May 1, 2019 at 1:39 pm #2367471DandyDogeParticipant
Can anyone help me with the question below? The solution is “C,” but I'm struggling with the underlying concepts used in the calculations.
Co. A sold to Co. B a $20,000, 8%, 5-year note that required five equal annual year-end payments. This note was discounted to yield a 9% rate to Co. B. 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 Co. B on this note?
//////////May 1, 2019 at 2:19 pm #2367555TNTTNParticipant
I was struggling on this question myself and I, in fact, also posted this question on this forum last week :D.
Check this link out https://www.another71.com/cpa-exam-forum/topic/total-interest-revenu-on-notes-receivable/May 1, 2019 at 3:49 pm #2367882AsjaParticipant
This is just a wierd question with a wierd explanation…I'd practice other questions on annuities and PVs. Something just seems off to me.
I actually came across some errors on Surgent's assessment…they say one thing in the solution but then mark the answer wrong that exactly matches what the solution said…Also, numbers in the solution don't use numbers from the problem in another question, and then another question has a grammatical error that confuses things: “To go from one figure to the other total, simply add or subtract the total accumulated difference so far, the amount in the LIFO reserve account.”, and then another one that says “If the possibility that a company will be required to pay a contingent liability is reasonably possible, the liability is not required to accrue the liability. “….Oh, the liabilty is required to accrue itself…May 5, 2019 at 12:55 pm #2378502DandyDogeParticipant
Thank you both! Glad to know that I’m not the only one confused with this problem.May 6, 2019 at 8:20 am #2380476chandlerParticipant
Okay so keep in mind here the note is being sold in this scenario. The note was written with an 8 % yield. Thus we divide $20,000 by 3.992 to get $5,010. The borrower makes 5 payments of $5,010 or $25,050 total. Co. B is interested in the note, but requires a 9% yield. Since the amount the borrower pays doesn't change (just as it wouldn't if your mortgage, car note, etc was sold to a different lender), Co B will make up this 1% in the purchase price of the note. Requiring a yield of 9%, we want to figure out how much the note as stated is worth. $5,010 * 3.890 = $19,489. Interest revenue over the life of the note is the difference in amount received vs amount fronted. $25,050 ($5,010 * 5 payments) – $19,489 = $5,561 (choice C after rounding).
Maybe this makes sense if you're still looking at it?May 6, 2019 at 5:38 pm #2382156TNTTNParticipant
@Chandler, your scores are very impressive @___@
Quick question though, to calculate the maturity of the note, there are 3 ways rights?
1. Take the annual payments x number of payments; or,
2. Take the FV of the annual payment x FV factor of an ordinary annuity; or,
3. Take the face value x interest rate + face value
Can you explain the following question?
On September 30, World Co. borrowed $1,000,000 on a 9 percent note payable. World paid the first of four quarterly payments of $264,200 when due on December 30. In its December 31 balance sheet, what amount should World report as note payable?
Explanation from Becker
Each payment of $264,200 will consist of both interest and principal, with only the principal reducing the liability owed. The interest portion ($22,500) of the initial payment is equal to $1,000,000 multiplied by the interest rate of 9 percent and divided by 4 because the payment is quarterly.
Payment of $264,200 − Interest of $22,500 = Principal of $241,700. The principal payment of $241,700 will reduce the liability from $1,000,000 to $758,300.
This is how I solved the problem and apparently it was incorrect but I don't get why
Maturity of the note = 264,200 x 4 payments = 1,056,800
Quarterly interest payment = (1,056,800 – 1,000,000) / 4 = 14,200
Quarterly principle payment = 264,200 – 14,200 = 250,000
Ending balance of note payable = face value – principle payment = 1,000,000 – 250,000 = 750,000
Please, tell me which part I am confused???? Thank you.May 6, 2019 at 8:24 pm #2382801KeycatParticipant
@TNTTN My score isn't that great but let me walk you through this problem.
The equal payments for the note mean that the principal and interest would NOT be changing equally each period. This means the principal will not be reduced by 250,000 every quarter like you suggested. Here we need to calculate only one period, which is easier.
$1000,000*.9% / 4 quarters = $22,500 – this is your Interest Expense for the 1st quarter.
264,200 (payment) – 22,500 (interest) = 241,700. This is the principal reduction.
1000,000 – 241700 = 758300. This is the principal payable,
This is not the Time Value of Money (TVM) question like you thought but the SIMPLE INTEREST question. It's important to differentiate between these two.May 7, 2019 at 10:04 am #2384469chandlerParticipant
@Keycat is exactly right. There is no discounting this one. Interest won't be recognized equally throughout the life of the loan since there is a smaller principal balance after each payment. Think about a car or house note, our payment stays the same but in the later term of the loan, a lot more is going to principal vs. interest. On the flip side, the bank/lender/creditor recognizes more interest income in the early term of the note.
As an aside, it would be unusual to discount a note that will be paid back within 12 months.May 31, 2021 at 2:41 pm #3303868rdubsParticipant
@TNTTN My main hang-up on this was not understanding that the four quarterly payments would all be 264,200. If you think of it like that, then you can think of it on an amortization schedule (like a mortgage) which helps explain why the principal payment is less than 250k.
Old thread, but I figured studying cpa takers are in same boat as me and looking at this thread years down the road.
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