This extra charge is calculated as a percentage of the mortgage amount and is referred to as mortgage points. For example, if 2 points are charged on a P100,000 mortgage, then 2 percent of P100,000, or P2,000, must be paid in addition to the stated interest.
More Facts
The borrower, therefore, is paying a higher price than if points were not chargedi.e., the effective rate of interest is increased. In order to determine what the effective rate of interest is when points are charged, it is necessary to deduct the peso amount resulting from the point calculation from the mortgage amount and add it to the interest amount to be paid. The borrower is viewed as having use of the mortgage amount less the point charge amount rather than the entire mortgage amount.
Example 9
Suppose that 2 points are charged on a 20-year, P100,000 mortgage where the rate of interest (declining balance calculation) is 7%. The payments are to be P775.30 per month. Once the borrower pays the P2,000 point charge, there is P98,000 to use. With payments of P775.30 a month over 20 years, the result of the 2-point charge is an effective rate of 7.262%.
Example 9
The longer the time period of the mortgage, the lower will be the effective rate of interest when points are charged because the point charge is spread out over more payments. In the above example, if the mortgage had been for 30 years instead of 20 years, the effective rate of interest would have been 7.201%.
Example 10
Suppose that P1,000 is borrowed at 5% from a bank to be paid back at the end of one year. Suppose, further, that the lending bank requires that 10% of the loan amount be kept on deposit. The borrower, therefore, has the use of only P900 (P1,000 less 10%) on which an interest amount of P50 (5% of P1,000 for one year) is charged. The effective rate of interest is, therefore, 5.556% as opposed to 5% when no compensating balance is required.
SUMMARY
Although not an exhaustive list, the methods of calculating interest described here are some of the more common methods in use. They indicate that the method of interest calculation can substantially affect the amount of interest paid, and that savers and borrowers should be aware not only of nominal interest rates but also of how nominal rates are used in calculating total interest charges. Always look to the EY that is to be disclosed for the actual effective interest rate.
Instructions: Prepare necessary accounting entries & compute for the SCR, unrealized profit percentage. SCR: Agreed Selling Price 120,000.00 Less: down payment 20,000.00 SCR 100,000.00 Unrealized Profit: Agreed Selling Price Less: Book Value Unrealized Profit Profit Percentage: Total Profit / Total Sales Price 36,188.62 / 120,000.00 120,000.00 83,000.00 36,188.62
30.16%
Unrealized Profit 3,015.72 Income from SCR Re: Amount earned relative to payment received 30.16% of
Valuation Reserves
Loan Loss reserve refers to allocations provided for portions of loans granted are deemed uncollectible. Loan loss reserves are determined by external auditors such as Central Bank SGV auditors. Loan loss Reserves shall be set up once every month in accordance with the following classifications: Per CB Policy;
Classified 0% Unclassified 0% Substandard 25% Doubtful 50% Loss 100% Per Banks Policy: Percentage of Loan Portfolio Auto loan 1 % of gross Other Loans 3 % of gross The amount of loan loss reserves shall not be constructed as an equivalent reduction of the borrowers obligation to the bank. Collection efforts on said reserves should still be actively pursued. Borrowers should not be informed on the reserve provided for his account.
DISCUSSION QUESTIONS
1. How does the method of repayment effect the annual percentage rate of interest?
2. Does compounding of interest effect the annual yield of a savings account. Explain. 3. What two federal laws have been passed to minimize some of the confusion consumers face when they borrow or lend money?
ACTIVITY
1. Give associates some other examples to compute interest for different periods, payment terms, and loan amounts. 2. Have associates figure the amount of money they would have in a year if they saved P100.00 a month at an interest rate of 3% and the interest is compounded quarterly. 3. Have associate compute a Rule of 78s refund for a loan of P5,000 with 36 payments of P188.38 paid out after 12 payments.