Here's another note payable question that if you can get you are a better man than I:
On October 1, year 1, Fleur Retailers signed a 4-month, 16% note payable to finance the purchase of holiday merchandise. At that date, there was no direct method of pricing the merchandise, and the note’s market rate of interest was 11%. Fleur recorded the purchase at the note’s face amount. All of the merchandise was sold by December 1, year 1. Fleur’s year 1 financial statements reported interest payable and interest expense on the note for 3 months at 16%. All amounts due on the note were paid February 1, year 2. Fleur’s year 1 cost of goods sold for the holiday merchandise was
A. Overstated by the difference between the note’s face amount and the note’s October 1, year 1 present value.
B. Overstated by the difference between the note’s face amount and the note’s October 1, year 1 present value plus 11% interest for 2 months.
C. Understated by the difference between the note’s face amount and the note’s October 1, year 1 present value.
D. Understated by the difference between the note’s face amount and the note’s October 1, year 1 present value plus 16% interest for 2 months.
Answer: C. (I chose B) Explanation: You Answered Incorrectly.
This answer is incorrect. Per ASC Topic 835, when a note is exchanged for property, goods, or services, the stated interest rate is presumed to be fair unless (1) interest is not stated, (2) the stated rate is unreasonable, or (3) the current cash price of the property, goods, or services is materially different from the market value of the note. In these circumstances, the note and the cost of the property, goods, or services should be recorded at the fair value of the property, goods, or services or the market value of the note, whichever is more clearly determinable. The note signed by Fleur bears an unreasonable interest rate of 16% as compared to the market rate of 11%. However, since the term of the note is less than 1 year (4 months), Fleur’s recording of the inventory purchase and the note payable at the face amount of the note is appropriate accounting treatment per ASC Topic 835.
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