Why does interest income increase the CV of the note?? I thought the amortization of the discount increased the CV of the note.
On January 1, year 1, Mill Co. exchanged equipment for a $200,000 noninterest-bearing note due on January 1, year 4. The prevailing rate of interest for a note of this type at January 1, year 1, was 10%. The present value of $1 at 10% for three periods is 0.75. What amount of interest revenue should be included in Mill’s year 2 income statement?
$0
$15,000
$16,500
$20,000
This answer is correct. Per ASC Topic 835, when property is exchanged for a note and neither the property nor the note has a known fair market value, interest is imputed using the prevailing rate of interest for a note of similar quality. Therefore, the note should be recorded at its present value of $150,000 ($200,000 × .75) by debiting notes receivable for $200,000 and crediting discount on notes receivable for $50,000 ($200,000 – $150,000). ASC Topic 835 states that the discount should be amortized and recognized as interest revenue over the life of the note using the interest method. Under the interest method, interest revenue/expense equals the carrying value of the note multiplied by the imputed interest rate. For year 1, interest revenue is $15,000 ($150,000 × 10%). Discount on notes receivable is debited for the amount of interest revenue recognized ($15,000) which increases the carrying value of the notes to $165,000. Thus, interest revenue reported in year 2 is $16,500 ($165,000 × 10%).
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