Notes receivable; solving for unknowns
• LO7–7
Cypress Oil Company’s December 31, 2018, balance sheet listed $645,000 of notes receivable and $16,000 of interest receivable included in current assets. The following notes make up the notes receivable balance:
Note 1 Dated 8/31/2018, principal of $300,000 and interest at 10% due on 2/28/2019.
Note 2 Dated 6/30/2018, principal of $150,000 and interest due 3/31/2019.
Note 3 $200,000 face value noninterest-bearing note dated 9/30/2018, due 3/31/2019. Note was issued in exchange for merchandise.
The company records
Required:
1. Determine the rate used to discount the noninterest-bearing note.
2. Determine the explicit interest rate on Note 2.
3. What is the amount of interest revenue that appears in the company’s 2018 income statement related to these notes?
(1)
Note receivable:
Note receivable refers to a written promise for the amounts to be received within a stipulated period of time. This written promise is issued by a debtor or borrower to lender or creditor. Notes receivable is an asset of a business.
To determine: The rate of interest of the noninterest-bearing note.
Explanation of Solution
The rate of interest of the noninterest-bearing note is determined as follows:
Compute the amount of remaining discount of note 3:
Face Value of Note 1 | $300,000 |
Face Value of Note 2 | 150,000 |
Face Value of Note 3 | 200,000 |
Total Face value of Notes | $650,000 |
Less: Carrying Value of Notes as Per Balance Sheet | (645,000) |
Remaining Discount on note 3 | $5,000 |
Table (1)
Compute the discount rate for 6 months:
Note 3 is a 6-month noninterest bearing note, with three months remaining. Hence, $5,000 represents the discount for three months. Therefore, the total amount of discount for 6 months is $10,000.
Annualize the discount rate:
Therefore, the discount rate is 10%.
(2)
Explanation of Solution
The accrued interest on note 2 is determined as follows:
Total Accrued interest Receivable | $16,000 |
Less: Interest Accrued on Note 1 | (10,000) (2) |
Accrued Interest on Note 2 | $6,000 |
Table (2)
Working note:
Compute the explicit interest rate of note 2:
Annualize the discount rate:
Therefore, the Interest rate is 8%.
(3)
Explanation of Solution
Interest on Notes Receivable:
The amount of interest on notes receivables is calculated as follows:
Compute the amount of interest for the following notes receivable.
Computation of Interest on Notes receivable | ||||
Note Number | Principal ($) |
Interest Rate (%) | Period (Days/Months | Interest ($) |
1 | 300,000 | 10 | 4 Months (August 31 to December 31) |
10,000 (1) |
2 | 150,000 | 8 | 6 Months (June 30 to December 31) |
6,000 (2) |
3 | 200,000 | 10 | 3 Months (September 30 to December 31) |
5,000 (3) |
Total Interest to be Reported in the Income Statement of 2016 | 21,000 |
Table (3)
Working Notes:
Note 1:
Note 2:
Note 3:
Therefore, the amount of interest revenue to be reported on the income statement of 2018 is $21,000.
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