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Working Capital and Fixed Assets


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#1 bella.dreamer

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Posted 24 August 2013 - 07:38 PM

Becker...FAR. ch.4-Working Capital and Fixed Assets

 

My question is, if there is no  interest, why do we record interest income in year one? Doesn't non-interest bearing note mean there is no interest on this note? I am just really confused.

 

 

On January 2, Year 1, Emme Co. sold equipment with a carrying amount of $480,000 in exchange for a $600,000 non-interest bearing note due January 2, Year 4. There was no established exchange price for the equipment. The prevailing rate of interest for a note of this type at January 2, Year 1, was 10%. The present value of 1 at 10% for three periods is 0.75.

In Emme's Year 1 income statement, what amount should be reported as interest income?

a.

$60,000

b.

$9,000

c.

$45,000

d.

$50,000

 

Explanation

Rule: A non-interest bearing note should be recorded at its present value calculated using the prevailing market interest rate. The market interest rate is then used to calculate interest on the note.

   
 
Face amount of non-interest bearing note $600,000
 
Present value factor at 10% for 3 periods .75
 
Carrying amount at 1-2-Year 1 450,000
 
Interest rate 10%
 
Interest income for Year 1 45,000

Choice "c" is correct. $45,000 interest income for Year 1.



#2 Ken

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Posted 28 September 2013 - 05:25 AM

 

Becker...FAR. ch.4-Working Capital and Fixed Assets

 

My question is, if there is no  interest, why do we record interest income in year one? Doesn't non-interest bearing note mean there is no interest on this note? I am just really confused.

 

While the note is non-interest bearing, it is essentially being purchased at a discount.  Over the life of the note the discount is amoritzed until the face value of $600,000 is attained at maturity.

 

~Ken



#3 Ken

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Posted 28 September 2013 - 05:25 AM

 

Becker...FAR. ch.4-Working Capital and Fixed Assets

 

My question is, if there is no  interest, why do we record interest income in year one? Doesn't non-interest bearing note mean there is no interest on this note? I am just really confused.

 

While the note is non-interest bearing, it is essentially being purchased at a discount.  Over the life of the note the discount is amoritzed until the face value of $600,000 is attained at maturity.

 

~Ken



#4 bella.dreamer

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Posted 04 November 2013 - 02:34 AM

Thank you Ken.