### Two questions on FAR (notes payable)

CPA Exam Forum FAR FAR Review Two questions on FAR (notes payable)

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• #157697

whitesoxfancpa
Participant

It's been a while since I have seen notes payable or receivable or bonds, and I am having a little trouble on a couple topics in F4 in Becker. Here is the first question:

On August 1, Year 1, Vann Corp.'s \$500,000, one year, noninterest-bearing note due July 31, Year 2, was discounted at Homestead Bank at 10.8%. Vann uses the straight-line method of amortizing bond discount. What amount should Vann report for notes payable in its December 31, Year 1 balance sheet?

The answer is \$468,500, as follows:

\$500,000 face amount of note

-\$54,000 discount (\$500,000 x 10.8%)

=\$446,000 proceeds when discounted

+\$22,500 straight-line amortization of discount for Aug-Dec (\$54,000 x 5/12)

= \$468,500 carrying amount at 12/31

That's fine, but can someone show the journal entries from start to finish for this? What is the initial entry? What are the monthly entries? I am really drawing a big fat blank here and without seeing the journal entries to come up with the \$468,500, their math doesn't really help me.

Is this right:

dr Cash \$446,000

dr Discount on notes payable \$54,000

cr Notes payable \$500,000

To discount note payable to bank

dr Interest expense \$4,500

cr Discount on notes payable \$4,500

To record monthly interest

So at December 31, Notes payable is \$500,000, discount is \$31,500, so carrying value is \$468,500. I am really grasping here. Would the note be recorded at \$446,000 or \$500,000? I know for notes receivable they are recorded at PV of future cash flows if they are noninterest bearing.

My second question has me totally lost. I don't get it at all:

Ace Co. sold to King Co. a \$20,000, 8% 5-year note that required five equal annual year-end payments. This notes was discounted to yield a 9% rate to King. The present value factors of an ordinary annuity of \$1 for five periods are as follows:

8% 3.992

9% 3.890

What should be the total interest revenue earned by King on this ntoe?

Answer is \$5,560 computed as follows:

Annual payments \$20,000 / 3.992 = \$5,010

multiplied by 5 equal payments of principal and interest =

total payments of \$25,050

Subtract discounted note \$5,010 x 3.890 = \$(19,490)

= Total interest over 5 years of \$5,560

WHAT?!?! I don't get that at all. Becker never even discussed annuities, PV factors, or how the accounting works for any of this stuff. There's a half page on discounting and a very simple example of discounting a note to a bank. Nothing about these stupid factors or anything. Can somebody logically and rationally explain how this works, PLEASE?

Thanks to all.

#228487

evaianos
Participant

I remember this question. I used Kaplan as review material, but I had same questions with same numbers.

Two steps to consider:

1. Ace has a 20000 note receivable 8% interest, which will be payd back in five payments

The present value of an 8% ordinary anuity for five years is 3.992

Ace will receive back five payments of 5010 each.. ( 20.000/3.992 = 5010/year.)

2. Ace sell the note to King. Thus King will receive 5 payments of 5010/year.

King will not pay 20000 for note because is discounted for 9% (same as bonds)

PV of the note for King is not 20000 because the note was discounted with 9%

PV =Anual payment x Factor

Factor = 3.890 ( ordinary anuity of 9% for 5 years)

PV of the note for King is 3.890×5010= 19489. Thus King will pay 19489 for note

19489 is the amount which King will pay for note, and will receive in exchange 5 payments of 5010

Difference from how much King pay for note and the amount receive in five payments is the interest

25050 – 19489 = 5561

#228488

NJCPA2B
Participant

Wow that question seems so hard…..I don't know how I passed FAR…

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