Two questions on FAR (notes payable)
May 16, 2010 at 10:21 pm #157697
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:
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.May 16, 2010 at 11:22 pm #228487
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 = 5561May 17, 2010 at 1:04 am #228488
Wow that question seems so hard…..I don’t know how I passed FAR…
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