[Anonymous]

Hello everyone,

I am completely confused on how notes work. The numerous multiple choices I keep running into always solve the interest expense in a different way than the next problem.

Could anyone provide an explanation on how accounting works for note?

From what I understand:

Notes receivable/payable are recorded at their present value (but can be recorded at face amount if it is from customary trade terms and it is less than a year to maturity)

But then what does the interest rates mean? For example, non-bearing notes still have interest?

Which rate do you use to calculate the interest expense/revenue?

Here are some examples w/ what I have confusion with:

1) On Sept 1, Year 1, a Note payable of 900,000 was issued w/ interest of 12%. Principal is due in 3 annually payments on every Sept 1. The market rate is 11%. What is the accrued interest payable?

The solution calculates it as:

900,000 – 300,000 = 600,000 x (12% x 4/12 months) = 24,000

The confusion I have is when I look at another problem:

2) A sold to K a 20,000, 8%, 5 year note, requiring 5 equal annual end of year payments. The note is discounted to a 9% rate to K.

PV of ordinary annuity of 1 for 5 periods = [8% = 3.992]. [9% = 3.890]

What is the total interest revenue?

Calculation -> 20,000/3.992 = 5010 x 5 payments of principal/interest = 25050 – (5010 x 3.980) = 5560.

Why does the 1st question use the note payable stated rate and not the market rate while question 2 use market rate and stated rate?

What is the accounting rule for notes? I am not understanding the explanation in my textbooks.

Thank you for your help.

[huytuan124]

Hey barronn30,

For the first question, did you miss any fact related to the accrued interest payable in terms of time? Looking at the answer, I think the question should ask: What is the accrued interest payable at December 31, Y2.

FAR: 80 02/01/2014
AUD: 53,80 12/09/2014
BEC: TBD
REG: TBD

Yaeger Home Study + Ninja Audio

[huytuan124]

Hey barronn30,

For the first question, did you miss any fact related to the accrued interest payable in terms of time? Looking at the answer, I think the question should ask: What is the accrued interest payable at December 31, Y2.

FAR: 80 02/01/2014
AUD: 53,80 12/09/2014
BEC: TBD
REG: TBD

Yaeger Home Study + Ninja Audio

[Anonymous]

Hi huytuan124,

Yes, sorry for question 1, it should be accrued interest payable @ December 31, Year 2.

[Anonymous]

Hi huytuan124,

Yes, sorry for question 1, it should be accrued interest payable @ December 31, Year 2.

[huytuan124]

Hi barronn30,

This is how I understand about the difference between these questions

In question 1, the repayments are to be in fixed principal payments + interest on the outstanding balance. For this type of problems, the stated rate is always used instead of the market rate.

However, in question 2, the stated rate is used to calculate the annual repayments which are to be in blended principal and interest payments. Once we have the annual repayments, we have to use the market rate to discount it to PV. It's similar to bond problems where we just use the stated rate to calculate the interest but we always use the market rate to discount it to PV.

FAR: 80 02/01/2014
AUD: 53,80 12/09/2014
BEC: TBD
REG: TBD

Yaeger Home Study + Ninja Audio

[huytuan124]

Hi barronn30,

This is how I understand about the difference between these questions

In question 1, the repayments are to be in fixed principal payments + interest on the outstanding balance. For this type of problems, the stated rate is always used instead of the market rate.

However, in question 2, the stated rate is used to calculate the annual repayments which are to be in blended principal and interest payments. Once we have the annual repayments, we have to use the market rate to discount it to PV. It's similar to bond problems where we just use the stated rate to calculate the interest but we always use the market rate to discount it to PV.

FAR: 80 02/01/2014
AUD: 53,80 12/09/2014
BEC: TBD
REG: TBD

Yaeger Home Study + Ninja Audio

[Whopper Warrior]

The 1st question is asking about a payable (a liability)

The 2nd question is asking about a revenue

For Example

(dr) Interest Expense (pv of bond * .11 * 4/12) 23,000

(dr) premium on Bond 1,000

(cr) Interest payable (600,000 * .12 * 4/12) 24,000

*I did not calculate the pv of bond to calculate the true expense, see below)

The contractual terms (payable and receivable) never fluctuate if a note says 12% you receive 12% However;

2nd problem (assuming january 1, January 1 payments (normal, non-accelerated), and 9% discount is market rate)

Record Issuance

(dr) Cash 19,222

(cr) Note 19,222

1st payment

(dr) Interest Expense (19222 * .09) 1,730

(cr) Note payable 130

(cr) Interest payable (20,000 * .08) 1,600

As we can see the interest payable does not fluctuate, but expense over time will grow larger in proportion to the interest payable. I did not show the declining balance of the note because it is a little more time consuming, and would contradict my earlier statement .

Key Take Away: payable (question 1) does not always equal revenue/expense (question 2)

or

payables / receivables = use stated rate

expense / revenue = use market rate at issuance

ALL 4 parts passed summer 13
Ethics October 13
Experience (waiting)

Becker Only

[Whopper Warrior]

The 1st question is asking about a payable (a liability)

The 2nd question is asking about a revenue

For Example

(dr) Interest Expense (pv of bond * .11 * 4/12) 23,000

(dr) premium on Bond 1,000

(cr) Interest payable (600,000 * .12 * 4/12) 24,000

*I did not calculate the pv of bond to calculate the true expense, see below)

The contractual terms (payable and receivable) never fluctuate if a note says 12% you receive 12% However;

2nd problem (assuming january 1, January 1 payments (normal, non-accelerated), and 9% discount is market rate)

Record Issuance

(dr) Cash 19,222

(cr) Note 19,222

1st payment

(dr) Interest Expense (19222 * .09) 1,730

(cr) Note payable 130

(cr) Interest payable (20,000 * .08) 1,600

As we can see the interest payable does not fluctuate, but expense over time will grow larger in proportion to the interest payable. I did not show the declining balance of the note because it is a little more time consuming, and would contradict my earlier statement .

Key Take Away: payable (question 1) does not always equal revenue/expense (question 2)

or

payables / receivables = use stated rate

expense / revenue = use market rate at issuance

ALL 4 parts passed summer 13
Ethics October 13
Experience (waiting)

Becker Only

[Anonymous]

Oh okay, I see.

Thanks for your helps!

[Anonymous]

Oh okay, I see.

Thanks for your helps!

[Author]

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